Friday, 29 November 2013

Crypto Currency Part 2

Its Gold 2.0
Winklevoss Twins

It's been a year that I last posted about the crypto currency known as Bitcoin, since then its been on quite a bull run. From a price of around $10 per coin to now over a $1000, more interest from the public has caused the price to continue to rise. China has taken particular interest and the recent senate hearings in the US has praised its innovation and how it could be of great use. Even Richard Branson has begun accepting it should you wish to fly into space. It's recent price rise is nothing new, its part of Bitcoins short history. The recent run has definitely overshot its medium to long term trend but it will still make a good investment moving forward. So how valuable could Bitcoin become? The quick answer, very valuable indeed. I've broken this post into sections to detail some important topics on the subject.

Its a ponzi scheme

This charge is raised all the time by many. People look at the price rise from nothing to hundreds and conclude that this must be a bubble. Now Bitcoin may collapse tomorrow with a flaw that no one has seen yet. However Bitcoin is not a bubble. Its a revolutionary concept, one that will more than justify its current price over the long term. 

Before refuting the bubble hypothesis lets first accept, for arguments sake, that it is a bubble. Now when bubbles happen the masses never call it a bubble, its the financial acute amongst us that call bubbles. Its the public, not investors, who are calling it a bubble. When was the last bubble you know of that was identified by the media and the public? The Dot Com Boom? Housing? The complete opposite was said for these genuine bubbles at the time. Your mum who has as much economic knowledge as John Prescott was calling it "a new era", "prices will rise forever", "whats a bubble?". Until your mum is saying that, it ain't a bubble. My mum still doesn't know what a Bitcoin is.

Some look at people in finance such as Peter Schiff who say it is a bubble and conclude it must be, however Peter Schiff doesn't like Bitcoin because you don't need to go to his brokerage firm to buy some. He doesn't get a cut. Its puts finance at the hands of everyone, even people in the third world. A last thing about bubbles - they always go on longer then people think, usually years after the first person called a bubble. 

We can use history as a guide. When the internet was created there was one very large problem. How are people going to find the information they want? There was no central registration system where web sites had to register with (thank god the Government didn't know about it - they probably would have tried to do this!), so search engines appeared. Now at the time in the nineties no one knew if there was a business model behind such a thing, allowing people to search the internet for free. It was also a vastly complex computer science problem to solve and some of the industries best minds set to work to solve such problems. Google was around then, but it was tiny. The big guys were DEC with AltaVista, Yahoo, AOL etc. Of course you would have made money if you bought their stocks but the real winner would have been what has become the market leader since, Google. It came from nothing and made Multi-Billionaires. Even after the Dot Com bust its value has still increased. Why? Because the internet wasn't a bubble, it really was a revolutionary concept. Its price went too fast in the short and medium term but the dollar worth of the Internet is far greater than 10 years ago.

So if we compare search engines altavista was once a leader who used centralised large computers to process the internet which was beaten out by Google's superior infrastruture which used lots of cheap computers all seemingly working as one. Their innovations such GFS and MapReduce in what would be published and create the field BigData. So will Bitcoin be the leading crypto currency in ten years? Probably not.

Alternatives to Bitcoin

There are many alternatives already appearing to challenge Bitcoin. As Bitcoins protocol and source is open anyone can now create their own currency. The value that bitcoin has over the others is its eco-system - the services, the entrepreneurs  the user-base  however that doesn't mean it will be a leader forever. Here are some "flaws" that other currencies could take advantage from.

  • Relative long transaction times (10 minutes for verification)
  • Hard limit of 21 million
  • Proof of Work (the mining you will hear of)
  • Ever expanding Block Chain public ledger
There are others, in fact there will be flaws we haven't even thought of. Remember this was the first crypto currency that was truly distributed and solved the double spend attacks that has now revolutionised finance and payments forever. But it will carry this baggage.

