That Bitcoin, and its ilk, are experiencing a “Netscape Moment” should serve as a cautionary note on many levels to investors. The practical similarities between the web browser Netscape Navigator as an investment, and Bitcoin as an investment are obvious. Netscape made using the World Wide Web practical for the average computer user. Bitcoin is the first application to make blockchain technology accessible for the average computer user. But with technology stocks, it does not usually payoff to be the first person at the party. So, it should come as no surprise if the “Bitcoin Moment” ends badly.
How the web was like blockchain
The World Wide Web was for much of its early years an intriguing idea without any widespread application beyond the military and academia. It took the creation of a universal access tool, initially Netscape Navigator, to make a sprawling, but difficult to access network something everyone could find a use for. Navigator made it possible for anyone to get aboard what is now called the Internet and communicate (email), connect (Facebook), share information (Google) and offer a platform for commerce (Amazon).
Long story short: Navigator launched in late 1994 with an IPO in late 1995 being one of the most successful ever, up to that time. Additionally, Netscape set what many investors would still consider a bad precedent by also being unprofitable when it went public. Long story short, by 1997 Microsoft’s Internet Explorer was the hand’s down winner in the so-called “browser wars” and Netscape never recovered. In 1998 AOL acquired Netscape. Its fate was the canary in the dot.com coal mine.
For our conversation today, let’s sum up the browser analogy this way. When Netscape opened up access to the Internet, few people were thinking about e-commerce or online bullying. The evolution of the Internet browser was trial-and-error in its purest form. Where blockchain ultimately ends up taking us remains unknown and we are still very early on a long journey.
So, what’s up with the futures exchanges?
What grabbed my attention was the announcement of the two Chicago options exchanges now offering futures contracts on Bitcoin. And there is some irony to the fact the contracts can only be bought and sold using dollars – you can’t actually short your Bitcoin collection, just gamble on its price variations. Yet the speed with which the options exchanges embraced the blockchain left me baffled until reading about a couple of projects MIT is working on in collaboration with two very different consortiums. Herein might be the next phase of blockchain implementation with the potential for serious impact on the global financial system.
One powerful application of blockchain is to create a viable currency to be shared among fringe economies. Think of Eastern bloc countries like Bulgaria, Romania, Albania and Hungary creating a shared currency for use on par with the Euro and Ruble. Or of the many marginal countries in central Africa, also challenged by failed economies. In theory, the open nature of blockchain ledgers would make it possible for everyone – both inside and outside of the currency network – to see when a government is, for lack of a better term, cheating the system and exclude just their blocks from commercial use. Here, the transparency of an open ledger creates value and stability, making allies of adversaries.
Another interesting idea is using blockchain to create a cryptocurrency tied to physical commodities like gold, oil, sugar or wheat. This would eliminate the necessity of having to price commodities in dollars, Euros or rubles, reducing the amount of friction and cost in transactions by moving toward a true barter system. For international trade, this would be a huge shift in the balance of power away from the major currencies. To my mind, this scenario provides a perfect explanation for the rush to embrace blockchain by the futures exchanges.
Blockchains and Blockheads
First, while not qualified to discuss the intricacies of the blockchain, I do have a firm grasp of the concept. Bitcoin will be discussed here only as an example of how blockchain technology works. However, blockchain is the engine for all of the recent wave of “initial coin offerings” (ICO) and Bitcoin competitors like Ethereum and Ripple. Though ICOs have now been banned in China, the government of Argentina has proposed an ICO to replace its own now worthless currency. And for the truly gullible, many shady companies are using ICOs to raise capital, bypassing any credible oversight and making fraud easy.
Which brings us to a second point which is counter-intuitive. Bitcoins are money. In the final analysis, the goal is to have a currency accepted worldwide that is not regulated and cannot, in theory, be manipulated by governments or central banks. Unlike dollars, Euros, renminbi and yen, there is, in theory, a permanent, public record of every time a Bitcoin is used in a financial transaction. Which can also make its widespread use for illegal and nefarious purposes hard to understand. And if the use of cryptocurrencies for transactions actually takes hold, imagine how big a blockchain could become to manage.
