Tuesday, February 25, 2014

Hope and Fear, Greed, Responsibility and Bitcoin

People are strange, businesses are lead by people and stability emerges gradually.

This is what crosses my mind reading about the latest Mt. Gox Bitcoin incident at Coindesk and triggered putting down my thoughts on "What is Bitcoin?" below.

Disclaimer: I own bitcoin but have no money at Mt. Gox. Invest your time and money at your own risk.

Interesting to see how other bitcoin related businesses and people, blogs, journalists and all jump to tweeting and commenting on the subject. I am still trying to make sense of what happened at Mt. Gox and how it connects with Transaction Malleability. Whatever details will surface, if Mt. Gox managed to loose your coins and money you need to remember the risk you took was your personal responsibility.

Don't take me wrong, risk is tough and realized risk hurts. Managing risk and coping with whatever risks manifest in your life is at the very core of investing, starting and running businesses and of life itself.
Hope makes us go for a chance, fear helps to keep us away from risks too big and greed kicks in, when things play out smoothly or even better than expected.
But success is dangerous ground. If you allow greed to change how much risk you are willing to take, the blow you take will be harder than you like and expect, when success gives in to trouble. Success and failiure, every life has it both. Everyone successful in the long run knows and plans for this.

So what about bitcoin, money and the money industry?

1) Everybody investing in bitcoin knows that this is quite risky from whatever perspective you choose to look at it:

  • Fragile Usecase: Bitcoin based consumption of goods is a tiny fraction of the transactions generated. Trading bitcoin vs various fiat-currencies ($, €, ...) is what happens most.
  • Volatile Pricing: Bitcoin price went from a single cent to a thousand dollars in a snap but not without massive drawbacks along the way. 
  • Young Technology: The technical bitcoin ecosystem is young, so is the business and service ecosystem building on top of that.
  • Attractive Target: Bitcoin is a worthy target for digital theft, IT-Security is bad on average, so storing bitcoin safely is not easy.  
  • Political Impact: Bitcoin money might be very disruptive to the system of fiat-currencies which has a lot of quite potent stakeholders.
2) Everybody investing at all should know that investing is inherently risky:
  • Leaving your money alone decreases your money's worth.
  • When first taking money to your bank you signed a contract that is about risk.
  • When buying an asset you try to make an informed decision balancing chance, that is risk and potential in your favor.
  • Buying and selling assets doesn't always leave you with more money.
  • The value of your assets keep changing every day.
  • There is a lot of folks telling you how to invest and most of them earn their money from feeding you this information as opposed to following their own advice. 
3) Fiat-money is established and regulated:
  • Digging down in the history of money is interesting and boils down to the basic fact that money is about the convenience of trading goods and risks. 
  • Money needs services and infrastructure to be practically useful.
  • Those providing established money related services tend to be powerful players in their time.
  • Seems like power needs regulation to keep a society stable. 
  • Regulation is never perfect and always biased. Beneficiaries of the bias are essential to keeping the regulation up and running.
  • Most people have small money and little knowledge about it. They end up using established services of big money companies to manage their money. 
  • Small money tends not to be smart money and the small money people tend not to be among those who benefit the most. Stability and a reasonable standard of living is what they get out of the system.
  • The harsh downside of the established system is all those people struggling to get mere minimal access to the system, devoting their lifetime to sawing clothes is some factory in Bangladesh or whatever.
What is Bitcoin?

Bitcoin is yet another currency, a label to attach at numbers used to trade goods and risks. The currency is algorithmically designed, so that the amount available increases but scarcity remains intact. Provided that demand does not break down that is. The rules of the game are coded in software and fortified by cryptography. Who owns what is stored redundantly by the peers themselves. Bitcoin wallets are a decentralized net of peers keeping each others transactions. No need for Banks, that's it. 

It is quite common to think of bitcoin as digital gold. That is why the process of bitcoin creation is referred to as "mining".  The cryptography is there to ensure there won't be no alchemists somehow magically creating bitcoin (gold) from lead (electricity). Actually mining is alchemy transforming electricity to bitcoin but the cryptographic challenge keeps getting harder and harder.

The digital peer2peer nature of bitcoin make it a much better fit for the digital and mobile age than gold. But as with gold there is no man made central authority in charge of creating bitcoin as it is with the nation dominated fiat-money system.

As with every currency the value of bitcoin is derived from trust. Lacking the central authority backup and as opposed to gold being around for a very short time only, the trust basis of bitcoin is quite volatile. (I kind of miss out on why people keep being dumbfounded by this.)

What value does the Bitcoin-System create?

As a currency bitcoin is a measure for value not a value in itself. But the bitcoin infrastructure provides value by cutting down on transaction costs for currencies especially in a global digital economy.

Cutting down on transaction cost is profane but disruptive. It is disruptive to the established money system. In fact i think this to be so disruptive that I'll have to do another article to dig into this.

Finally: Is  the Mt. Gox incident a mortal wound for Bitcoin?

I doubt so very much. Reading what I read, I tend to believe that another early mover in the bitcoin ecosystem stumbled. Maybe they stumbled for the last time, maybe some investor grabs them by their hair pulling them from the mud.

Either way, digital money rigorously cutting down on transaction costs won't go away. But could not some other currency take over? Sure. If bitcoin demand drops in favor of some other digital currency that might happen. 
I tend to think this won't happen unless someone finds a major unfixable flaw in the bitcoin concept or the unknown-digital-currency-to-be offers a major benefit that i can not think of for now. Remember there are lots of alternative digital currencies around, but they all trade for bitcoin thus increasing the bitcoin ecosystem.

In a nutshell Mt. Gox seems to have lost track of what they have been doing on a really big scale. There is no excuse for that and courts will have to judge if this was careless, negligent or criminal. Bitcoin will move on and that is move on without being "put back 5 to 10 years". This pu-back-hypothesis from the crisis strategy draft of Mt. Gox tells a lot. It is a self-deceiving notion of Mt. Gox to believe they are an essential ingredient to the bitcoin-ecosystem. They are not. Investors won't move on the behalf of Mt. Gox to save the bitcoin-ecosystem. Why should they?

Investors balance risk and potential. So should you!

Best of luck!

Update: Nice dive into the Mt Gox Topic by @aantonop is at http://www.youtube.com/watch?v=1mWkY5yIAnc. The main point is: when in  take and keep control of your keys, ensure that your trust is based on the blockchain.

Three hours into this live video and still running. This is the internet age. Tech-kids running major businesses and before anyone notices what the hell happens, they fail miserably. Will Karpeles join the session? Will MtGox rize again as gox.com? Is @goxreloaded a hoax? Staying tuned.

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