Transaction Times
Currently it takes around 10 minutes to confirm a transaction for it to be added to a Block in the public ledger. This is phenomenally quick compared to traditional finance, however you wouldn't want to pay for a quick cup of coffee and have to wait 10 minutes to get confirmation. Other alternatives such as Litecoin have slashed this to 2.5 minutes. Others further, Primecoin down to a minute. There is no doubt there will be further innovation in this area. Who knows what currency will come about that offers quicker times?

Hard limit of 21 million
Now the creator did this so it would be a deflationary currency and the currency does go down to around 8 decimal places, however I think he didn't account for the fact that people loose their coins and once they are gone, they are gone. If Bitcoin did make it Global then along with coins getting lost I don't think the currency will be divisible enough. A fork of the protocol would be difficult.

Proof of Work
Known as mining to many, however the coin rewards will eventually cease to be. The belief is that people will want to pay transaction fees in order to secure the network. I'm not too sure on this one. Miners are incentivised to secure the network because the current lottery system gives them some form of guaranteed payout. In the future this however may not be the case and the network could become susceptible to a 51% attack.

Ever expanding Block Chain
By all accounts the block chain is currently Gigabytes in size, however this will go to Terrabytes and beyond at an ever increasing rate. They don't have a solution to this yet. If people want to have a local wallet they are not going to want a public ledger of that size.

The alternatives of interest I have seen so far:
  • LiteCoin - 2.5 minute transaction times
  • PeerCoin - Proof of Stake and Proof of Work
  • PrimeCoin - 1 minute transaction time
The last two are of interest. They were created by a developer called Sunny King, probably an alias like Bitcoins creator Satoshi Nakamoto, he is by all accounts another genius and a very motivated developer. PeerCoin in principle can eventually work under a proof of stake to secure its network. The has a number of advantages over Bitcoins Proof of work:
  • It requires less energy - People don't have to run dedicated hardware to mine. They just hold their coins.
  • A 51% attack is less likely - In order to do this someone would have to obtain half the currency. However this would cost a lot as market forces would drive the price higher (assuming over 50% of the current holders wish to sell). Then if the attacker wished to compromise the network their holding would decrease as their 51% stake would devalue. Compare this to Bitcoin; an attacker would have to get the hardware but they could re-sell this hardware, thus the costs of the attack are not as great. For a large currency the hardware costs less relative to half a global currency.
PeerCoin has been earmarked as a future savings account. It has a 2 Billion coin limit (although in practice it will never get that high) and fixed transaction costs, thus making it expensive to pay for small items, but with the proof of stake could be potentially more secure.

PrimeCoin is by the same developer, this would be used for regular payments, as the transaction times are very fast and the fees are lower.

Ultimately I can see people will hold multiple crypto currencies and will not be limited to one. They will still hold their national currencies, their credit cards and even cash. 

How High?

So how high could Bitcoins price go? They are already at $1,000 a coin, that was easy, I mean you still can't buy anything with them! What about $10,000 or $100,000 or even $1,000,000 per coin. That is not as high as you may think. Bitcoin has no barriers at all, it only requires an internet connection. More people have access to the internet then access to a bank account. The global population is 6 billion. 3 Billion people can't use conventional banking. The Global economy is worth Trillions. Bitcoin has a limit of 21 million coins. Warren Buffet can still comfortably buy every bitcoin in current existence  Thats why $1,000 is nothing. When Bitcoin becomes usable a price of $1,000,000 could become a reality. 

In the short term I'm convinced Bitcoins price will crash. It will probably go back down in the $100-$200 range killing all the recent interest and people feeling vindicated that they called the bubble (when did the masses ever call a bubble?). In between the spikes Bitcoins price has been remarkably stable for a new currency, but like all new things it has these wild swings as more interest and potential is unleashed.

Of course Bitcoin could crash tomorrow. Its experimental. Its cutting edge. No one knows for sure whats going to happen. All I know is its been one hell of a ride so far and its only going to get more interesting. Got Gold? You bet, thats got bags of history. Got Gold 2.0? It could be the one asset you buy that could change your life. Even if you don't buy, it will change all our lives for the better.

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