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Home > Legal & Financial > Magic Beans?

Magic Beans?

I have been meaning to write about Bitcoin for a few years now, and have been making a valiant attempt to understand it before I do so. After many hours of research I’ve watched everything, and read everything and must confess that I have come up a little short. One thing I can be certain of however, is that many observers more qualified than I are also a little unsure, so here goes……

After the global, crash in 2008 trust in the traditional financial system and its venerable institutions was at an all time low, and pretty much remains so. This mistrust coupled with the exponential growth in what the internet had made possible prompted the elusive, and quite possibly fictional, Satoshi Nakamoto to create the blockchain and cryptocurrency Bitcoin as a way of circumventing the established finance systems. Basically anyone can pay anyone else with Bitcoins across the blockchain without involving a bank or any single central entity. The blockchain is a decentralised system of record keeping where a large global network of interlinked computers keep records of currency balances and transactions, rather than your bank keeping the definitive record of how much money you have. The distributed nature of this network ensures distribution of risk, i.e. removes the risk of your bank going bust and losing your money, and ensures transparency. Got it? Good.

Bitcoins are a little more mysterious however. Firstly they are limited, there will only ever be 21 million of them, to get some you can buy them, via the blockchain, or you can mine for them. Bitcoins are mined by utilising mind thumpingly powerful computers to solve mind thumpingly complex mathematical problems, which are rewarded with new Bitcoins which are then held on the blockchain…hmm, yes I know, it all sounds a bit weird, but let’s not forget that we are all more or less satisfied with a system where at the end of the month your boss moves some numbers into your bank’s computer, so you can go to a machine in the wall and take out some pieces of paper that the man in the bar will swap for some beer. Conceptually at least, Bitcoin and the blockchain is not revolutionary, just the next phase in the evolution of the convoluted way humans choose to record and transfer wealth. What is revolutionary however is just how crazy people have gone over them in the last few years.

Bitcoin, and other cryptocurrencies (there are loads) are notionally called currencies, and you can buy and sell things with them, but so far at least, they should properly be referred to as an asset, a store of value, rather than a medium for transferring it. Most assets that people hold are a little more tangible, you might hold traditional cash, perhaps some shares in a company mining coal or making aeroplanes, or a government bond. Assets that while they might have the occasional hiccup, at least people can have a level of understanding of exactly what it is they own and therefore have at least some way of calculating their worth. The mania around Bitcoin is almost unprecedented. In 2009 you could buy one Bitcoin for $0.05, at the start of 2017 one would set you back about $950.00, last month the price hit nearly $15,000.00 and climbing fast. At that valuation it was worth more than Boeing or New Zealand, and greater than the combined value of banking giants Goldman Sachs and UBS. All this from an entity that has no ownership, no shareholders, no CEO or headquarters, and manufactures nothing, it has the look of the gold rush about it. Last month things got even more surreal. Two derivatives exchanges in Chicago began supporting trade in Bitcoin futures, so you can now bet on the future value of something that few people really understand with a valuation based on unhinged speculative investment, it’s all sounding eerily reminiscent of those now infamous derivatives that heralded the crash of 2008 that kicked off the crypto currencies in the first place.

There have of course been asset bubbles for as long as people have traded, the first famous example is of the price of tulips in the 17th Century (Google it, it’s a great story), where a single flower bulb was traded for the equivalent of 18 years salary, this has been mentioned in the same breath as Bitcoin over recent weeks as a cautionary tale. More recently you may recall the dotcom bubbles of the late 90’s and early 00’s where again investors blinded by a future they didn’t fully understand piled money into anything with a website regardless of the business model that lay behind it and watched dumbfounded as values tumbled.

The blockchain and its currencies are almost certain to have a place in our future in one form or another, but whether Bitcoin turns out to be a Myspace or a Facebook, an Altavista or a Google only the time will tell, and a few people are going to get very rich, or very poor in the process.

Phill McCoffers