I’m both a financial advisor and a computer science professional. I spend most of my day either helping customers solve their software problems or helping people solve their financial problems.
As such, I believe I’m in a unique position to be able to analyze Bitcoin and other cryptocurrencies as investments. I understand the technology and I understand the finance.
With that being said, here’s my short and sweet analysis of Bitcoin:
Investing in Bitcoin is stupid.
No, this isn’t something where I tell you to do your own research, or only invest the amount of money that you can use. I’m not going to say that you’ll probably lose money on Bitcoin but there’s a chance your investment will turn into a lottery ticket. None of those things are true.
So, let me reiterate:
Investing in Bitcoin is stupid.
Blockchain vs. Bitcoin
Before we jump into discussing Bitcoin (and why investing in Bitcoin is stupid) we need to differentiate Bitcoin from the underlying technology, called blockchain. Blockchain IS, in fact, some badass technology. Blockchain lets you guarantee the origin of something. Blockchain has real-world applications. At its core, think of blockchain as a public ledger showing transfers of something.
For example, you could use a blockchain to track the movement of concert tickets. If person A transfers 2 tickets to person B, that transfer could be tracked via blockchain. The blockchain would show that person A no longer has the tickets and person B now has the tickets. If person A tried to also sell those same tickets to person C everybody could see that person A no longer has the tickets and thus the transfer couldn’t happen.
Blockchain is used today for awesome, real-world applications. It’s used for secure online voting in Estonia. It’s being used to track supply chains. It’s being used for financial services and telecommunications.
Blockchain is real. Blockchain is going to (and already is) changing the world.
Blockchain is an idea. Nobody owns blockchain. It’s not controlled by a patent. Anybody can implement a blockchain to track something.
Bitcoin uses blockchain. Bitcoin is just one implementation of a blockchain. Bitcoin is just one of many, many cryptocurrencies available today that use blockchain.
There are lots of cryptocurrencies
Here’s the single largest problem with thinking that there’s any value in Bitcoin – although there are a limited number of Bitcoins that can be created (just under 21 million), there’s no limit to the number of other cryptocurrencies that can be created. In fact, as of Nov, 2017 there are almost 1,400 different cryptocurrencies.
What’s special about Bitcoin?
Nothing.
Seriously – there’s nothing special about Bitcoin.
Think of it this way – let’s say I decide to create a new credit card payment system to compete with Visa, MasterCard, Discover, and American Express. These cards are going to use a new payment network called TheMoneyCommando Network (TMCN). TMCN credit cards will be accepted at the same places that Visa, MasterCard,Discover, and AmEx are accepted..
But here’s the kicker – I decide that I’m only going to issue a total of 21 million credit cards. Ever. That’s right – once those 21 million cards have been issued that’s it.
Now – how much money would you pay me for one of these credit cards? $1? $100? $20,000? Do these credit cards now suddenly have some sort of special value because there will be a limited number of them?
Of course not. A credit card is just a payment mechanism. If you don’t have one of the 21M cards that I issue you could just get a Visa or MasterCard credit card and pay for things with them.
It’s the same thing with Bitcoin. As a vendor, accepting Bitcoin isn’t any easier or harder than accepting Ethereum, Bitcoin Cash, or any of the other cryptocurrencies. If the value in Bitcoin is being able to pay for something with a cryptocurrency, then you could just as easily pay with Ethereum, Bitcoin Cash, or any of the other 1,400 cryptocurrencies.
Although the idea of cryptocurrencies is potentially interesting, the Bitcoin implementation isn’t particularly interesting for any other reason than being first.
The problem with being first is that whoever is first is usually the one who makes all the mistakes and learns everything the hard way.
And in fact, Bitcoin has some HUGE problems that will prevent it from ever being widely used for payments.
Bitcoin isn’t scalable
Bitcoin has a huge inherent flaw in that a significant amount of processing power is needed to complete a transaction. This is what keeps Bitcoin secure – the distributed ledger of transactions is being evaluated by lots of computers around the world simultaneously.
