Bitcoin/Cryptocurrencies – Digital Gold or Tulip Bulb?

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What is a Cryptocurrency ?

A cryptocurrency is a digital or virtual currency that uses cryptography for security. The first cryptocurrency to capture the public imagination was Bitcoin, which was launched in 2009 by an individual or group known under the pseudonym Satoshi Nakamoto. As of 21-Oct-2017, there are about 16.6 million bitcoins in circulation with a total market value of $101 billion. It’s price has risen by about 16 times in the past 3 years. Bitcoin’s success has spawned a number of competing cryptocurrencies (there are about 1200 Cryptocurrencies as listed on coinmarketcap.com as on 21-Oct-2017.

Technology behind Cryptocurrencies:

The Blockchain is the technology behind bitcoin and other cryptocurrencies.

The Bitcoin blockchain allows transfer of bitcoin from person to person without any intermediary. Think of the Bitcoin blockchain as a giant Excel spreadsheet that shows the complete transaction history and location of every bitcoin. Every few minutes the spreadsheet gets updated as an additional block of new transactions is added to the spreadsheet. Everyone can have their own copy of the spreadsheet. It’s completely transparent.

Hence, Blockchain is a fully transparent system of financial transactions, in which every single transaction ever made can be tracked by anyone. It’s decentralized, meaning you don’t need a central institution, like a bank, to confirm anything.

How to buy and sell Cryptocurrencies:

The Cryptocurrencies can be purchased and sold through cryptocurrency exchanges and stored in Cryptocurrency Wallets.

A Cryptocurrency Wallet comprises:

  1. A Public Key: It’s a string of numbers and letters. Think of it like an account number.
  2. A Private Key: This is effectively the password to access the wallet, and needs to be kept safe. If you lose it, it means you lose access to your cryptocurrencies. There’s no centralised entity that can recover your password for you – it’s not like if you forget your bank password and your bank sends you instructions on how to reset it.

Major Bitcoin Exchanges in India include Zebpay, Unocoin, Coinsecure. However, these exchanges allow you to trade only in Bitcoin. If you want to trade in multiple cryptocurrencies, Koinex.in appears to be a good option (it allows you to trade in 5 major cryptocurrencies).

Risks

The biggest risk arises due to novelty of the concept of digital currencies. It might eventually turn out to be a fad (like the tulip bulbs, dot coms, and countless other such fads that arise every 20 years or so) and the values might go down to zero.

Another major risk arises out of the fact that these are virtual and do not have a central repository, a digital cryptocurrency balance can be wiped out by a computer crash if a backup copy of the holdings does not exist. Cryptocurrencies are not immune to the threat of hacking. In Bitcoin’s short history, it has been subject to over 40 thefts, including a few that exceeded $1 million in value. One way to minimize the threat of theft is to store your cryptocurrencies in a offline wallet (in a specialized hardware that resembles a pen drive and costs Rs 7,000 – 10,000 in India).

Disclosure: I own bitcoins worth about 0.2% of my Net Worth. Keenly watching this space for exploring the possibility of putting some more money in Bitcoin and other cryptocurrencies such as Ether, Ripple, Litecoin, etc, totalling around 0.5% of my Net Worth. Please note that at this stage, there can be no ‘investment’ in cryptocurrencies, only ‘speculation’, as the basic tenets used for investment valuation do not exist.

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Biggest problem I see is by their design. e.g. price of bitcoin is rocketing because stock is very limited and it is becoming more and more difficult to mine new bitcoins. As price keep rising, people will have tendency to hoarde the available bitcoins as that is a natural human behaviour. We hoarde what is scarce, so that will create liquidity issues, which will make it difficult for such currencies from becoming mainstream replacing other forms of currencies. Answer to that is to create liquidity by making additional bitcoins available and make it more accessible/transactable, but that’s easier said than done in absence of any regulator. (This includes answering questions like ‘who will regulate’, ‘how regulator will be selected’, ‘how much to dilute’, ‘when to dilute’ etc.). Also that will dilute value of existing bitcoins and will prove problematic for existing bitcoin holders. Also appointing regulator will take away the main benefits of bitcoin i.e. ‘no government control and surveying’.

