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John T. Reed on bitcoin

Posted by John T. Reed on

I do not recommend bitcoin as a store of value.

It is interesting as a better, faster, cheaper SWIFT wire, but you must get a trustworthy guarantor of the bitcoin transfer. For example, ask Wells Fargo to transfer $20,000 to Westpac Bank in Australia. They can use bitcoin for that if they want, but if anything goes wrong, Wells Fargo gives you your money back. As far as as I know, neither Wells nor any other traditional bank currently offers bitcoin transfer service.

I am greatly alarmed by the popularity of Bitcoin. If you don’t own it now, don’t buy it. If you do own it now, sell it.

Am I saying it will drop in value? Hell, no! Neither I nor anyone else on earth knows. That is the problem.

If you own it and you keep it, you are thereby saying you believe it will go up in value and not go down in value. You’re a liar. No one earth knows and that includes you.

Here is the apparently “reasoning” of Bitcoin buyers and advocates:

A. Bitcoin is electric and everyone knows the electric version of everything is better than previous versions like gold or dollar bills.
B. Bitcoin is computer based and everyone knows the computer version of everything is better than previous versions.
C. Bitcoin is Internet based and everyone knows the internet version of everything is better than previous versions.
D. Bitcoin “is going up.”
E. The fact that bitcoin went up in the recent past means it will continue to go up in the future.
F. Bitcoin is more modern than cash or bank account entries therefore it is better.
G. Bitcoin is the new new thing.
H. Bitcoin is hot.
I. The government hates bitcoin.
J. Bitcoin is better than traditional currencies because they are not backed by anything.
K. Early adopters always make out like bandits.

A through K are childish nonsense and/or false.

Reversion toward the mean

Regression toward the mean is a statistical principle that applies to time series, that is, graphs where the bottom of the graph is time. In layman’s language, the value of something tends to spend more time around the average than at the extremes, just as a pendulum spends more time at the middle than at the ends of its swing.

The financial version of the phrase is reversion toward the mean. Another way to put it is that prices higher than average are eventually followed by a fall in price and vice versa. The first sentence in an article titled Some Stocks Flip Script On Big Tech” in the 11/30/17 Wall Street Journal is “The rubber band snapped back. That analogy is another way to describe reversion to the mean in asset prices. Extreme low or high prices are like stretching a rubber band to its extreme length. It will snap back.

Laymen seem to believe that if an asset rises in value, that proves it is in the nature of that asset to rise forever. The more it rises, the more that proves it will continue to rise. We see that in all asset classes at times, including real estate, gold, stocks, commodities.

But no asset has such a history, not even bitcoin. Some assets have trended upward over time, but that can generally be eliminated by adjusting the prices for inflation. If you borrow the money to buy a hard asset with fixed-rate debt, as is common with homes, you can make a real (adjusted for inflation) profit from the hard asset holding its value and the real value of the mortgage falling.

The average adjusted-for-inflation price of gold since 1968 is around $645. The current price is around $1,350. That means it will be below $600 a lot in the future. It must in order for the average price to continue to be $645. I cannot tell you when the price will fall or that it will not go up before it falls. But I can tell you it averaged $645 in the past and will average $645 in the future.

The same is true of bitcoin, but it is a little early to know what the long-term adjusted-for-inflation average price of bitcoin is. It only came into being in 2008. For all other assets, paying more than long-term average adjusted-for-inflation is generally a bad idea and paying less than that average is generally a good idea.

With bitcoin, the absence of a long-term, adjusted-for-inflation price, bitcoin owners are flying blind. They do not know if they are “flying into the side of a mountain or at 10,000 over the ocean” at its current price. So bail out.

‘Going up’

Investors often justify their purchase of an asset on the basis that “It’s going up.”

In this context, the suffix “ing” is a present participle. It is for actions that are still happening. But there is no real time price ticker for bitcoin. The most recent information you have about the price of bit coin is not current. It may be a day old or an hour old or five minutes old, but it absolutely is not “still happening.”

All anyone can truly say about the price of bitcoin is that it recently went up. If you are asked what it is doing now or going to do in the future, the only accurate answer you can give is “I don’t know.”

Because of all the unknowns about bitcoin, “I don’t know” is also the answer to the big question: “Should you invest in it?”

No asset can just go up in value forever. For one thing, who could afford to buy it? For example, in the early 2000s, home prices were skyrocketing. But they are tied to mortgage interest rates and the incomes of the buyers. If your income did not skyrocket along with home prices, you cannot afford to buy the home whose price skyrocketed. And generally, neither can enough other people to sustain the prices.


A price is something people will pay. To pay it, they must be able to afford it.