Unfortunately, this distributed processing is also slow. The Bitcoin network has a theoretical maximum of 3.3 to 7 transactions per second. Visa has a maximum of around 47,000 transactions per second.
The use of Bitcoin for transactions is in its infancy, and even now it can take a LONG time to process a Bitcoin transaction. As of the end of December, 2017 the average Bitcoin transaction time is about 50 minutes. Let me be clear what that means – if I go to a grocery store and want to buy my groceries with Bitcoin, it will take, on average, 50 minutes for the transaction to be completed. Until the transaction is confirmed the grocery store has no guarantee that they will, in fact, be given the Bitcoins that I’ve used to pay for my groceries. By comparison, the average Visa transaction takes 5-15 seconds.
So, in practice, what does this mean? Would I need to start the Bitcoin transaction, then wait around for 50 minutes until I’m allowed to take my groceries? There is just no way to use Bitcoin for daily transactions.
And that’s not all. Processing and verifying Bitcoin transactions is expensive (it takes computing power and electricity). As a result, when you submit a Bitcoin transaction to be processed you also offer a processing fee. The transactions with the highest offered processing fees will be processed first. The average transaction fee has skyrocketed recently, and as of December 22, 2017 it was $54.90/transaction. As recently as September, 2017 it was as low as $1.68/transaction.
Now here’s the kicker – let’s say you want to buy something inexpensive using Bitcoin. Maybe you owe a friend $20 and want to pay him back via Bitcoin. Well, you obviously aren’t going to offer to pay a $50 transaction fee for a $20 transfer. Plus, this transfer isn’t time critical – it doesn’t matter if your friend is paid now, 6 hours from now, or tomorrow. As a result, you offer a mere $.50 transaction fee when submitting this transaction.
What’s going to happen?
The transaction will probably never happen. There’s NO GUARANTEE that any Bitcoin transaction will EVER happen. If your transaction doesn’t pop to the top of the stack within 72 hours it’s dropped and you need to resubmit it. And as long as somebody else is offering a higher transaction fee than you are your transaction will never pop to the top of the stack.
If you want to ensure that your transaction will be confirmed you’ll need to offer a high enough transaction fee. This involves a lot of guesswork and might require you to resubmit your transaction multiple times over the course of days or weeks.
The Bitcoin community has proposed a number of changes to Bitcoin to address these problems. Some of the changes involve creating a separate cryptocurrency (Bitcoin Cash, for example). Of course, as we discussed above, there are ALREADY about 1,400 cryptocurrencies available. There’s nothing special about Bitcoin (other than being first) and, in fact, some other cryptocurrencies have superior designs that mean those cryptocurrencies will scale far better than Bitcoin.
Why use a potential future modified Bitcoin when you could just use another crypto currency today that’s more scalable?
Bitcoin has no alternative uses
Some Bitcoin proponents claim that Bitcoin’s real value isn’t as a payment mechanism (for which it isn’t very useful) but rather as a store of value. The claim is that Bitcoin will replace gold for this purpose.
I don’t see it. Gold at least has other, real-world uses. Gold can be worn as jewelry. Gold is an excellent conductor and can be used for a variety of industrial uses. I hate gold as an investment, but at least you could use it for SOMETHING if people decide it no longer has value as a currency or store of value.
Bitcoin doesn’t have any intrinsic value. It can’t be used for anything other than buying and selling stuff, and it’s only useful for that for as long as other people are willing to accept it.
Bitcoin proponents will say that the same issues apply to US dollars or any other “fiat” currency – it’s only useful for as long as other people believe it has value. The difference is that the US government accepts US dollars and has legislated that companies doing business in the US must accept US dollars. If you’re a US government employee you get paid in US dollars. You are required to pay your taxes in US dollars. The US government has created a permanent market that US dollars must be used for.
The fact that the average US postal worker gets $53,000/year for 2,000 hours of work puts a certain value on US dollars. There is nothing that sets a value on Bitcoin beyond a common belief that it is worth something.
It’s not anonymous
Another feature of Bitcoin that’s often touted by its proponents is the idea that Bitcoin transactions are anonymous. That is, I can transfer Bitcoin to you and nobody will know my identity or your identity.
