Citi's Steve Englander Addresses 5 key responses to his
previous more negative view on Bitcoin.
1) Bitcoin is a
generic payment system as much or more than a specific store of value and has
tremendous advantages over current payments systems
2) Its run-up in price
represents dissatisfaction with central banks and money printing and the desire
for a currency not driven by political opportunism
3) First mover and
networking economies of scale advantage will make Bitcoin and a couple of other
internet moneys dominate Internet money in the future
4) It can keep growing
as long as there was a group of individuals and businesses willing to accept it
5) It’s a tulip bubble
and will collapse
1)
Bitcoin as a payments vehicle
Many commented that Bitcoin was
revolutionary as a payments mechanism, rather than as a store of value. The run-up in the price of Bitcoin could be viewed as speculative but
its impact on the payments system would be durable, even if the price
stabilized or fell. Bitcoin’s competitors are credit card companies, wire
transfer companies, weak fiat currencies and the like. Its advantage was that
that its secure cryptography gives it strong security with respect to
falsifying transactions and the transactions cost is almost zero. So you
would not have to hold Bitcoin in order to transact in it, at least not for
very long.
Anonymity was also viewed as a
plus by many, but whether governments can, will and should get some handle on
internet transactions is under debate. Some
also argue that its decentralization is an advantage. The ‘ledger’ that keeps
track of Bitcoin transaction seems resistant to fraud, but there have been
issues with Bitcoin exchanges and other elements of the transactions process.
Investors who focused on the potential
Impact of Bitcoin on the payments system sometimes saw the Bitcoin
appreciation as a distraction. Bitcoin’s
sharp price run-up is attracting more involvement now, but could be a
disadvantage if price ever took a big fall.
2) Bitcoin as an
alternative to fiat currencies
When G3 central banks are
expanding their balance sheets like there is no tomorrow, you can understand
the search for alternative stores of value. Some
make a ‘wisdom of crowds’ argument that monetary management is likely to be
better if it reflects the judgment of a diffuse constituency of users rather
than a central bank governor or board. In short, this is the gold standard, but
with a lot more portability and ability to transact. That said, Bitcoin
protocols are decided by a group of programmers, and their goodwill is taken
for granted.
To some investors it is perfectly
clear that the combined judgments of individuals across the globe will be superior
to the centralized policies made by central banks. To many holding this viewpoint, the ineptness of global central
banks has made the bar for outperformance pretty low. This view probably
appeals to you if you think the panics of 1837, 1873 or 1893 were preferable to
the Great Recession of 2008 (http://en.wikipedia.org/wiki/Panic_of_1837,http://en.wikipedia.org/wiki/Panic_of_1873, http://en.wikipedia.org/wiki/Panic_of_1893). In those times the absence of a central bank did not preclude private
sector speculation from generating bubbles and panics. Admittedly, some of
those panics started because of failed attempts to manipulate or corner certain
markets, a feature Bitcoin’s proponents may feel it is immune to.
Bitcoin started as an experiment
in a currency that was neither commodity-based nor backed by a governmental
authority. There is a risk that
participants in the Bitcoin ecosystem may become more self-interested over
time, the way broadcast television started with Paddy Chayefsky and quickly
morphed into The Beverley Hillbillies. Even now it is unclear to what degree
the ‘miners’ out there should be seen as public servants.
We are left with the possibility
that the properties of a Bitcoin ecosystem that comes to be driven by
individual self-interest will differ from its intended properties. Greed and
panic could enter as a significant part of the ecosystem. By contrast, central banks have a mandate to stabilize the economy
and financial system, even if you see their performance as inept in practice. Nevertheless,
it is not so obvious that a good system driven by individual self-interest will
produce a more stable economic and financial system than an imperfect system of
central banks trying to stabilize economic and financial markets. Many
supporters of Bitcoin argue strongly that this is the case, however.
2a) Bitcoin as a
reserves alternative
Reserve managers are likely
wondering whether Bitcoin is the answer to their most perplexing problem –
where to find a pure store of value, how to avoid currencies backed by erratic
central banks and how to dethrone the USD from its perch in the
international monetary system. Bitcoin
is much more interesting than the IMF’s SDRs from a reserve manager perspective
because it is independent of major currencies. The reserve manager operational
problem is two-fold: 1) how to sell a truckload of USD, and to a lesser degree
EUR and JPY, without excessively depressing the value of the USD that they are
selling and 2) what to buy when there are few attractive, liquid alternative. Bitcoin
doesn’t avoid 1) but addresses 2) to some degree.
Bitcoin with its inelastic supply
and deflationary bias would look attractive to reserve managers as a complement
to gold, and in contrast to fiat currencies in unlimited supply. As a group, reserve managers are conservative and probably would
like to see how Bitcoin evolves. Given the reserves management problem
discussed above, there is some incentive for the biggest reserve managers to
encourage development of this market to see if it is viable in the long term. Even
if it ends up just as a transactions vehicle, countries may choose to transact
in Bitcoin or the like, if it enables them to reduce the overhang of USD that
they need to hold because of its role in international trade and finance.