The 2017 movement of bitcoin prices is generally described in the financial press as a “mania.” 

mental illness marked by periods of great excitement, euphoria, delusions, and overactivity
synonyms: madness, derangement, dementiainsanitylunacypsychosis, mental illness;
an excessive enthusiasm or desire; an obsession.
That is an accurate description.
The 11/5/17 Wall Street Journal article says if bitcoin double in value in 2018, it will be worth the GDP of Canada or half the GDP sf the U.K. Does there come a point where you recognize that no one should think some computer code is worth the same as all the goods and services produced by Canada in a year?

What is bitcoin?

What is bitcoin anyway? Is it a currency? Not really. Hardly any sellers accept it. Just a few vendors who announce they accept it as a publicity stunt.
Forbes says,
The most important feature of a currency is that it be a stable store of value. 
Another basic feature of a currency, beyond being a stable store of value, is to facilitate transactions. Barter’s big drawback is it is inconvenient. It’s hard to make change and you must find two people who want to exchange goods; three or four way trades get complicated. Currency solves those problems meaning I can buy groceries without having to sell economic services to the supermarket. This convenience is why people moved from barter to currencies (and then from metal to paper, from paper to plastic, and from plastic to electronic bits).
Given these drawbacks, the only reasons to own Bitcoins are not to use them as a currency, but to either speculate on their asset value or use them to shield transactions from others. Without a stable value Bitcoin cannot truly be a currency. Rather it is a commodity asset that one trades, like gold or silver, in hopes that its value will rise and yield a trading profit. There is nothing wrong with speculation; the actions of speculators help to add market liquidity and to determine the market value of assets. However, usually the asset being valued also has an actual underlying use: you can invest in gold or use it to make jewelry or electronic components. Bitcoins have no uses other than allowing people to hide wealth, conceal (often illegal) transactions, and make and lose money by trading them.”
Seeking Alpha says,

“I would hasten to add that fiat currencies (like the US dollar, Euro or Yen) are not asset classes either. You cannot value Bitcoin, you can only price it: This follows from the acceptance that Bitcoin is a currency, not an asset or a commodity.

Here is an article on the SEC answer to whether bitcoin is a security:

The short version is SEC says bitcoin may be a security.

Who cares what the government says bitcoin is?

You do. What the government says it is determines how it is taxed, what reports you have to file regarding it. For example, if it is a currency, it is a foreign one and that means you must reports accounts denominated in it, on your tax return and on the annual Fincen form. There are severe penalties for noncompliance. Those at the other end of your bitcoin transaction may have to issue 1099s about it. You may have to issue 1099s about it.

Also if it is a currency, and it is not your “functional” currency, you must pay tax on gains in it relative to your functional currency.

What does IRS say bitcoin is?

If it is a security, only licensed people can sell it. In some cases, only certified investors can buy it.

If it is a commodity, the Commodity Futures Trading Commission regulates it. Here is what the CFTC says,

Here is what the South Korean Central Bank says,

Here is an article about US regulator confusion on the issue  by a bitcoin website:

This would be funny is unexpected tax bills are funny, or unexpected fines for failing to file required forms are funny, or being convicted of selling securities without a license or a proper prospectuses.
Here is a simple principle. If the pertinent actors in the financial markets around the world cannot agree on whether bitcoin is fish or fowl, you cannot know what it is, or how it will be treated by the law. How can you buy any asset the fundamental nature of which you do not even know?

It’s not a fiat currency. No government has issued a fiat saying it is good for anything. Fiat currencies get no respect, but they are probably one of the most important features of finance in all the world and in all of history. The alternative to fiat currencies today is barter, a sort of economic hell (See Venezuela in 2017).

Can fiat currencies be abused by their governments? Absolutely. I wrote a book about it. How to Protect Your Life Savings from Hyperinflation and Depression, 2nd edition. Have governments abused fiat currency in the past? Hell, yes. Venezuela is right now. But the fact remains that the world economy is currently setting GDP records using 100% fiat money. And if somehow the world now had to switch to bitcoin, there would be an instant worldwide depression from insufficient money supply.

There was yet another excellent article about Bitcoin in the 12/5/17 Wall Street Journal titled “Traders Beware, a Reckoning Awaits.” Google the title to read it.

One of its points is that one big feature that attracts investors—lack of government control—will insure the banning of bitcoin in the event of a financial crisis.

Bitcoin purports to be what gold used to be: a form of money that the government cannot control.

It’s true. And a currency that cannot be controlled prevents the government from using inflation to avoid having to pay off its debts with real money. That requires unpopular things like raising taxes and cutting spending. 

Gold bugs and bitcoin bugs believe gold or bitcoin will prevent the the government from hurting holders of bitcoin through intentional inflation. And the voters hurt by the cuts and tax raises will just sit there and take it?

Like hell. They will demand the politicians fix it.

It happened in Germany in the early 1920s, the U.S. in the Great Depression. The problem “currency” was gold. So what did the government do? In 1933, they ordered all U.S. owners of bullion gold to sell it to the nearest Federal Reserve Bank for $20.67 per troy ounce—a below market price. And they banned owning gold—until 1975.

