So what do you think about Bitcoin?

on Wednesday, February 7, 2018

Every time someone asks if I have heard about Bitcoin or tells me they want to invest, there are so many things that I think I could tell and so many links that I would like to share, that I thought it would be better to compile everything in a blog post. And, what the hell, nowadays you're nobody if you do not have a blog post about Bitcoin and which topic could be better to wake up my blog from its two-year lethargy than the bubble of the moment.

So there we go. First of all, I will always refer only to Bitcoin but almost everything I tell could be applied to all the other currencies that appeared later also based on Blockchain (Litecoin, Ethereum, BCash, ...) even though some Bitcoin evangelists consider other cryptocurrencies a scam made up by opportunists who want to get rich.

First of all, we would need to understand what Bitcoin is and the Blockchain technology it's based on, and for that purpose, I haven't seen anything better than one article by Ars Technica. The Ars Technica article is simply excellent, as usual, and explains it in a very clear way, but it would be very difficult to summarize here, so just read it first.

Done? OK, so now we already know what's necessary to understand how Bitcoin works, now it's time to ask the uncomfortable question: what is it useful for? Some enthusiasts have the hope (and even the belief) that it will become a substitute for current fiduciary money, but apart from some anecdotal uses, it's difficult at the moment to find a real use and, as Jaime Buelta says, its functioning makes such use quite difficult to ever arrive.

I think, however, Jaime Buelta is even optimistic, since it does not cite the main problem for Bitcoin to get some practical use, which is its slowness and high transaction costs. Due to the fixed limit established in Bitcoin, only a very small number of transactions per second can be processed, which means that we have to choose between either having to wait even hours for our transaction to be confirmed, or paying a higher fee for our transaction to jump the queue in front of those who paid fewer fees. At the time I am writing this, the average fee is above $7. A month ago it was above $20. Is it possible to imagine that Bitcoin could be used with such transaction fees for everyday tasks such as paying for a coffee or our weekly groceries shopping as some enthusiasts expect? Or paying a smaller fee and have to wait for hours until your transaction is confirmed? These are the reasons that led Steam to remove Bitcoin as a payment method, since its high commissions and volatility made it unsustainable.

Anyway, as I said at the beginning of the previous paragraph, part of these problems are caused by the design of Bitcoin itself. May it be possible that other cryptocurrencies based on Blockchain can solve this problem? Actually, some Bitcoin variants such as Litecoin first and Bitcoin Cash later were created to try to solve the problem by introducing variations in the protocol. But if these problems are already arising with the marginal adoption that Bitcoin currently has, the variants introduced by Litecoin and BCash are only postponing it before a hypothetical real use of cryptocurrencies based on Blockchain.
The whole problem of the transaction fees is very well explained, again, in Ars Technica.

If the Blockchain-based coins fail, is there any other utility for Blockchain? The fact is that Blockchain is an interesting idea, but as Kai Stinchcombe says in Hackernoon, ten years later we still haven't found any practical use for Blockchain, not even with the stubborn effort of IBM to find a way to sell it, and it doesn't seem to solve any real problem, but creates new ones.

So what's the point of Bitcoin after all? What is it useful for and what's the reason for the large fluctuations in its price? The common answer to these questions is speculation.
With very little chance that Bitcoin will have a real use, most of those who invest in Bitcoin do it as a speculative investment product with new buyers coming in as the only thing that makes the price of Bitcoin rise, in what looks more like a Ponzi scheme than anything else, but with its own peculiarities.

The first obstacle that an investor will find is the difficulty to enter the market. It is not as easy as we could imagine. Just going to a web page and paying with your card your brand new Bitcoins that you get instantly? Well — no.

Although transactions in bitcoins are not anonymous (as opposed to what some people think) since all transactions are public, it can indeed be difficult to identify their author, besides that (for the time being) they escape from taxes and the supervision of regulators. All this attracted the anarcho-capitalist libertarians who saw Bitcoin as its deregulated utopia, but also attracted criminals like drug dealers and ransomware distributors, who are the only ones who have found a real use of Bitcoin until they abandoned it for other cryptocurrencies when Bitcoin fees soared.
For these reasons or due to lack of resources on their side, many markets also do not comply with the anti-money laundering regulations that require them to identify their customers (KYC/AML). And of course, your traditional bank —which usually doesn't want to be so easily involved with funds from criminal activities, tax evasion and money laundering— will not want to be mixed with Bitcoin. That is why the bitcoin markets have so many problems to obtain banking services.
At best, if the market of your choice has still managed to keep its banking services, you can transfer funds directly with a bank transfer, which will take a day or two. In other cases, when the bank transfer is not an option (and of course cards aren't either), you will have to make a chain of transfers going through different payment services and making different currency changes leaving fees on the way until you are finally able to convert your money in Bitcoin and your funds reach the target market. By then, the price of Bitcoin will have already changed.

And even if problems to enter a Bitcoin market weren't enough, getting out is even more difficult. If you've been lucky enough to make a fortune speculating with bitcoins, you'll probably want to exchange it back into the stable and useful fiat money you can use to buy things and also keep your wealth from disappearing in the next bitcoin price crash, but in the exit path you will find the same difficulties as in the entry —as it's logical—, but additionally, you will have problems to justify that income to IRS, which is now finally taking action. Your bank will also find suspicious that you suddenly have an unjustified significant increase in your balance and even more if it detects that it is related to Bitcoin.
That's why, as David Gerard explains, even if you really get to make profits with Bitcoin, it's hard to get out of the market and turn your profits into stable money that you can use.

