Sunday, 16 July 2017

Bitcoin - Pick a number, any number.

I’m going to write about Bitcoin. Not because I like it, or hate it, just because I rank it as one of the maddest delusions of a market that I have ever known.

A market which is a case study of -

Correlation vs causality
Wealth redistribution.
Randomised social mobility acceleration
Disconnected arguments
The technical analysis of noise.
Cyber crime indices

Bitcoin is the blockchain equivalent of Trevithick's 1802 Coalbrookdale steam locomotive

It is the harbinger of a technology of coding that will change the way many data management functions are performed. It is also an anonymised payment system.

As a payment system, its value can be calculated in the same way you calculate that of a credit card company - the value of the sum of charges made for the transactions by the company, less the costs to run it.  I don’t believe Bitcoin charge transaction fees so on that basis it is zero and I don’t believe they have any IP ownership of the blockchain idea, so zero value there too. As a stock price is effectively a discounted function of future cash flow and Bitcoin has no cash flow, the value of Bitcoin Inc is zero.

Some say that Bitcoin is a currency. Is it? What drives currency price differentials?

Trade balances - Does Bitcoin represent a trade bloc and so move on trade flows? No

Interest Rate Differentials - Does Bitcoin have an interest rate benefit? At zero interest rate, it has a negative carry against any +ve yielding currency - Mostly no (unless you are Swiss).

Foreign Direct Investment - Does Bitcoin see demand due to FDI into a domestic economy? No.

Reserve Asset - Is Bitcoin a global reserve currency displaying all the criteria needed to be seen as such? No.

Inflation - Does Bitcoin move due to relative supply against competitive monetary systems. - Yes, but with the contraction of global QE this is not moving in Bitcoin's favour. An additional consideration is the uncertainty of the evolution of other competing pseudo currencies or the competitive function of gold or any other non-monetary commodity. Why buy Bitcoin when you can hedge your future demand for an underlying essential directly rather than using an intermediary?

Even if we assume Bitcoin is a currency, on the basis that it can be used for transactions, using the parallel to FX markets the transactional function of Bitcoin is identical to a very very short duration FX swap, where both parties agree on a fixing spot rate on which to base other charges, such as interest differentials. As it is on a micro time scale with no transactional charges, those costs are pretty near zero and the fixing rate is immaterial. It doesn’t matter whether the  GBP amount you need to buy something priced in USD is 1 Bitcoin or 0.0001. You also expect the recipient to really be pricing in USD with a BTC conversion occurring at their end - just doing the reverse action as soon as possible. If anyone is mad enough to price their goods at fixed Bitcoin prices then they deserve to see no business or go bust as folk arbitrage the FX rates.

If a retailer does decide to hold its BTC receivables as BTC then they are taking a massive FX risk. Which is why I read this from an Overstock ($OSTK) exec saying they keep 50% of their BTC received as BTC somewhat of a concern if they see themselves as a retailer rather than an FX punter. So should I be short or VERY short of their stock?

Having decided that Bitcoin technology has no unique value to Bitcoin itself, as it can be replicated by others (indeed the proliferation of crypto-currencies is a testament to this) and decided that for transactions one only needs to rent it for a fraction of a second, then why would one want to hold and store it?

It is said that Bitcoin is a store of value that will only go up as there is a limited supply and the rules of issue are immutable.

Even before the current issue of a bifurcation of the Bitcoin platform is considered, the primary condition for storing value is that the value of your store does not change relative to what you value. Most of us value the security of food, shelter and warmth, all of which have to be purchased in local currency. The value of Bitcoin relative to these things is currently oscillating at +/-30% a month. That is one heck of a risk that leaves even investing in CDOs a preferable store of value.

Yet despite all of my cynicism towards the price of Bitcoin, the price has indeed gone up. When the price of something moves in the direction that the narrator predicted it is used as a form of substantiation of their initial arguments. The ‘see I was right’ view is dangerous for the old reason that correlation does not imply causation. Bitcoin prices can effectively soar on the ‘greater fool’ theory rather than any of the tulip like arguments of long term value holding water.

In some cases, the huge volatility risk is a price worth paying for anonymity. Cybercrime ransom holders, money launderers and capital restriction bypassers may well be happy to run the risk but if these are the sole beneficiaries then you can be pretty sure that society will clamp down on the tool tat facilitates their crimes.

I mentioned in my last post on wine and trade selection that complexity is used to imply expertise and I seen this demonstrated in the complexity of technical analysis that is applied to crypto-currency trading. I agree that technical analysis is a fine tool to apply for market timing and can be used to detect changing behavioral trends but its over-precise application to a market which is impossible to apply a fundamental value to strikes me as futile.

