Blockchains, or why Bitcoin is not a Tulip

Skeptically, but with some audacity, I took five thousand dollars out of my savings account and bought a fraction of a cryptocurrency, the popular Bitcoin. I became owner of 0.42625601 bitcoins. After one week going through clearance to complete the transaction at CoinBase, my broker of choice, I looked at the value of a Bitcoin. In one week, I had made a two thousand dollars profit, exactly 40% of my original investment. Surreal. The twenty-first century version of the Ponzi scheme that overwhelmed the Dutch with their Tulips in the sixteenth century. “It is a bubble just waiting to burst”, all bank portfolio managers I spoke to have argued. Had I caught it just before doom? Or is it months or years away and, in spite of so much volatility, I had been a winner that week.

I confess I am clueless. Somewhat more informed after reading some literature on wikipedia and watching TEDx on YouTube, I still do not quite grasp how the logic of cryptocurrencies operates in a speculative environment. The concept of a virtual currency for commercial transactions, close enough to that of a virtual wallet such as PayPal, is sufficiently attainable to me. But the decentralized ledger upon which these cryptocurrencies function – blockchains – and their value as commodities or stocks in an open market environment, where investors seek profit from buying and selling them against real currencies, boggles me. Evidently, these currencies are intended to facilitate transactions using technology, but like there counterparts in the “real” world, they had become the object of speculation. Buy and sell, support and resistance, volatility, bearish and bullish movements. The only question that remains unanswered is what hedges these currencies, if no central authority or private enterprise is available to be held accountable?

Soon thereafter,  I met the other side of cryptocurrencies, the so-called alt-coins. I bought a pack of the booming Ethereum currency, and in a matter of one hour, I had loss close to ten percent of my investment. It really doesn’t matter now as Coinbase will only consider the transaction processed in seven days. Only then the price of ETH will matter. Not sure whether it will climb back up or continue spiraling down. Using basic TA, commonly used to evaluate stocks and options, I discovered that speculation over this cryptocurrency was respecting some very simple stock exchange concepts. Indeed ETH had a strong support and there was no signals of resistance at my entry price; volatility probably the culprit of prices going down. ETH behaved like a fad over a normal stock market asset. Bitcoin’s behavior over the week following my sell for profit also showed traditional downward movement as investors realized gains. Prices still remained higher than expected. A first-time player in the cryptocurrency market, I rushed to realize my Bitcoin gains – perhaps should have waited longer. Possibly, I was off to my first loss with ETH. But then, who knows? Seven days from then, when the transaction was consummated, I might have become a winner again.

The long intervals between purchases or sales is easily explained by an accelerated market, with many more transactions, and exchanges, wallets, and other dealers not being liquid enough to honor these contracts as fast as NASDAQ, Chicago or Wall Street. Never mind. But the concept of the blockchain is complex. There are “miners” that earn bitcoins by solving mathematical problems set in complex SHA-256 hash algorithms in order to host blocks they will put on the blockchain.  The concept of a decentralized ledger is far more unattainable. It took me a while until I started seeing the real world economy behind cryptocurrencies. Companies like AntMiner, who sell high performance processing machines that allow miners to discover numbers that are smaller then the stipulated target number. Working in pools most of the time, and mostly in China, these miners earn 25 bitcoins per block they unveil, plus all fees on the transactions that were placed on that block of the ledger.

Recently, Coinbase finally began to trade Bitcoin Cash (BCH), which is the result of a quarrel among the Bitcoin core and the main players surrounding its economy, who sought more liquid assets. Every block takes on average ten minutes to find its place on the blockchain, and one of the reasons for this “delay” in a world of fast, very fast, computers, was the fact that each block, by fiat when the chain was created, has a fixed size of 1MB. Roger Ver, one of the prominent promoters of BCH, and other people in the business, including CoinBase, wanted to increase the size of each block to 8MB, thus allowing more transactions to be processed in the same amount of time. The Bitcoin core was against this idea, concerned with the cryptocurrency becoming a speculative asset, like a stock, and losing its (already) declining function as a means of exchange over the internet. Previous forks, spinoffs from the original cryptocurrency had already occurred, but they had all been soft forks, as they call them, since the new coins were born from changes in the original code. The new proposal, presented in 2016, then named Bitcoin Classic, represented a hard fork, one that would change the very principals and structure of the currency by “increasing” eightfold the “crypto-monetary base” – each block carried 8MB of information about transactions.

Skeptically, but with some audacity, I have tried to explain what I learned (and got wrong)  about cryptocurrencies. My Ethereum investment panned out well, with a 10% gain over the week while the transaction was pending. I took the profit, and threw the five thousand dollar back into Bitcoin (BTC). Maybe Bitcoin Cash (BCH) will beat me out. So far they are moving practically together.

My relative success with speculating with cryptocurrencies aside, I think I learned two things about it. Actually, one I already knew: when you convert your money into something else, and expect to get more money back, you are speculating. People speculated with mortgages and the Great Recession showed them wrong. When you do make money, many times you do not even know the reasons why. Some people read sound data about their investment, others look at technical analysis demonstrating patterns over time. Both often win, both often lose.

The second thing I learned is that cryptocurrencies are not that different from presumed hard currencies issued by central authorities. People accept dollars at the candy store in the US, but the store will not accept the Algerian dinar. And it has nothing to do with centralized or decentralized ledgers, or even the existence of a guarantor for the transaction in last instance. Online purchases require means of exchange and, for a  while, we have been using bank accounts, credit cards, virtual wallets, airline miles and all sorts of virtual fiduciary means. IBM, Dell, and other big companies of the technology industry have already been using cryptocurrencies. I am sure the day will come when big online retailers such as Amazon.com and eBay will do the same. The only difference might be that, when they decide to do so, they might elect to create their own cryptocurrency. Investment banks yell and stomp that these assets cannot be trusted because they are not under any government regulation. Ironically, those who always cry for less regulation now want more of it. In the meanwhile, behind locked doors, they certainly are speculating about when to enter this market. Before it is too late. After all, they also know Bitcoin is not a tulip.

P.S.- Take a look at the graphs below from two giants of the internet industry. Bubbles?

1f514074ae34c6f003ecc73c11060a7f
Evolution Amazon Stock
1*FGF7YbNOubyUZ8TUkMwAhg
Evolution Microsoft Stock

 

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