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.

Why we don't need Manufacturing

A common assumption among many commentators is that Western countries need a manufacturing base. We have these trade and budget deficits because we don't 'produce' anything tangible. I suppose 200 years ago the same people would have said we need an agricultural base and not this 'phoney' manufacturing industrialisation many nations embarked towards. I disagree with Peter Schiff, Americans don't need manufacturing any more than a country used to employ huge numbers of the population in the agricultural sector. They just need to do things that other nations can't. The service sector is not a drag on the economy, its a path to further prosperity and represents an increase to a nations living standards. 

The purpose of conducting trade on a global scale is take advantage of one another's skills. Argentina and New Zealand are rich in agricultural, so we import their produce as it is more efficient than producing our own. Japan has virtually no natural resources so they turned to electronics and car production and export such goods for the exchange of oil or steel for example. China has an army of low cost workers, impoverished by Mao's Communism, they now look to improve their living standards by using Western expertise in tooling, to produce goods we buy here in the West. America has been a nation of great entrepreneurship, producing some of the leading technologies we use throughout the world. Apple, Microsoft, Google - even Facebook - they all came from an American and throughout the world we all enjoy using their services in some instances for free.

The point is a country does not require manufacturing in order to prosper. American Manufacturing lost out to the first wave of Asian tigers such as Japan, South Korea, Taiwan - not because of 'Government Regulation' as Peter Schiff wrongly associates in the video, but because they could do the work better and cheaper than the Americans. They do it so well, that the US exports their Iron Ore for the South Koreas to use, then South Korea sells it back to America in its end form, and it is still cheaper than doing the work domestically. 

The decline of manufacturing in America is not an isolated case. Throughout the West - Germany, France and Britain, the sector has continually shrunk. That's nothing compared with Hong Kong. It's manufacturing base is 10% of the total economy. Yet Hong Kong is an impressive place. I was impressed by how efficient things worked when I visited. The service was excellent where ever I went and cheap. Hong Kong used to be predominately a manufacturing economy along with the other first wave of Asian Tiger economies - Singapore, Taiwan, Japan, South Korea. Now they have all to some degree expanded into a post industrial economy, into services, yet all these countries generally run trade and budget surpluses. 

The fact that the second wave of Asian tigers have picked up the manufacturing tasks - India, China, Vietnam, Indonesia, Malaysia and so forth shouldn't be something to fear, we should embrace it. We all benefit.

Its easy to use emotive arguments to state that paying Asian workers a dollar a day is immoral, but every society needs to begin somewhere, and history illustrates this. 200-150 years ago our Western ancestors lived in conditions we can't begin to imagine. They lived in fear of constant starvation, literally if the weather was bad that year people would starve, it was that bleak. We moved out of these conditions into the relative utopia today by our ancestors working, innovating and building the capital structure we inherit today. They built the infrastructure, knowledge and tools we use today. And as generations move on, a free market improves this process and each generation should be better off than the previous one (excluding Government stupidity).

Take for example a Chinese person. They are beginning this process our ancestors went through, however they can access a wealth of Western knowledge that will greatly speed up this process. For example the Chinese worker on a Dollar a day now, can feed himself and his family while in comparison under Mao millions starved. As China exports more to pay for technical imports they can build roads, lightening fast railways and improve their capital structure like we did. His Children then have access to more education, tools, computers - objects their father never had. Instead of working at the factory for a Dollar a day, they set up a company that competes with the Western firm. This is what happened in many places like South Korea and Taiwan. Now they have their own companies, HTC (I highly recommend their phones), LG, Samsung, which the Children of the similar hard working parents indirectly helped to create. 

The so called humanitarians are currently protesting against such wage rates, but wait another generation to see how it transforms the ancestors of the people who walked before them. It will be a different picture.

The common mistake is that when a manufacturing job is lost, this will deteriorate our living standards. When we joke that everything is made in China, we also talk about the decline of our living standards to come. The opposite is in fact true. Both sets of nations benefit. 