Now, let me make my bias clear. While appreciating the argument of why we should not trust “fiat money” like dollars, Euros and yuan, cryptocurrencies take this concept to an extreme. Because the dollar is no longer backed by a physical commodity – gold – doesn’t mean there are no assets of the United States government to support a value for our currency. Just one example, the value of 52-million acres of national parks on the auction block is worth a lot more than whatever is in Fort Knox. Most cryptocurrencies are backed by no one and nothing. This is what makes the blockchain work of MIT and the futures exchanges so interesting.
Perhaps the most accessible conversations about cryptocurrencies and their potential future are described in the January 2018 issue of Scientific American.
Gaming the system
The metal found in a dime may not be worth ten cents when melted down, and the paper a Euro is printed on has no value, but both are widely accepted and easily used for commercial transactions. To spend a Bitcoin you have to have both electricity and Internet access while still relying on an exchange (like the currency kiosk in international airports) to facilitate a transaction. The word “coin” couldn’t be more incongruous as a descriptor in this instance. That cryptocurrencies are “mined” is an even more egregious misuse of a word to give gravitas to the idea of digital money having some physicality.
So, it works like this. Massive amounts of computing power are necessary to solve cryptographic number puzzles (yeah, it’s a computer game). The prize for solving one of these number puzzles is a unique, one-of-a-kind “block” that is subsequently entered into a massive digital database. Each block becomes a Bitcoin, or whatever the blockchain owner decides – like a share of “stock” in a bogus enterprise. Bitcoins are created and verified solely by raw number crunching. In Siberia (a hotbed of Bitcoin “mining”) you can now buy a home heated by the computers being used to “generate currency”.
The digital ledgers (or databases) belonging to each cryptocurrency are open for anyone with the right equipment to access. When it comes time to make a purchase, or perhaps trade cryptocurrency for old-fashioned dollars, computers work to verify the legitimacy of the block(s) and add this latest transaction to the block’s history without any centralized authority being involved. In theory, blockchains cannot be altered and will exist forever. Massive fraud has recently seen hundreds of millions of dollars-worth of cryptocurrencies disappear making this “fact” suspect as a reality. Assuming your counterparty in a transaction will accept Bitcoin for payment you can pay for a car or illegal narcotics. The average transaction fee of around $30 making buying things like a latte or sandwich impractical. And some vendors won’t accept Bitcoins whose history includes the creation of, or use by, entities known for their involvement in criminal activities.
Finally, if you decide to join the cryptocurrency crowd, all it takes is opening an account online (cash up front) with a Bitcoin exchange and you are given a “digital wallet” for making transactions – pretty much the same way as using a mobile phone payment system. Best guess is that around $8-billion was spent using credit cards to open Bitcoin accounts in the 4th quarter of 2017. It just couldn’t be easier to set yourself up to be fleeced.
What could possibly go wrong with cryptocurrencies?
Quite a lot, actually.
On a practical note, recently one of the Bitcoin exchanges (Bitstamp) saw the value of one Bitcoin go from $17,000 to $19,000 to $15,000 in less than half an hour. One explanation attributed the wild swings to traders in Asia, where it has been suggested that on any given day up to 20% of all Bitcoin transactions are taking place in South Korea. A coin exchange went bankrupt a few of weeks ago in South Korea after being hacked. There is no legal recourse for account holders, they are simply wiped out. And tell me again how you’d feel about paying $30 to use a Bitcoin ATM to get some fast cash?
Perhaps most scary, and telling, is this quote, “A survey of over 200 board-level British executives recently found that while over half of businesses sampled are planning Blockchain initiatives, more than 40% of non-IT/data senior executives admit to not fully understanding Blockchain technology.” In other words, we have no idea what this is, but we want some. APNIC: Don’t Get Caught Up in Blockchain Hype