First, this isn’t true.
Bitcoin transactions are better thought of as pseudoanonymous. That is, transactions are linked to a key rather than a person. So when I transfer money to you what I’m really doing is transferring the Bitcoin linked to my key so that it’s now linked to your key.
If nobody knows who owns my key and who owns your key then the transfer is anonymous.
But the reality is that it’s fairly easy to figure out who owns the keys. First, you had to attach Bitcoin to your key somehow, and that means that, at some point in the past, you either exchanged dollars for Bitcoin, or bought something that was shipped to you, or made some other transaction that’s linked to you. And if the government has a search warrant and checks your phone and/or computer and finds the key then they can link your transactions to you.
Of course, there are hoops you can jump through involving prepaid debit cards, burner phones, and other steps to keep your Bitcoins truly anonymous, but you can do the same thing with regular dollars…it’s called money laundering.
The simple act of using Bitcoin as a transfer mechanism won’t actually keep your transaction anonymous.
Second, who cares if Bitcoin is anonymous?
This is one of those solutions in search of a problem. Who needs to make anonymous transfers? Drug dealers, arms dealers, child pornographers, etc. Somehow we’ve all been able to buy sex toys, Cleveland Browns jerseys, and Jersey Girl DVDs without anonymity and life has gone on.
Reasons given by proponents to buy Bitcoin
When proponents talk about Bitcoin they usually mention a few reasons that Bitcoin makes a great investment:
- Bitcoin is the future of the Internet
- There’s a limited supply of Bitcoin
- It’s not controlled by any single entity
Let’s examine each of these reasons:
Bitcoin is the future of the Internet – No. It’s not. The blockchain technology is revolutionary, but Bitcoin is just one implementation of blockchain (and not a particularly good one). Blockchain technology will find numerous new uses (both online and offline). Bitcoin will not.
There’s a limited supply of Bitcoin – the idea here is that scarcity leads to value. You know what else there’s a limited supply of? 2016 Charles Shaw Chardonnay (also known as “Two Buck Chuck”). That doesn’t suddenly make it valuable. And while it might be true that there is a limited supply of Bitcoin, there’s an unlimited supply of cryptocurrencies.
It’s not controlled by any single entity – I actually think there’s a small amount of merit to this argument. For the vast majority of currencies in the world, having a governmental agency (or quasi-governmental agency, as is the case in the US) is a benefit. It provides stability and reliability. However, there are places like Venezuela, Zimbabwe, or North Korea, where governmental control of the currency has lead to hyperinflation and other problems. And counties like China put strict controls on the currency. The benefit of cryptocurrencies to citizens of these countries is that it provides a more stable medium of exchange. However, would anybody use the word stable to describe Bitcoin? Bitcoin has been one of the least stable currencies in the world, which kind of defeats the whole purpose of using it as a stable medium exchange.
Conclusion
Bitcoin is clearly in one of the largest bubbles we’ve seen in the last century or so. Investing in Bitcoin is pure speculation – when you buy Bitcoin you’re only buying it because you hope that somebody else will pay you more money in the future. Unlike an actual investment, there’s no way to calculate the intrinsic value of Bitcoin. There are no future cash flows to discount. Bitcoin doesn’t provide any income.
Since I started writing this article a few days ago the price of Bitcoin has already fallen by about 30%. I expect this is the beginning of a larger crash.
Investing in Bitcoin is stupid.
I expect I’ll get a few responses from Bitcoin proponents telling me why they disagree and what’s wrong with my analysis. I’m happy to read and respond to all input, but I ask one thing – if you think I’m wrong, please tell me why Bitcoin in particular is a good investment. That is, your argument shouldn’t be about the blockchain technology, but about Bitcoin specifically.
Have any of you bought Bitcoin? If so, when and why? Do you still have it?
Very good breakdown. You have credentials to speak of the merits etc. I’m interested in the “blockchain” though. Wondering if there is another currency where transactions are quicker and could hold value.
For the record I too thought it was merely gambling. Any time your hope is that the next guy buys in is troublesome.
