Barnett and Company

Personal Finance: What is this Bitcoin thing?

By now, most everyone with electric power has at least heard of Bitcoin. Some readers may have taken the plunge and invested (and are either ecstatic or despondent depending upon when they bought). And like many shiny new objects, the hype and hyperbole are fevered. So just what is it and what’s the big deal?

Quite simply, Bitcoin (and its many brethren) are virtual money. They exist only as electrons zipping around thousands of computers throughout the world, and depend upon a complex data storage and encryption protocol known as “blockchain.” They are not issued by any government and were essentially conjured in 2008 by a reclusive (and possibly pseudonymous) computer scientist named Satoshi Nakamoto. His intent was to create a decentralized cash exchange system that did not rely on banks or any central authority. Because it depends upon sophisticated computer encryption for its existence, Bitcoin and its ilk are known as “cryptocurrencies”.

Today, there are roughly 2,300 different cryptocurrencies besides Bitcoin (Etherium, XRP and Litecoin being the largest). The list of offerings reads like a reflection upon a bad acid trip: TRON, Tezos, Grin, Tierion, Bunny Token, Veltor; most very small and few likely to survive. Proponents of this technology (and they are fanatical) fully expect cryptocurrencies to replace sovereign money like the U.S. dollar and the euro in due course. Perhaps. But the prospect of abandoning Swiss francs in favor of Cheesecoins seems unlikely any time soon.

Cryptocurrencies are traded on digital exchanges like Coinbase, Bittrex and Kraken (continuing our acid trip), where investors can buy Bitcoins et al. with real currencies, and store the electronic loot in a “digital wallet” to use for purchases or to transfer to other parties, like a virtual Western Union. Some mainstream merchants are accepting Bitcoin as a form of payment including Microsoft, Overstock.com and AT&T. Richard Branson will let you pay for a future trip to space on Virgin Galactic with them.

Despite the rhapsodic enthusiasm, it is doubtful that traditional currencies are on the way out just yet. There are now many electronic methods for buying a pizza or paying the rent without changing into cyber clams first.

One essential function of money is as a store of value. Implicit in this formulation is the assumption that the currency is relatively stable. Bitcoin may be many things, but stable it is not. Its value has ranged from $250 per “coin” in 2015, to $17,000 in 2017 and back to $3,800 at the beginning of this year. If you bought one in January, it would be worth $10,000 today. For now, cryptocurrencies are highly speculative electronic casinos and not in any way suitable for saving or routine transactions.

The supply of Bitcoin is limited by the complex algorithms by which they are created (don’t ask). This is analogous to the U.S. gold standard, wherein the money supply was limited by the discovery and mining of gold and therefore outside the control of central banks. History has consistently proven that commodity-linked money often turns economic recessions into depressions.

Finally, the anonymity of cryptos make them a money launderer’s dream. Governments are wrestling with the growing challenge of policing illicit activity without the ability to follow the money. This anonymity is exactly one of the attractions for some of the more anarchic fans who tend to distrust governments.

The real, legitimate appeal is the underlying technology, the blockchain. This innovation promises to revolutionize and securitize aspects of life from financial services to medical records to voting. And it’s coming fast.

Christopher A. Hopkins, CFA
Vice President and Portfolio Manager
Barnett & Company

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