Chartered Accountants and Professional Business Advisers

Bitcoin - Is it the future?

During our May 2018 meeting we talked about Bitcoin - we looked at the hype surrounding it and talked about how it was shaping the future.

Introduction

James Howell an IT worker from Newport South Wales mined 7500 Bitcoins in 2009 and had them stored on his computer. He spilt a drink on the PC and threw out the hard drive in 2013 and it ended up in a landfill site. It hit the headlines when he realised what he had done and the value of those Bitcoins would have been £4.6 million.

You need a ‘wallet’ which is a place to store the digital currency. This stores your private key, as secret number that gives you access to your Bitcoins. Your private key also allows you to move across marketplaces. You can use any marketplace with your wallet.

There are different kinds of wallets – software ones are apps that connect to your traditional bank account. There are also hardware wallets that look like flashdrives. These are considered more secure because they disconnect from the internet and are less likely to be hacked.

You create a wallet, download the app (if it is a software one), visit the exchange and buy your bitcoin. You can buy less than one Bitcoin (they can divided up to 8 decimal points) to suit your budget.

What is Bitcoin?

It's a crypto currency built on blockchain!

What is Blockchain?

A blockchain is essentially a ledger of transactions which gets larger over time as more transactions are added to it. When a bunch of new transactions are ready to be added, they are called a block. A blockchain is simply a chain of blocks added together to form a ledger.

The ledger itself is not in one place. Full and partial copies of it are spread out across computers across the world. You may have heard the term Distributed Ledger Technology, and this is what this means, as the ledgers are distributed across many locations.

The appeal of blockchain technology is that when you want to add some more transactions to the ledger, all the existing transactions are verified using a complex algorithm.

The theory goes that you can’t cheat the system, as the list is being continuously verified. If one copy of the ledger is altered, then it is disregarded by the system as there are many other correct copies.

It has got big

  • One of the first ‘crypto’ currencies and has to date been the most successful.
  • Its market value has at times been greater than that of Disney or IBM.
  • Bitcoin is bigger than the total currency supply of Denmark!
  • There are currently about 16.7 million Bitcoins in circulation

Why are people interested?

The sheep effect – everyone is talking about it.

  • New technology behind it
  • Wide media coverage can heighten the sense that we’re missing out on something that everyone else is doing,
  • The more we hear about something like bitcoin, the less risky it seems to us. “Simply because it’s more familiar, people are more willing to get involved,”
  • A bit like dreaded pyramid selling then?

Trade

Just look at the price changes:

  • Yesterday 1 bitcoin was worth £6,150
  • This time last year 1 bitcoin was worth £1,829

You can buy Bitcoins from other people using online marketplaces. There are also crypto currency brokers – like Coinbase, Bitstamp, Kraken and Gatehub.

There will only ever be a maximum of 21 million Bitcoins produced – not a feature many other currencies can boast. Some investors compare its finite supply to gold.

To help fund your new business

ICO = "initial coin offering," and refers to the creation and sale of digital tokens. Perhaps ‘Vouchers’ is better.

Buyers either want:

  1. The inherent benefit - it typically grants the holder access to a service
  2. The benefit will be in increasing demand, which will push up the market price of the token, enabling them to be sold for a profit.

For the enterprise:

  1. raise funds without giving up equity,
  2. Getting customers up front (albeit might not be paying full price for the service as they use it)

To hold your wealth securely?

  • blockchain technology, means every transaction is recorded and theoretically immutable.
  • It can be divided, stored and transferred
  • It has a limited supply
  • No devaluation

Use as a currency

  • It is a decentralised currency, not linked to any bank or country. This makes it an appealing way of putting your money somewhere else if you are worried about your own currency.
  • Proper currency? OED defines a currency as ‘A system of money in general use in a particular country’ Many ways yes but not yet the routinely used medium of exchange and nor is the state involved
  • Seems to avoid exchange control
  • Holders are anonymous
  • Others are available!

Because you are a miner

  • Bitcoin mining is done by specialized computers.
  • The role of miners is to secure the network and to process every Bitcoin transaction.
  • Miners achieve this by solving a computational problem which allows them to chain together blocks of transactions (hence Bitcoin’s famous “blockchain”).
  • For this service, miners are rewarded with newly-created Bitcoins and transaction fees.

Are there other crypto currencies?

  • Litecoin (LTC) Litecoin, launched in the year 2011, was among the initial cryptocurrencies following bitcoin and was often referred to as 'silver to Bitcoin's gold.'
  • Ethereum (ETH)
  • Zcash (ZEC)
  • Dash.
  • Ripple (XRP)
  • Monero (XMR)

Is it the future?