I'll apply a BTC example I saw last night

Technical analyst - Price is approaching huge support at $2000!
Price - Cleanly passes through 2000 and keeps grinding lower.
Tech Analyst - Price has broken huge support at $2000! Next support at $1800
Reality - $2000 was never a massive support apart from in the eye of someone with a pencil and ruler and $1800 is just as likely not to be either.

So what does this tell us? Apart from adding to the belief that Bitcoin price is as irrelevant and unpredictable as a random walk, it tells us that a lot of people are applying a lot of effort in the wrong direction, trying to make free money from a gambling machine.

Does this serve a function to society? In one respect it does - It redistributes money. In effect, it is a steroid to social mobility. As 'social mobility' has become a term that solely reflects wealth Bitcoin is a wonderful way to take from one person and give to another. Poor people get rich and rich people get poor though rich people can get richer and poor people poorer. It is a lottery ticket with the benefit of an average yield of 0%, which is better than the -50% of most lottery tickets and winning the lottery is the fastest way up the income tree, even if many winners wouldn't be classed as moving one jot in the true meaning of ‘social class’.

In summary, I remain of the belief that Bitcoin has provided the world with a wonderful starting point from which humanity will benefit, but anyone buying a Bitcoin for long term investment purposes will end up as rich as a man who ordered 200 of Trevithick's 1802 Coalbrookdale steam locomotives expecting them to dominate the railway age for the next hundred years.


Asian Trader said...

'......will end up as rich as a man' who "knew his tulips"

northshore said...

There are transaction fees in practice (to get it confirmed, not delayed)

Fixed income trader said...

Frankly disappointed by this article, it's not the same quality as what we're used to.

1) Rates: 0% is better than a lot of stuff. Also from a credit standpoint, any cash in a bank deposit account is a loan above the govt-gteed limit.
2) QE: CB balance sheets might contract, but they might also expand at the next crisis. Bitcoin's supply is known forever.
3) Reserve asset: could become one in the future. Certainly it's already better than the worst 3rd world currencies.
4) Anonymity: definitely valuable in cashless society or in the current context of reducing privacy rights
5) Transactional value: even if for short periods of time, MV=PQ implies that bitcoin must have value as soon as there's a non-zero float of it "held" in transactions.

You don't need to be a bitcoin evangelist (I certainly am not one of those) to figure out the above

ScotsWhaHae said...

While I accept that Bitcoin has a value, there is no way of knowing what it is.
Like a share, it is worth what someone will pay for it, however there are several commonly acceptable ways to measure or value a share.

People say it can keep climbing, why? Because there are a finite amount of bitcoins and if they were the only currency in the world, then their value would be millions per bitcoin?

But there are already a number of other cryptocurrencies. I cannot see why there would os should be a limit on the number of other cryptocurrencies. So if everybody in the world created their own cryptocurrency, none of them would have any value. Can someone explain if it is theoretically impossible for everyone with a computer to issue their own cryptocurrency?

I suspect that governments will soon step in and issue a crypto currency. How will it be backed? I don't know. How is Bitcoin backed?

Fixed income trader said...

Anyone can create one but no one will buy it. Bitcoin is accepted and valued by many, the network effect is very hard to replicate.

The acceptable ways to value a share are irrelevant, it's just a market. Certainly today's PE ratios would have looked unacceptable in the 80s.

Bitcoin is digital gold, whether people like it or not.

matt said...

Well, bitcoins intrinsic value is derived from the cost of computational power required to perform the calculation that validates the next block in the chain. Same for all crypto currencies in essence. The fact its started off (now almost mainstream in recognition) as a retail product which people can trade, as opposed to the complete reverse, a product which only producers or professionals can trade - explains the casino. It has a value, which is equal to energy needed to perform a task.

My 2 cents. Lmie....

Polemic said...

matt, isn't the computational power requirement to validate a transaction a cost to the system rather than an asset, so a negative intrinsic value?,

matt said...
This comment has been removed by the author.
matt said...

It's neither a cost or an asset to the system. The most efficient rig can earn a bitcoin at a rate of $1000 per BTC (as an example), so if BTC goes to $900 that rig will switch to a profitable mining product, so maybe intrinsic was the wrong word. In essence, the price is set before the goods are made. BTCs 'core value'? Is like any other commodity, the cost to pull it out the ground.

Polemic said...

I do have to disagree that the value of a commodity is the cost of pulling it out of the ground.
I could dig a hole and only find a cat turd. The turd is not worth the cost of the shovel and my time.

matt said...

Think we need to sit in a pub and carry this conversation on!

Polemic said...

Now you're talking