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Biggest problem I see is by their design. e.g. price of bitcoin is rocketing because stock is very limited and it is becoming more and more difficult to mine new bitcoin

The other side of the argument is that the design makes it appropriate as a store of value. Inflation is good for currency but not for store of value (gold etc.). Bitcoin tries to be both and I agree it will probably find acceptance as a store of a value than as a currency. I believe governments recognize it as a commodity, apart from Japan (which recognizes it as a currency).

As price keep rising, people will have tendency to hoarde the available bitcoins as that is a natural human behaviour.

That is already happening. Also a lot of early bitcoins were lost, or the holders might be deceased - putting them out of circulation forever. Since the total supply is capped at 21 million this creates an upward pressure on the price.

Answer to that is to create liquidity by making additional bitcoins available and make it more accessible/transactable, but that’s easier said than done in absence of any regulator.

The code is the law in blockchain economies. There is a logic to their inflation schedule and governments cannot create new Bitcoins outside of the methods coded to do that. The one possibility is what is known as a 51% attack, when the majority of the miners want to create new Bitcoins like governments print money. I see this as a feature rather than a bug. A good store of value like gold should not be easily counterfeited like currency.

Also appointing regulator will take away the main benefits of bitcoin i.e. ‘no government control and surveying’.

Regulation is already afoot. Bitcoin is not untraceable (the IRS uses tool of a company called chainanalysis to track movement of Bitcoins). Neither is it completely anonymous. I think governments are leaning towards compromise and acceptance. Even countries with Capital Controls like Russia, India have leaned towards regulation than a ban. This is good for the price as it pushes away the grey and black market away from Bitcoins to alternate coins like Monero and legitimizes its adoption, paving the way for banks and hedge funds to become market makers.

Disclosure: I bought Bitcoin at $1800 and have about 5% of my net worth in cryptocurrencies. They are high risk, high return investments and what I’ve learned is the huge profits come with stress and anxiety that traditional value investors may not be cut out for.

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How do you account for the profits/loss from a taxation point of view? Is it business income, other income or capital gains?

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Based on the interpretation of several tax experts, it is treated as capital gains / losses (long term if held for more than 3 yrs and short term if held for less than that). However, if you trade in cryptocurrencies very extensively and frequently, it might get treated as a business income / loss.

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Recent sharp price rise in Bitcoin may be due to proposed split in Bitcoin network 25 Oct and in another one in Nov. On 25 Oct Split in network will create another Bitcoin network called Bitcoin Gold BTG and holders of Bitcoin will automatically get Bitcoin Gold free. It will be intresting to watch price after above events.

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Out of total 21million Bitcoin , 16.6 million Bitcoin in circulation out of which Satoshi Nakamoto’s hold estimated 1,000,000 bitcoins another 144336 Bitcoin were seized by US govt which will further reduced total available Bitcoin in circulation and effectively push prices further.

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I have been following Cryptos since 2012.

In my opinion the recent surge is caused simply by a large number of people speculating it to grow in value. Its just a big bubble. I have invested and profited from cryptos as I had invested in them in 2016 and made money from the recent surge but honestly I was just gambling.

Here are the reasons I will not invest in cryptos for long term:

  1. There is no proper data about where cryptos are actually being used. Nobody properly knows if most people are simply trading between each other or actually buying and selling goods and services.One thing I do know is that it is being used in DarkWeb ecommerce sites to trade illegal goods which is obviously extremely volatile. A few big sites like namecheap and fiverr are also accepting it.

  2. Its not easy to use. I know for sure my grandparents or even my parents will not properly understand how to make payments with it.

  3. For all that fad about it being “decentralized”, if you actually follow these cryptos properly you will notice that they are technically being controlled by miners. If the blockchain needs to fixed or patched for vulnerabilities, the coders will need the approval of a majority of miners as the miners need to shift to a new fixed version of the blockchain for the fix to be applied.

Ethereum was using DAO to make smart contracts for payments. DAO had a vulnerability which enabled hackers to steal a lot of Ethereum. Then the coders took up a vote to remove the DAO and fix the blockchain and undo the hack. Majority of the miners voted YES to fix and move to the new blockchain. The ones that voted NO, kept the old blockchain alive and renamed it Ethereum Classic as they rightly stated that it does not hold the principle of “decentralized” if the stolen ethereum can be returned like that.
Similar situations can occur for all the other cryptos including Bitcoins.
Even bitcoin runs on miners. If mining stops for some reason the currency will collapse as transactions cannot be made.