Well, but this is the price you have to pay to fulfill the anarcho-capitalist dream of investing in a deregulated market, right? Well, there is more.
Being markets that are often operated by opaque companies in tax havens totally out of reach of the regulators, it becomes a world where anything goes and the investors themselves are also victims of the schemes of other investors and even of the markets themselves to alter the price of bitcoin at convenience using traps that in regulated markets are illegal.
For example, as mentioned by David Gerard in another article, Bitfinex, the world's largest market, allows fraudulent techniques to manipulate prices such as wash trading and painting the tape (buying or selling to oneself or other accomplices of the fraud) or spoofing (creating buy or sell orders that are canceled immediately as they start to run), also allowed by Coinbase and GDAX and documented in an extensive article by Bitfinex'ed where he explains how spoofing could be used to manipulate the price in the largest market of bitcoins.
There are at least two occasions of insider trading by Coinbase employees using information not available to the general public. The case of Bitcoin Cash even appeared in the mainstream media and is being investigated by the market itself, but even more alarming is the case of Litecoin when Coinbase hired the creator of Litecoin to implement his cryptocurrency in the list of currencies available in Coinbase and then he sold all his Litecoin coins at the time of its maximum value just before it collapsed in a movement that in the traditional markets would trigger all alarms, but in the markets of total deregulation in which cryptocurrencies operate anything goes.
The manipulation of the price of Bitcoin is something even analyzed in a paper after a joint investigation of the Universities of Tulsa and Tel Aviv and the use of these fraudulent techniques was massive, proved and admitted in Mt.Gox, which until the moment of its collapse was the biggest bitcoin market. Fraud reached a point where fraudulent transactions appeared at zero fees and at times when the market was offline, proving that the fraud was committed by the market itself. The lack of regulation also causes each market to act as an island, which —added to the possible manipulations to which each market may be subject and the movement of funds between markets— can cause large discrepancies in the price of Bitcoin, as pointed out by David Gerard's article aforementioned.

All these shenanigans and frauds —either admitted or hidden— added to the dubious origins and deficient controls in cryptocurrency transactions, does nothing more than providing arguments to the banks that do not want to have anything to do with Bitcoin, which causes many problems to most of the Bitcoin markets to maintain the necessary banking services to allow their clients to enter the market or withdraw their funds. How do the markets react to solve their banking problems? It's then when Tether comes up.

Despite their attempts to hide it, even by denying it publicly, we now know thanks to the Panama Papers that Tether is a Bitfinex company, one of the main Bitcoin markets. The principle of Tether is to use a virtual currency that maintains its value in parity with the dollar so that it can be used as a substitute representation of the dollar, but without using dollars. Something like the laundry tokens. This way, the markets, instead of using the problematic dollars that require having banking services subject to anti-money laundering laws, can switch to tethers issued by a mysterious and opaque company that does not ask them to submit to any control. In fact, in an old version of their website they highlighted avoiding anti-money laundering controls as one of the advantages of using Tether.
How do we know how tether issuing works? Well, we don't really know, because despite what is usual in financial institutions and the constant demands of the community, Tether has never done an audit and we wouldn't even know who is behind the company if Panama Papers didn't disclose it. The only proof that Tether is willing to offer of its solvency and the cleanliness of its finances is by some journalist reviewing their accounts under an NDA thus attesting the good state of their accounts. However, there is a reason why audits are done by auditors and not journalists under NDA, as we learnt when Roger Ver reviewed the accounts of Mt.Gox affirming that the company was solvent shortly before it went bankrupt and when it was already insolvent.

So, in the absence of evidence, all we have to trust in Tether's goodwill are their promises that every tether issued is backed by the same amount in his bank accounts. However, it is very surprising that hundreds of millions of dollars in daily investments are received by a company that has been hacked several times (and has the curious habit of taking funds from their customers to cover losses from hacks), that does not publish any information about its structure and finances, without any audit and with previous banking problems. Between the 14th and 20th of January 100 million dollars in tokens were issued every day (except for the 15th) in the middle of a Bitcoin crash, reaching 2 billion tethers issued. Without providing any convincing evidence of solvency, the company has a hard time to persuade some people to believe they have 2 billion dollars in the bank from investments in a company that does not provide any audit or information on their management. And those doubts have even reached the general press with accusations from other sources that Bitfinex is issuing more tethers than the dollars they have to manipulate the price of Bitcoin. Some have analyzed how the issue of tethers relates to the price of bitcoin and in what quantities they are issued and have seen signs of market manipulation (archive) as mentioned in the study of the Tulsa and Tel Aviv Universities mentioned before.

With all these dark spots in the Bitcoin markets in general and in Tether/Bitfinex in particular, not many will have been caught by surprise when learnt that the US Government could be investigating Tether/Bitfinex.

So, if after reading all this you still need to ask me what I think about Bitcoin (or other cryptocurrencies), my answer is that I do not see any reason why someone might want to enter that world. Because even if you really, really know how it works and you are able to dodge all the traps and dangers in it and you and are so lucky to make profits, you will have a hard time converting those profits into money that you can really use.

And if you want to stay informed while keeping critical view: