My tech article this week is dedicated to FOMO (Fear of Missing Out). I have been inundated with questions lately related to bitcoin specifically – or cryptocurrencies in general. When media articles are written about people who have turned US$3,000 into US$25 million in just a few years, everyone wants to jump on that same boat for fear of missing out. This is not a financial advice column so I won’t tell you whether you should invest in bitcoin (for the record I have zero investments in any cryptocurrencies and the world-famous investor, Warren Buffett, says he will never have a position in cryptocurrencies and they will almost certainly come to a bad ending) but I will try and condense into 650 words the burning question I am continually asked. What is bitcoin and how do I get me some?
Answering the initial question is not that easy. Technically, bitcoin is a digital currency that operates independently of any central bank. It is not country specific or company specific. High-level encryption is used to regulate both the generation of bitcoin units and the transfer of the currency.
The first red flag for me is the fact that the creator of bitcoin is unknown. Satoshi Nakamoto is the pseudonym used by the individual or group that created bitcoin but, despite years of research and some spurious claims by various people (including one Australian) the actual creator of bitcoin is unknown. The altruistic version of the creation of bitcoin says that the creator/s wanted to bypass the power of central banking authorities. The more common version says that it was all about money. Satoshi Nakamoto has one million bitcoins of the current total of 14 million bitcoins – or seven per cent of the total bitcoin wealth. Depending on when you look at the value of bitcoin (it is incredibly volatile) this makes Nakamoto worth around US$10-19 billion or in the Top 50 richest in the world.
To obtain bitcoins, you need to ‘mine’ them or buy them. The idea is that you mine bitcoins in the same way as you mine gold – with the significant difference being the fact that gold is physical and a bitcoin is virtual. You can setup your computer with software to mine bitcoins but the amount of computing power and electrical power required to run the algorithms results in a slow and expensive process. Dedicated mining hardware is sold to allow you to mine your own bitcoins but the creators set an upper limit of 21 million bitcoins as a maximum number. The closer the number of total bitcoins mined approaches 21 million, the harder they are to mine with the estimation that the 21 millionth bitcoin will not be mined until the year 2140. In the early days, mining was the preferred option to obtain bitcoins but now people simply buy them. There are various companies that trade in bitcoins – although they are easier to buy than they are to sell.
When it comes to buying them, you are buying a virtual currency that is unregulated with the sole hope that the value increases. There are various businesses that will now accept bitcoins for a purchase but the pricing is difficult due to the volatile nature of the currency. When a supplier is internally comparing bitcoin pricing to normal pricing, the price they may set for an item in bitcoins could change several times a day. To illustrate the volatility, from mid-October last year through to yesterday when I wrote this article, the value has gone (in US dollars) from $5,518 up to $7,458 then down to $5,857 then back up to a high of $19,343 before dropping to $13,857 and then this year it has gone from $17,135 down to $9,767. Enough to make any investor nervous at the least.
The total number of bitcoins is currently set at 21 million but a change in protocol could be made to change that number. Just like Pauline Hanson’s idea many years ago to just print more money to make Australians richer, and just like the hyper-inflation we saw in Germany in 1922 and Zimbabwe in 2008 when those governments did just that, issuing more bitcoins would have an immediate impact on the value of a bitcoin. If your ultimate goal is to have all of your wealth in bitcoins then be prepared for your wealth to vary dramatically based on items outside your control.
Some people compare the virtual currency to the idea that we don’t deal with as much cash in our economy now as we once did. Our money is shown as a number on a computer screen. The confidence I have in that system is that we have a centralised democratically elected government regulating that number on a computer screen. I have more confidence in that system then a digital currency with an anonymous creator.
Bitcoins and cryptocurrencies are interesting from a technical viewpoint and the commentary on human nature is fascinating, but I am not convinced this will be the currency of the future – although there are many bitcoin ‘millionaires’ that would beg to differ! Keep in mind there is some self-interest there. For anyone that already has bitcoins, they want the popularity to rise to keep upward pressure on prices. If the bitcoin bubble bursts (which I think it will) then the huge virtual gains made by current owners will disappear in a flash of ones and zeroes.
Mathew Dickerson