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Never invest in a business you do not understand.
This is a column I’ve tried to avoid because it takes time to understand blockchain technology and how immutable, distributed ledgers will eventually revolutionize commerce. Thanks to some basic cryptography classes from my Army days, I even understand how bitcoin is mined and its integrity is maintained.
Bitcoin does not, however, void the basic laws of economics. Strings of computer code will never become a true currency capable of holding value over time. And just as gravity holds us to the Earth, economics will bring bitcoin’s perceived value crashing down.
Proponents of cryptocurrencies love the fact that no government regulates or controls them. Bitcoin exist only as pieces of computer code stored on a ledger shared by thousands of servers around the world, and it only has value because those users say it does, not because a government guarantees it.
Unlike the dollar, which the central bank can print or take off the market as economic needs require, bitcoin are released at a standard rate per week. New bitcoin are awarded to the owners of the servers that maintain the ledger and perform difficult mathematical calculations, a process known as bitcoin mining. The bitcoin supply is determined by an algorithm.
Anyone in the world, meanwhile, can spend real money to buy bitcoin and anonymously trade it with other owners of bitcoin without anyone tracing it. That’s why bitcoin is popular among criminals, particularly extortionists, embezzlers and money launderers.
The value of bitcoin is determined solely by how much the owner of a bitcoin wants for it and how much a buyer is willing to pay. Prices vary widely based on which exchange is used, and most transactions take place in China, South Korea and Japan.
Some say bitcoin is the new gold, but you can’t bury bitcoin in the backyard, and there are no industrial uses for it. Bitcoin only exists on the shared ledger, where hackers can and have stolen it.
Others have compared bitcoin to the tulip bulb bubble of 1636. But that’s unfair, because you can store bulbs in the backyard, and if they lose financial value, you can still enjoy the flowers in the spring.
However, if a government, such as China, bans bitcoin, or everyone wakes up tomorrow and decides it is a fad, then it becomes worthless instantly.
There is no rational explanation for why bitcoin traded at 6 cents in September 2010, reached $ 3,025 in June and hit $ 17,513 at noon last Tuesday, according to Coindesk.com. That’s a lot for something that exists solely as a mathematical equation in a market that no single person or institution controls or regulates.
Traders also need to explain this: Why bitcoin and not one of the 800 other crypto-currencies that use the same technology? Why not litecoin, etherium, crypterium, titcoin or potcoin?
Human greed and ignorance are the only explanations.
Remember the late 1990s, when everyone said dot-coms could only go up? That led to the telecoms-led recession of 2001.
No sane person can look at bitcoin’s 1,600 per cent price increase this year and deny that speculators have taken over something that was supposed to be an alternative to official currencies for international transactions. The only way 15 per cent daily price gyrations happen is when investors are making huge bets and cashing in huge profits.
The federal Commodity Futures Trading Commission regulates these markets, and Cboe, and beginning this week the Chicago Mercantile Exchange, must adhere to government oversight. Bitcoin exchanges that settle the futures contracts will also need to conform.
Widespread bitcoin adoption would also introduce unmitigated risk into global currency markets because you have to buy bitcoin with an existing currency. If central banks see bitcoin as a risk to the global economy, they will regulate it, shut it down or replace it.
South Korea’s prime minister, a deputy governor of China’s central bank, and regulatory officials from Japan and the U.S. have all warned investors and markets about cryptocurrencies, signaling their anxiety over what happens if the bubble gets any bigger. Of course, if they step in, the bubble will definitely burst.