There are lots of other cryptocurrencies that are better suited for smaller, faster transactions. Ethereum is a bit better than Bitcoin. Bitcoin Cash is also a bit better. The Lightning Network is a system that will be built on top of Bitcoin that would allow small, fast transactions and scale much better than Bitcoin.
But even if these other solutions solve the scaling problem, there’s still the question of – why should a currency appreciate so much? At the end of the day, it’s just a medium of exchange.
Thank you for this great post on Bitcoin! I’ve thought for some time now that Bitcoin doesn’t seem stable or viable as a currency but I was not aware of all the detailed information you presented.
Thanks – I’m glad you found the analysis useful.
Thank You for this, I feel I have a way better handle on the reasons why i was never going to invest in bitcoin.
I think a lot of people instinctively know that the whole Bitcoin craze is ridiculous but couldn’t put a finger on exactly why. I’m hoping that this article helps gives the details that a lot of people are looking for.
Thanks for the analysis. I don’t have my head fully wrapped around Bitcoin and I suspect most “investors” don’t either. That’s why I’m staying away. I was tempted and went as far as opening an account on Coinbase but did not fund it. Your arguments have pulled me back from the ledge.
I suspect the vast majority of people buying Bitcoin have no idea about the details either. To me, the whole cryptocurrency crazy is eerily reminiscent of the Dot Com craze/bust in the late 90’s.
So is any crypto currency worth investing in or no?
The short answer is no. I don’t see any reason to invest in any crypto currencies.
The long answer is this – in order to invest in something you need to be able to value it, then compare the value and the price. There is no way to value cryptocurrencies. Note that valuing something is different that pricing it. Cryptocurrencies can be easily and constantly priced. Bitcoin is traded 24/7 and, as of 4 pm on January 16, 2017, is priced at $11,496.89 dollars. But how much is it WORTH? Businesses can be valued based on profits, sales, physical assets owned, etc. Land can be valued based on expected rents. There is no way to value cryptocurrencies and thus they are not something you should invest in.
As to whether or not cryptocurrencies are something worth speculating on – I don’t really have an opinion on that. I’m not a speculator (and I don’t recommend that anybody else speculate either). There’s no way of ensuring you make money on speculation. It’s pure gambling, and you never know if the odds are in your favor or not.
I agree with your treatment of Bitcoin overall and the notion that it should not be considered an investment. However, Bitcoin is a great hedge against traditional financial systems. Scalability is a non-issue. It is firmly established with a large user-base and prominent mind-share, hence its true value as a “store of value.” It is the best hedge you can make against unforeseeable “black swan” events. Of course those events are extremely unlikely, and perhaps absurdly apocalyptic. But I believe it is in your best interest to put up to .5% of your net worth into cryptocurrencies as a long-term, low-risk hedge bet.
I’m curious what type of “black swan” even you’re referring to. Could you give me an example of the type of event that could occur and have Bitcoin be a functional currency?
I’m working on a new post with more details of why I strongly believe that Bitcoin is NOT a store of value.
I’m referring to any event where traditional financial systems as we know them will cease to function or be broken beyond repair. I won’t get into possible scenarios as it will only detract from my point. History has proven the folly of relying on the status quo and hindsight is always 20/20.
My next article will be published tomorrow morning at 7 am PT. I’d be very interested in hearing your thoughts after you read my additional analysis on Bitcoin.
Any event where the “traditional financial systems as we know them will cease to function or be broken beyond repair” implies a collapse of civilization to some extent. This means that anything that relies on highly technical and complex technology such as Bitcoin has an extremely high probability of simply ceasing to exist. A better hedge against collapse of the financial system would be hard assets such as gold or real estate or cartons of cigarettes, anything but some esoteric pyramid scheme.
Beautiful analysis! I still expect it to rise greatly at least one or two more times before the inevitable crash and replacement with a more viable currency, but I certainly won’t be riding that wave since I don’t have the money to risk!
The hardest part about watching a bubble is resisting the temptation to join it. Human nature makes it almost impossible to not jump onboard when you hear about other people making 100% profits in a month.