Think about it. Since China has become the manufacturing hub of the world every good conceivable has come down in price. This increases our purchasing power and living standards. It helps China move out of poverty. We move into work that pays better and exchange this other service based products for such goods.

That's not to say its all a bed of roses. People who previously had these types of jobs in the West are displaced. They need to find alternative work. With the advent of minimum wage rates and generous benefit options it has become increasing hard for such people to find alternative work. They are the forgotten minority, the underclass who become stuck in a vicious cycle, created by the plethora of Government experiments. A free market society would find jobs for such people. The Government hampers this process. 

Peter Schiff has also made comments in the past stating that China should send their push bikes to America (indicating a reverse in living standards for Americans as opposed to China). Peter is also wrong on this front and history again has the answer. The UK used to be like America, the most prosperous country in the world, ahead of the game. As we went into decline others became more prosperous. Now if we take like for like, Britain was once America and America was once the China of the world, do I now have lower living conditions than my great grandfather? Relative to Americans conditions may have declined, but over time both sets of peoples living conditions have risen. Its the same with the rise of Developing countries today. Just as America made huge innovations in technology and exported it to the world to use, Chinas rise will also benefit us all.

With 3 Billion people awakening from the shackles of Socialist or right wing Statist Military dictatorships, all that extra human labour will be a great boon for the global economy, just as it has been already. Historically the native Han Chinese are a very entrepreneurial people. When Mao took control, many such individuals fled - Singapore, Taiwan, Hong Kong, the West - and they all prospered. With Chinas embracement towards freer trade I'm willing to bet there are some smart people there that will have some great ideas, products that people will want, innovations that will make our lives better. Jobs we don't even know exist will be created from such ideas. Just as Americas innovators have made our lives better with their products, it will be the same with developing nations as they rise in prosperity. 

As more of the world becomes educated, more service jobs will be created. More wealth will be created at an ever increasing rate. There's only been hundreds of millions in the West over the past Century who have had free speech and markets. Imagine what another 3 Billion people can bring to the equation as they become increasingly educated and freer. 

To contrast markets to Governments look at the technology sector, the industry I work in. It is probably the most dynamic and fast paced industry continually making our lives easier and more productive. Its also one of the few sectors that has no Government interference at all. No regulation. No government agencies monitoring it. Yet it continually increases the quality of goods with more features. We are told that we need regulation and Governmental agencies to 'protect the consumer' condescending people that they are too stupid to manage their own interests. Yet the technology sector flies in the face of such logic. Bad products and companies go bust quickly, and quality always wins out at as consumers are rational and don't need an agency to co-ordinate such an activity. Contrast that with the financial sector - fractional reserve banking instigated by the Government, Regulation after Regulation, Agencies (Moody, S&P, FSA etc), price fixing of interest rates, currency monopolies - its no coincidence that its in a mess. It will always be in a terrible condition and a drag on society with the Governments involvement, meanwhile the technology counterpart continues to efficiently mobilise societies resources effectively using the free market. If you ever need to argue the merits of a free market then this is the example to choose and will stump anyone opposed to the concept of Capitalism. I don't even think the Socialists would dare contemplating nationalising this sector. On the other hand many financial service jobs we could do without. Just like propping up our Steel, Coal and Car industries of the seventies its with finance this time and its counter-productive.

I'm bullish for the Century to come. Sure we all know many Governments are walking head on towards the next crisis of their own doing - stagflation, trying to erode our capital structure and removing individual liberties. Its going to be rough for at least the next decade, probably slightly longer. Going forward however we have a lot to look forward too. Markets will be embraced further, people will see our Governments misdoings. The Socialist and Communist experiment is dead. Thatcher or Regan didn't kill the left, it was the free market. I don't agree with Peter Schiff, I personally align more with Warren Buffets recent statement where he said our children will have better lives than we did. So long as we allow markets not Governments to enhance our lives this will always be the case. Relative decline, sure, but as with the example of the UK's decline each generation has had a better standard of living because we never truly abandoned the free market despite a few wobbles along the way. Look forward to the future, the innovation revolution is only just beginning.