Ban will not happen because a ban is impossible to enforce properly. No government can really stop people from using cryptos unless people stop mining cryptos so their best bet is to regulate it.

I would honestly prefer to keep my currency controlled by a central bank of a stable government like India, UK or US. In the worst case precious metals are always the better option as its a physical medium for preservation of wealth.

Just my 2 cents.

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Well after QE there is a bubble in everything. Why single out Bitcoin?

The Bitcoin network is the first de-centralized cross-border network in the history of the world which is fully open source and auditable. It maintains an irreversible, immutable transaction ledger verified on the network. The blockchain just happens to be perfect technology for facilitating payments while maintaining pseudo-anonymity. You cannot fake or print a Bitcoin. You can’t bypass the inflation schedule that is hardcoded into the network. This is Math as a Central Bank. The next step in evolution of money and perhaps how globalized human societies should be organized as opposed to the nation state and other 18th century governance.

This makes the Idea of a trustless peer-to-peer, de-centralized global payment ledger invaluable in itself. But this is not just an idea. It has been implemented. More money has been put into Unicorns with far from certain returns and yet no one call it gambling.

Speaking of its business applications. What is the value of the global remittance industry? Is government overreach not a concern in these times of Aadhar, de-monetization and NSA?
Although the space is rife with speculation Bitcoin captures a very real demand

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More than 99% of the whole Cryptocurrency space is definitely a bubble and is going to zero eventually. The question is if a handful will survive and if yes, then in what form.

The Bitcoin is hardly being used for actual legal transactions. In fact it is not suitable for use for day to day transactions due to issues such as slow speed, etc. Hence, even the most staunch supporters of Bitcoin agree that it would be used as a store of value (the digital equivalent of Gold) and not for day to day transactions.

As for illegal transactions, the governments will eventually regulate it and impose enough restrictions to make the illegal use very difficult.

That’s the reason why a lot of people became negative on Ethereum and it has been falling over the past few months (it’s almost 30% below it high reached in mid-june). In fact Bitcoin is the only major Cryptocurrency that has been making new highs every few days. All other major cryptocurrencies have been falling over the past few months (Ripple needs to more than double just to reach its all time high made in May and Litecoin is 40% below its all time highs reached in Sep). It seems people are realizing that Bitcoin is the only cryptocurrency that has a chance of survival, if at all. All others are simply hot air.

Most of my own money is in equity market and a small percentage is in physical Gold (as an insurance).

Speculations such as Cryptocurrencies form less than 1% of my Net Worth. If these things go down to zero, you lose less than 1% of your Net Worth. If some of these become really big, you can potentially make 100 times or even more (of the less than 1% allocation).

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There are basic difference between Bitcoin, Ethereum and Ripple

Bitcoin is like a payment network, it has first mover advantage and greater acceptability. Bitcoin netwok also divied into multiple this year and created Biotcoin Cash, Bitcoin Gold (praposed on 25 Oct) and Bitcoin 2X in Nov 2017.

Ethereum’s smart contracts is a promising technology and can be applied to a particular set of computer applications like logistic, settlements, gambling, real estate. Ethereum has programming capability which also makes also makes it venerable to programming bugs. With ethereum ERC20 token standard various tokes can be created on ethereum platform. Ethereum has well defined development plans. Metropolis is a current version is third phase in it 4 phase development plan. Ethereum is also moving from Proof of Work (PoW) consensus algorithm to Proof Of Stake (PoS) which will save electricity and require miners to hold ethereum. Ethereum Enterprise Alliance is group of companies which will help ethereum technlogoy to show clear roadmap for enterprise features and requirements.

Ripple is not decentralized, ripple is primarily targeting remittance and interbank settlements, cross boarder payments. Bank and financial companies are using ripple network but not binded to use ripple tokens. Ripple are pre mined and 100 billion tokens are available in quantity, most of the token controlled by a parent company. Recently company had locked up ripple in escrow smart contract and will be release in controlled manner yearly. Ripple in very small quantity will be destroyed with each transaction. Ripple looks like a long term bet.

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An interesting read. They even went on to compare with gold, since bitcoin/ethereum is considered as stored value just like gold.

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Very Interesting !

Julian Assange Says Wikileaks Has Made a 50,000% Return on Bitcoin

Wikileaks has seen an amazing return on investments in bitcoin, founder Julian Assange says, and he is “thanking” the U.S. government for forcing the controversial organization to get into bitcoin in the first place.