Conclusions: i)
Reserve managers will not be the first to adopt Internet currencies but they
have incentives not to be the last; and ii) The USD would likely be undermined
on its international role, were this to occur.
3) First mover
advantages
This may be the most contentious
area. Bitcoin fans argue that
being the first in any area where there are networking economies gives you an
immense advantage. Replicability is not an issue because
potential imitators will find that businesses and households will sign up with
the network that gives them the greatest ability to interact. The analogy is
drawn to Internet retail and social media businesses where the business model
can be copied but where a couple of companies at most dominate the space. (On
the other hand, I still have my login/passwords to a variety of ‘first movers’
services that no one under 40 would even recognize.)
With respect to money, households
and businesses will choose the one with the greatest acceptance, so the first
mover has a big advantage even if the technology can be copied.This is a very important argument for entrepreneurs involved with
Bitcoin and the few other currencies that are leading the charge to
commercialize it..
Where diseconomies of scale enter
Bitcoin is through the price exposure. The
maximum amount of Bitcoin is predetermined and looks likely to be hit in the
22st century. The supply of Bitcoin is set to grow relatively slowly, arguing
that the price should keep rising. You can argue that the price of Bitcoin is
irrelevant, since it simply reflects the unit of account for transactions. You
can also see that there is a host of alternatives that may have some modest
advantage over Bitcoin. Both holders of Bitcoin and transactors in Bitcoin have
to assess whether the Bitcoin network advantage is strong enough to outweigh
the benefits from Bitcoin alternatives. You can find examples of both, but
networking situations in other domains are less dependent on reputation than
are Bitcoin and other Internet currencies. And such reputational equilibria are very fragile, and
probably will not survive any unaddressed issues of theft or fraud.
Moreover, if you transact in
Bitcoin, you likely will choose to hold some to facilitate transactions.The speculative surge in Bitcoin may be a disadvantage
if you can find a substitute that has similar characteristics but less of a
speculative component. The question is how expensive is it for
a business or individual to have more than one internet currency and how much
of a disincentive is it to hold a Bitcoin if the price is high, when there are
good substitutes with lower prices.
4) The Bitcoin
ecosystem is growing exponentially
There is a short to medium term Bitcoin
argument that goes something like this. We are just scratching the surface of
payment system/alternative currency development. Whatever the competitive
environment, in a market that is growing exponentially fast, any reasonable
player will get bid up. Ultimately
when market growth flattens out, there will be a sorting out of winners and
losers, but that flattening out is not visible anytime soon, barring disaster. If
this is a repeat of the Internet bubble, we are in 1997, not 2000, so the
gravitational pull of the technology will mask small warts and crevices in
individual applications.
This is not an argument most of us
feel comfortable with, because there is the risk that our calculus is wrong or
that some disaster either through fraud, government interference or some
breakdown in the system occurs before the market flattens. However, many investors feel so confident that we are just in the
takeoff stage, that they see themselves with a margin to invest. They also have
incentives to advocate forcefully the widening of the market because that
enhances the value of all existing applications.
5) Tulip bubbles
About 40% of the comments I received
argued outright that Bitcoin and similar internet currencies were bubbles, or
tools to evade taxes, or conduct illegal activity. Basically, the view was that
the Bitcoin appreciation reflects a mixture of greed and optimism, as in
Boileau (1674), “A fool always finds a greater fool to admire him." The
major issues have been touched on above – replicability, susceptibility to
government interference, security vulnerabilities outside the ‘ledger’ level,
inability to reverse any transaction, dependence on reputation, fragility and
so on. Those who think this is
the internet in 1997 should recall that the NASDAQ was back to 1997 levels in
2002, and even briefly touched 1996 levels, so getting in early may mean
getting in really early. Just as with the railroads and Internet, it may
revolutionize society more than it makes money for investors.
Some investors argued the reverse of most
of the pro-Bitcoin commentators, seeing it as most likely a bubble but on the
off chance that it wasn’t, it was worth buying a couple in case the price kept
shooting up. It was viewed as the high risk, high return investment, with
compensation that it was good cocktail party conversation.
Conclusions
Bitcoin and other Internet currencies are
viewed by some as a Beanie baby fad and by others as revolutionizing the
financial system. Market
acceptance of alternative currencies now looks to be growing a lot faster than
the pace at which the supply of Bitcoin and Bitcoin wannabees is expanding the
Internet money supply. That is unlikely to persist over
the medium and long term, but for now it looks as if it would take a major
scandal, security breach or heavy-handed governmental intervention to derail
it.
Internet currencies suffer from the
absence of an anchor to determine their value and from their dependence on
reputation and fashion. Replicability is an issue that the Internet currencies
will not be able to overcome easily. The role in the payments system is very
concrete to investors, although many also see value in a currency in inelastic
supply whose value is determined by consensus rather than the monetary
authority. Among skeptics,
a minority think that security is a much bigger issue than proponents admit. However
correct the longer-term concerns, there is nothing obvious to derail the
expansion of Internet currencies in the near-term, as they are meeting both
legitimate and illicit economic and social needs.
ZEROHEDGE
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