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Saturday, December 09, 2017

Bitcoin's Wild Ride

What is money worth? When it was tangible and made from rare metals such as gold or silver, people felt it had an intrinsic value. Yet you can't eat gold. Silver won't keep the rain off you or keep you warm. These precious metals are very useful in electronics, though we toss tons and tons of old cellphones and TVs into landfills without extracting the metal. 

When money started being printed on paper it was originally backed by precious metals held by governments: the pound sterling was a pound of sterling silver in 775 AD. But over time the intrinsic value of paper money essentially became zero -- though you can burn it to keep yourself warm.

Most of our money is no longer tangible: our paychecks are not even checks anymore -- they're automatically deposited to our bank accounts. We use automatic transfers to pay our mortgages, utility bills, property taxes. We use credit cards or our cellphones to buy food, clothing and all the other necessities of life.

What makes gold and silver valuable? Scarcity and greed. They are also durable: precious metals won't freeze or burn in a fire. They tend to hold their value over time.

The latest currency fad is bitcoin. In recent days the value of bitcoin has fluctuated wildly:
In a hectic day on Thursday, bitcoin leapt from below $16,000 to $19,500 in less than an hour on the U.S.-based GDAX, one of the biggest exchanges globally, while it was still changing hands at about $15,900 on the Luxembourg-based Bitstamp. Some market watchers attributed the lurch higher to the coming launch of bitcoin futures on major exchanges.

Having then climbed to $16,666 on Bitstamp at around 0200 GMT on Friday, it tumbled to $13,482 by around 1200 GMT - a slide of more than 19 percent. It was last down 8.2 percent at $15,232.32 on BitStamp.

Bitcoin is a "cryptocurrency" that has no intrinsic value. It is not a metal, or precious gemstone, or even paper. It exists only as a string of binary digits, typically stored on a flash drive. If you lose that flash drive, or encrypt it and forget the key, or the flash drive becomes corrupt (which could happen in 10 years), or someone steals it, the bitcoin that was on it is gone forever.
Bitcoin is scarce because it is "mined" by running a computer algorithm that cranks out a series of numbers. The raw materials used are CPU seconds and electricity, and it takes a lot of electricity. The electricity used to mine bitcoin could power all of Ireland. That's about 1% of all the power used by the internet.

Bitcoin scarcity is further increased by the virtue that there is a finite number of bitcoin that can ever be created. In the minds of crazed and greedy investors, this makes bitcoin perfect: it's like using Picasso or da Vinci paintings as a unit of currency. Gold is less valuable because we can always mine more -- and when we run out here, we can find more in the solar system. Somewhere out there in the asteroid belt is a rock with more gold in it than mankind has mined in all of history.

Up this point bitcoin has been the province of hackers and criminals -- heroin dealers, forgers, prostitutes, hit men -- who lurk on the dark net. But almost every other day there's another story about someone being hacked and losing millions of dollars worth of bitcoin, or another bitcoin currency exchange going bankrupt.

Bitcoin has become so volatile that many companies are no longer accepting it as a form of payment: it's value is fluctuating crazily and the processing fees for converting it into real money make it useless.

Bitcoin supporters love it because they think it's anonymous, it uses a fancy distributed blockchain that eschews centralized control, and doesn't have the backing of any government.

But the anonymity is illusory: to use bitcoin to buy anything, you have to convert it to real money or find a seller who will accept it in exchange for a physical object or service that will eventually find its way to you. These transactions are all ultimately trackable. So, unless you're using bitcoin to hire anonymous hitmen to murder people you don't know, the anonymity is overrated.

And as for governments: the biggest bitcoin mines are in China, where they use cheap computers and electricity generated by dirty coal-fired power plants. These companies use computers that have custom designed ASICs (computer chips) that implement the mining algorithm in hardware.

American companies, pushed by investors to minimize production costs and increase profits, have for years sold out this country by sending jobs and manufacturing to China. Now these investors are starting to sink billions of real dollars into bitcoin, a completely fake currency that no government backs but which China has a de facto monopoly on.

The prices of gold, silver and diamonds have fluctuated over the years. But at the end of the day, they have some use in the real world. Gold, silver and diamonds can be used in jewelry, electronics, drill bits and saws.

Bitcoin has no intrinsic value: the CPU seconds and electricity used to mine it are gone forever, though the CO2 from burning Chinese coal for that electricity will warm the earth for centuries.

When bitcoin crashes the bits on all those flash drives will be completely and utterly worthless. Though I suppose you can use the flash drive to save all your cat videos.

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