I made 15k on bitcoins in like 3 weeks? But instead of being happy about the easiest money I’ve ever made, I decided that I can do better by investing more money into cryptocurrencies even though I actually share the same view as the author. I don’t see how this thing can ever become mainstream currency.
But the temptation to make another round of quick bucks was so great since the market was having a historic month and the trend of the market was so hyper-bullish that I poured more money into it. I took out my sp500 funds too.
So what happened? I lost all of my gains and another 6k in the following month due to my own bad trading (being too emotional when the market dips) and the overall trend of the market going down. This thing is stupid. I knew it would go down too. I just didn’t realize how fast the market would turn around into bear territory. Stay away!!!! Even if I hadn’t lost 6k in this thing, this was still a total loss for me. I lost sleep over it because overnight (aka Asian market time) things always went crazy, and felt anxious all the time because I put so much money into the most volatile asset class in existence. I kept finding myself checking the exchange like 100 times a day. Was this worth it? I briefly had a dream of retiring early and becoming a bitcoin millionaire. But instead I woke up from my dream with a smaller wallet and tax implications. (Now I incurred short term capital gain tax from taking my sp500 funds out)
So what did I learn? I suck at day trading and bitcoins suck too
Thanks for trading your story. Unfortunately, I think your experience is all too common.
The fear of missing out on “easy money” is really hard to ignore, even if you think the underlying asset is a bad one. Everybody thinks (or maybe just hopes) that they can get in and out of the asset before it crashes. The problem is that once you make money doing something it’s hard to walk away. If you get lucky and catch a speculative investment on an upswing it’s easy to convince yourself the gain was due to skill, not luck, and then you tell yourself you can reproduce your earlier success. Unfortunately, it rarely works that way, as you found out.
What are you doing with your money now?
Some of your reasons might sound very solid but for a long run only, cause as long as Bitcoin shows good profits it’s no way stupid to invest your money in it. Today it’s mostly a speculative kind of thing and people, sad to say, don’t care much about the technologies or anything which lies behind it.
I think that, by definition, investing must be for the long run. You can’t really say you’re “investing” in something if you’re hoping to profit from in in the next few days, weeks, or even months.
That said, anybody who put money into Bitcoin in the last few months has almost certainly lost money, given that Bitcoin is down just over 50% from its peak in December.
Bitcoins have got a lot of advantages to offer and surely have some disadvantages too. In its early stages, Bitcoin was rapidly used in Money Laundering activities as well as Black Market operations, which gave Bitcoin a bad name. But things have started to change lately and Bitcoin is growing at a pretty fast rate now. Despite of all the advantages and disadvantages, Bitcoin is the future of Financial Transactions and it is up to the people and the society about how they decide to use it. We have to understand the power and importance of Digital Currencies and look forward to the future in a positive form.
I disagree.
I think it’s true that cryptocurrencies will be involved in a non-zero number of transactions in the future, but I don’t think Bitcoin is going to be the winner. It’s likely that the most widely used cryptocurrency will be one that doesn’t even exist yet. There are too many disadvantages to the Bitcoin model for it to be widely used in the future.
In these discussions it’s important to differentiate between the technology (cryptocurrency) and a specific implementation (Bitcoin). Cryptocurrencies are here to stay. There’s no real reason to think that Bitcoin will be a (or THE) dominant cryptocurrency.
Thank you for the info. I will probably never use it, as I never used Silk Road (and as these days, I rarely use anything but MJ), but I DO think responsible adults should have safe, convenient access to recreational drugs.
One thought. Bitcoin can be a workaround for whole governments on sanctions lists. Such as Russia. Also with commodities, stocks, bonds, currencies, if you wanted to cash out today, you could do it. If you wanted to cash out 1 million Bitcoin, how would you do it? There would have to be a buyer for sure. You cloud be stuck with your coin, no matter how strong the value, until someone buys it. Such the value is 15/17K$ You would be hard pressed to cash out and then not get taxed on that, when you do. You are required to report gains and losses.
“Frankly I do not understand bitcoin or the blockchain.
Can anyone please direct me to a book or site that is very BASIC on the subject.”