Or is it a bubble?

Noreiel Roubini (the economist credited with predicting the 2008 global financial crisis) said in February that it was the ‘mother of all bubbles’ It has some of the hallmarks of a speculative bubble that could burst – like the dotcom boon and the US subprime housing crash.

Stages of a bubble:

  1. Stealth phase. A period of quiet, slow rises - after the invention, but before wider awareness. It ends as the price starts to take off
  2. Awareness phase. More people get involved - often from banks and investment companies - as they see the potential and the price rises faster. At the end of this phase there's a sell off, that catches out pessimists. The price soon recovers
  3. Mania phase. This is the point the media get involved and the public start buying it up. Enthusiasm for the product is followed by greed, which is followed by delusion and culminates in the proud proclamation of a "new model" that allegedly explains the growth
  4. Blow off phase. The price drops. Not a lot, but a bit. Then recovers - although not to its previous level. The true believers say it's nothing to worry about and buy more after the drop. Then prices drop again and reality sets in. People get scared and start selling, then desperate, then they just give up as the price ends up back where it was in the "stealth" phase and fortunes are lost. Eventually there's a recovery to around the level seen in the "awareness" phase followed by normal growth - because most of the time at the start of every bubble is a good idea

Common elements in most bubbles:

  1. The willingness of participants to suspend their disbelief and to steadfastly ignore the increasing clamor of cautionary signals.
  2. The bigger a bubble, the greater the damage it inflicts when it finally bursts.

Is the real question not about bitcoin or even crypto currencies, but about blockchain and how that can change the world?

  • Decentralised Internet. Programmers are currently working on decentralised internet platforms to distribute all the functions of the internet over distributed nodes which will increase the resiliency of the world wide web.
  • Smart Contracts. Smart contracts can be built on top of a ledger and operate as decentralised applications. These programs can run functions which are becoming more sophisticated and may diminish the need for standard legal contracts.
  • Decentralised Markets. One challenge with cryptocurrencies such as Bitcoin is the need to trade on centralised exchanges which can be shut down or hacked. Decentralised markets allow trading without having to trust a third party.
  • Distributed Cloud Storage. Distributed cloud storage avoids the need to place faith in large centralised companies where personal data is vulnerable and pricing may escalate to cover the expanding number of data servers.
  • Decentralised Social Networking Sites. Social networking sites are centralised and are prone to censorship of information. Decentralised social media platforms such as Steemit mitigate this and financially reward the content creators.
  • Encrypted Messaging. Peer to peer messaging can leverage blockchain technology to encrypt messages and store data bits efficiently on many different computers where they can only be accessed with a private key.
  • Proof of Ownership. Items that are purchased could be tracked on the blockchain to demonstrate proof of ownership and to prevent the sale of stolen goods which may eventually help to reduce crime.
  • Authenticated Voting. While digital voting can be susceptible to tampering, blockchain voting technology is verifiable and would allow anybody to audit the blockchain to confirm votes are time stamped and legitimate.
  • Stock exchange. In traditional stockmarket there is typically a delay of 2–3 days for settlement of stocks and bonds. Trading stocks on a blockchain is more cost effective and provides instant settlement.
  • Real Estate. Property titles, transactions and historic value can be built onto the blockchain providing transparency and reducing the time and cost associated with real estate transactions.

Comparison with Amazon

The growth of bitcoin can be compared to the growth of Amazon in the 1990s. That has revolutionised many aspects of our lives. Even by the start of 1997, everyone knew Amazon had a great idea, but no one could fully explain how much its shares should be worth. Amazon has a market value of $723bn (taken from the American version of the Guardian April 2018)

Consequently, investors had to guess at the company’s value, notoriously overestimating the possibilities for a time. Amazon rose more than 6,000% in its first two years after its public offering. 18 years later the peak price from back then looks cheap by comparison today.

Surprisingly, Bitcoin’s performance in its first two years only achieved two-thirds of Amazon’s original run-up. The recent price appreciation of Bitcoin over the last two years and the price of Etherium since its initial coin offering have both made dramatic gains, but have yet to match Amazon’s meteoric rise.

It’s possible that cryptocurrencies are not only here to stay, but potentially a life changing mechanism for all of us. If that’s the case, then Bitcoin offers investors a multi-decade investment opportunity, rising like Amazon's market cap — and a price — that defies logic.

Blockchain - the technology behind it will make massive changes.

The disrupter top of the pile?