In a Tweet on Saturday, Assange said the group’s investment in the cryptocurrency has seen a return greater than 50,000% since 2010. Wikileaks began investing in bitcoin back then because global payment processors like Visa, Mastercard, and Paypal were under pressure by the U.S. government to block the ability of the group to take payments.

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At what rate etherum classic given.? Against dao anyone knows …

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I am surprised to see that no one is bothered to discuss that there is no underlying for Crypto currencies. It is surely a bubble going to burst someday IMHO. ValuePickr was perceived by me as community of investors who seek value and there is none in these currencies.

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I too believe that it is a bubble going to burst. If there is no underlying business making the money, then it’s all make believe. With the total number of coins limited, it’s a perfect pyramid scheme. You are safe as long as someone else would buy from you down the line. If not, all hell will break loose. Like the way it is raising it will not take much time for the currency to loose 90% of its value in a matter of days. On top, there are a number of copy cat coins these days. So it is not even unique.

We can discuss the risks involved in crypto currencies in this forum as well so that we take informed decisions with collective wisdom.

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At price of $6,000/bitcon and 21 million bitcon the total value of all the bitcoins is $126 billion.

When the bubble busts, does this kind of money has any potential to upset the market?

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Take a step back and evaluate the underlying in the rupee.
Is it backed by gold? Government tender? 80% of currency value in circulation can be “de-monetized” overnight by a new regime. Legal tender is only as true as the government. Venezuela, Zimbabwe are use-cases for governments turning rogue and abusing monetary policy. Bitcoin is very popular in those regions.

What is Bitcoin’s backing? This is harder to quantify.

  1. Value of the Protocol:
    When the internet was created, the backbone was HTTP and TCP protocols. Companies were built on top of these protocols that issued stock. The creators and enablers of the protocol did not get rewarded. The value of the protocol in blockchains is tokenized. The value of the money transmission, remittance businesses that would run on top of the blockchain is captured by the token. What purpose does the token serve in the blockchain architecture itself? In a de-centralized system the “miners” who enable and verify the transactions need to have a fee and block reward. Without Bitcoin the system would collapse in the absence of incentives or a centralized administration.
  2. You can’t fake a Bitcoin: Bitcoins are entries in a ledger that everyone has a copy of. So if you try to “create” some, everyone else just looks at their copy of the ledger and sees that you don’t actually have any coins. How easily can currency notes be faked?
  3. Network to Transaction Value Ratio: Given Bitcoin captures the value of the underlying network itself, the value of the Network / TV is used analogous to a P/E ratio for stocks
    Bitcoin NVT Ratio : Woobull Charts

Here is some good reading:

Here is a comparison:
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Another interesting news item:

Bitcoin can now buy you citizenship of one of the world’s happiest countries

Vanuatu, a South Pacific archipelago of some 80 islands, will now let outsiders use the volatile cryptocurrency to apply for so-called investment citizenship. Fork over the equivalent of about $280,000, and your family of up to four can receive passports from what the New Economics Foundation, a UK-based think tank, calls the fourth-happiest country in the world.

Should you really want a place to escape, Vanuatu’s abundance of islands and relatively small population (about 290,000) mean that your own private island may be within reach. The least expensive one currently on the market, according to real estate website Private Islands Online, is Lenur, priced at about $645,000. For that you get 84 acres including three sandy beaches, a handful of sleeping bungalows, and an open-plan kitchen. Most of the property is covered in coconut, fruit, and nut trees.

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By concealing identities, cryptocurrencies fuel cybercrime

When hackers hold their victims’ data for ransom, as happened in the WannaCry and NotPetya ransomware attacks that spread across the globe in mid-2017, a key to the criminals’ success is getting away with the money. That often means they use cryptocurrencies like bitcoin to collect payment, hoping to remain hidden behind a digital mask.

All cryptocurrency systems work in roughly the same way. Groups of computers receive transaction information directly from users who want to send each other money. The computers order and permanently record these transactions in a public ledger so that anyone can read them.

The first major cryptocurrency system, bitcoin, allows users to conceal their real names. But users’ transaction amounts and bitcoin account numbers (known as “addresses”) are visible to anyone – even people who don’t use bitcoin but know how to read the transaction ledger.