My wife and I own some gold she inherited. I took it to Canada and put it in our safe deposit box there to protect it from a repeat of that 1933 Executive Order 6102 on gold.

So obviously, the the extent that bitcoin is effective at preventing the government from finding a way to avoid raising taxes and cutting spending, bitcoin will be outlawed just as gold was in 1933.

Gold bugs and bitcoin bugs claim gold and bitcoin are eternal—out of the reach of government. What is really eternal is politicians seizing dictatorial powers like the New Deal did in the 1930s to keep itself in power.

Gold stored abroad will probably survive U.S. government attempts to control it or seize it. Ditto foreign bank accounts or currency held abroad.

What protects you from the US government is not a block chain or a precious metal. Rather, it is owning assets other than US currency that are located outside the U.S. border. It is the border that protects you, not the technology or the periodic table precious metal element. 

Here is another excellent article about bitcoin:

$70 million in bitcoin was hacked and stolen from bitcoin “miner” NiceHash.
Google "Cryptocurrency miner is robbed" to read the 12/8/17 Wall Street Journal article.

The total market capitalization of bitcoin is now (12/17) approximately equal to the annual GDP of Singapore. That is the total sales of all the manufacturers, farmers, fishermen, and service providers in Singapore for a year. If you own bitcoin, you are implicitly saying you prefer the bitcoin to the corresponding share of Singapore’s GDP in USD.

The market cap of all bitcoin is approximately equal to the market cap of Wells Fargo bank at the end of March 2017. By owning bitcoin, you are saying you would rather own every bitcoin than every share of Wells Fargo stock, the world’s second largest bank by market cap.

You’re nuts.

My son Dan owns a bit coin. I urged him to sell. He may. We had a long talk about it tonight. Some points:

Do you have to understand all about it or is partial enough? A chain is only as strong as its weakest link. To judge the strength of a chain or maybe even a blockchain, you must know which is the weakest link and how weak.

One link with any investment are the government laws pertaining to it like how it is taxed, how it will be treated in law suits, how it must be reported, what license if any one needs to sell it, whether fiduciaries can buy it on behalf of their client, how foreign governments will treat it, etc. 

The notion that bitcoin in beyond the reach of government is nonsense. North Korea is probably more beyond the reach of the US government than bitcoin and North Korea is being greatly harmed by the sanctions by a US-led UN. Until you see how government will treat bitcoin, you have insufficient information to evaluate it.

Here’s another thing that is actually beyond the control of government: languages. Like the English language.

Maybe bitcoin and other crypto currencies are, in fact, a language, not an asset. For both currencies and bitcoin wide acceptance is key. English won the war to be the international language. It has flaws like irregular spelling, some declensions. Esperanto is a better language in those regards, but it has never been widely accepted.

Here are the top three most spoken native languages:
Mandarin (1197 million)
Spanish (406 million)
English (335 million)

And the most studied second language is English.

Network effect is key to both languages and currencies. English is the official language of finance, air craft, ocean going shipping, the U.N (along with French for some odd reason).

So English is the big success and growing stronger than ever. But does the fact that it won mean you could have profited from it? Other than teaching English to non-native English speakers, no.

Not every good idea can be profited from by investors. The fact that languages are out of the control of the government has the effect of taking them out of the category of being something you can buy and sell  English looks like a growth stock or hot commodity in terms of its spread. But there is no way to buy it. Maybe that is the case with bitcoin. It is merely a computer language/algorithm that is useful, popular, maybe important in the future—like English—but not a profit opportunity.

I often say I can tell you how to avoid loss, but not regret. Dan can avoid loss with regard to his $17,000 bitcoin by selling now. Regret is the unhappiness you feel when others make money that you could have also made by owning the profitable asset in question.

Avoiding regret requires a crystal ball. No one has one. Trying to time exiting a market for any given asset requires blind luck, which no one can know whether they will have in advance.

I have recently noted that bitcoin = ? in the sense of all the unknowns regarding this recent creation. I could have used zero as well. In a long equation where you multiply numbers together, the inclusion of a single zero turns the answer of the whole equation to zero, no matter how much you know about any or all of the other variables. That is a mathematical way of saying a chain is only as strong as its weakest link.

You cannot meaningfully analyze an asset—if bitcoin is even an asset at all—until you can identify the basic nature of what it is. You evaluate bonds based on the payment pattern and likelihood of getting paid; stocks based on dividend history and prospects, management, industry growth prospects and competition. You evaluate currencies based on the TI ratings and debt-to-GDP ratios and economic freedom rankings and so on. With all asset categories, you must identify all the risks they face and ow you are going to manage each.

You cannot begin to identify the too-high and bargain prices of bitcoin until you can answer those types of fundamental questions about it. At present, no one can. 

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