Stay away from Bitcoin

Why you should not risk it, and you should not support something that will hurt many people.

This made me decide to write:

Gary Vaynerchuk intro at SXSW

The interesting piece is between 38:51 and 39:41. If it does not start playing there please know that I tried to make it work a dozen times, and forgive me.

Bitcoin is a collectible item.
It is not a currency.
It will never be.

What makes a currency such, is a mechanism called “Legal tender“, where Legal tender is “a medium of payment allowed by law or recognized by a legal system to be valid for meeting a financial obligation.” (1).
The only known examples of currencies which worked without being legal tender were the Iraqi Swiss dinar and  the paper money issued by the Confederate States of America during the American Civil War.

Who can establish a Legal tender? A government. Legal tender issues have to be ascertained (you need courts) and enforced (you need police). Unless you have both, you cannot establish a legal tender.

Why do you need legal tender? To make the example real: let’s say you own 10.000 Bitcoins (today they are worth 501 Us$, i.e. 5,010,000$), and you enter into a transaction where you want to buy a mansion worth 5 million $. Because the Bitcoin is not legal tender, when you offer it to the home seller he might refuse. Whereas if you provide him with a 5 million Us$ payment, he can’t.

If you do not have legal tender, you might end up with those 10,000 bitcoins worth… 0 (zero). In fact, they are the perfect ingredients of a Ponzi scheme (2). “The perpetuation of the high returns requires an ever-increasing flow of money from new investors to sustain the scheme.” As soon as such flow withdraws, you are left with nothing.

“Oh but this is internet money, no one owns it”. LOL. You can bet that someone has benefited, and is benefiting, from the rise in its value. The first seller of a crisis is the winner. Most remain with a worthless currency in their hands.

“Yes, but until people are willing to accept it and/or there is a market…”. Have you ever ascertained the value of that “until” word? Even real currencies –with governments backing them up– have fallen prey to very serious losses of confidence (hyperinflation and the fall of the old Deutsche Mark opened the doors to Hitler; the dollar risked seriously in 1971 when the US exited the Gold Standard; I personally witnessed the European currency crisis of 1992/93 in the first real job of my career), what protects you if you lack legal tender? You are running on very thin, actually borrowed air.

“What if Google or some other internet giant buys it?” It would not make a difference, because even the largest corporations in the world do not have the authority to make it legal tender. It sure would increase its credibility, yet if Charles de Gaulle could make the US Government abandon the Gold Standard, or George Soros and a few large speculators kicked the British Pound out of the European Exchange Rate Mechanism (ERM), it would be much easier to make the Bitcoin falter.

“Why it will never be a currency?” For a country to make it worth making it a legal tender they would need the ability to print it. To maintain a legal tender is extremely expensive, because you need to be able to enforce it. Plus: why would any government give up the benefits of printing money, called Seigniorage (3), in exchange for nothing?

“It’s such a cool project, away from banks” Wake up: who would exchange your bitcoins? Have you ever traveled through an airport and glanced at exchange rates? If you did, you might have noticed that the difference between the price currencies are purchased and the one at which they are sold is often in excess of 15%, making it an extremely profitable business. Create a new currency, and you will have created such a business.

“The number of bitcoins is fixed, they can’t lose value” Sorry, their intrinsic value is zero. It does not matter how many of them are around, they are worth something until you find a buyer, and that might end soon.

“But you said they are a collectible” True, yet notice the difference between an old Rolex watch or a Picasso painting and a bitcoin. You could question the value of the first two, but they usually carry two characteristics: rarity and beauty, which make many people compete for them. Take out the expectation that the bitcoin will rise in (let alone keep its) value, and you are left with nothing at all.

By the way: did you notice that even if banks lost immense amounts of money in the past 10 years we did not have neither deflation nor inflation, actually we even had a little bit of growth, here and there? It took us approximately 100 years to figure out how to run appropriately the so called “monetary base” (*), and we decided it was plain stupidity to have a fixed monetary base because we keep inventing new brilliant things, and unless we want to compete for the same restricted pool of coins, we should accommodate for those. Why would we ever go back to a fixed number?

(1) http://en.wikipedia.org/wiki/Legal_tender
(2) http://en.wikipedia.org/wiki/Ponzi_scheme
(3) http://en.wikipedia.org/wiki/Seigniorage
(*) Please note that the monetary base management has limited abilities: it cannot counter balance political and fiscal mismanagement by governments, nor neutralize extremely poor business practices.