Tuesday, November 26, 2013

Bitcoins will fail. Part 1: Whats a bitcoin.

It seems like the world is going crazy over bitcoins as an investment and currency to replace the dollar. I wanted to give my view on it.
Bitcoins suck and you cannot take them seriously.
Alright so I've probably offended some so let me explain. Bitcoins sound great on paper but when you start thinking beyond what they are and instead focus on how they work the whole bitcoin story falls apart.

What are Bitcoins
Bitcoins are encrypted software files that are generated by a software client solving mathematical equations. Anyone may download and install the client and have their computer start solving these equations. All the clients communicate and update each other. When one of them solves one of the equations it notifies all the other clients that it was the first. Everyone else gets locked out of that equation and they all move on to some other equation.

The client that is credited with solving the equation creates 1 bitcoin. It is encrypted and tied to that client. It can be given to any other client and then both clients will update everyone announcing that ownership of this file has changed clients. If anyone tried to copy it to create an extra bitcoin the entire network would deny it because it doesn't follow the publicly known trail of ownership.

While bitcoins and their trails are public knowledge, who is using the client is not known. In this they are anonymous. Its not John Smith using his debit card to transfer dollars from his account to a store's bank account. Its Client #2,845 sending bitcoin #5,943 to Client #19,404. The reason why it was transferred is not recorded or known. Only the act of transferring ownership is transmitted. Bitcoins are stored in "wallets" and transferred to other user's wallets.

Why are Bitcoins valuable
The fact that they cannot be created easily gives them rarity. A person cannot Ctrl+C and Ctrl+P and create bitcoins so there is a limit. There is also a maximum amount of coins that can ever be created. The more mathematical equations that are solved the longer it takes to make the next one. Plus there is a limit as to how many equations were setup for the network to work off of. Now while the maximum number of bitcoins is in the millions and they can be broken up into 8 decimal points of bits of bitcoins, there is still a limit.

What was the intent of Bitcoins
Bitcoins were created as a way of having decentralized currency out of the hands of governments and the financial establishment. Fears that governments can turn on a printing press to create fiat dollars are avoided because nobody can just create bitcoins just as nobody can create gold. Without knowing who is behind the clients then users can avoid taxes and be out of the reach of national governments. The U.S. can pass a law about bitcoins but they have no way of knowing which country a user is in. This allows a person to do what they want with their wealth.

How are Bitcoins used as a currency
You cannot use bitcoins to purchase things directly. You have to convert it back and forth into dollars (or another national currency). Yes I know some websites will allow you to transfer bitcoins from your wallet to theirs and they will give you a service or good but they then have to convert it to dollars to pay their distributor that sold them the cellphone they sold you. Until a company harvesting natural resources used in the manufacture of a product takes bitcoins then it is still tied to a currency.
However there are exchanges that people have setup so that bitcoins can be turned into dollars and vice versa to get around this problem. You create an account with this exchange and connect your wallet to it. Just like any forex account, you can buy and sell one currency for another.
So really how the whole buying things for bitcoins online works is that you converted your dollars into a bitcoin, you send your bitcoin to someone who has agreed to ship you a good or service, they convert their bitcoin to a dollar because they need to pay rent on their office and pay their utilities and taxes.

But aren't bitcoins created by a computer program? If you bought a bitcoin from someone yes you converted your dollar into a bitcoin but what about when it was first created by the client. There are no manufacturing costs there? Actually there is. Electricity. It takes a large amount of processing power, time, and thusly electricity for a computer to create a bitcoin, commonly referred to as "mining" a bitcoin. For awhile it cost more money in electricity for your utilities then what a bitcoin was worth. Let alone the mining computers that they have. If the first computer to solve the equation gets the bitcoin then the biggest and fastest computer has an advantage. They do. Graphic cards had the best processors for solving these and people were buying 4 or more at a time to put into one computer. There were lots of Youtube videos showing elaborate setups with multiple computers working side by side. Bitcoins are past the time that an average person is going to be able to realistically user the home PC to mine some bitcoins. The early adopters could and did but that time has past.

Up to this point it sounds great and I admit that I am fascinated by the technology behind bitcoins. I do think its an interesting idea. However when we start seeing bitcoins in practice it losses its appeal. I'll get into that in my next entry...

Disclaimer: The investments and trades discussed are not recommendations for others. I am not a financial planner, financial advisor, accountant, or tax adviser. The financial actions I talk about are for my own portfolio and money and only suited for my own risk tolerance, strategy, and ideas. Copying another person's financial moves can lead to large losses. Each person needs to do their due diligence in researching and planning their own actions in the financial markets.


  1. At the moment it's really a pain to buy/sell bitcoins from what I've seen. Exchange sites like BTC-E or Bitstamp can do wire transfers and some other pay methods that I've never heard of and don't trust. No paypal, no visa, no mastercard. So it's pretty inconvenient to trade the stuff from what I've seen. There is a finite amount of bitcoins so as demand rises so will the price. A $10,000/bitcoin could be down the road in the not so far future. Perhaps not but I wouldn't be surprised to see it.

    1. Thats definitely one of the drawbacks to bitcoins right now. I read about all these millionaire bitcoin investors that bought into bitcoins when they were under $0.30. I have yet to hear anyone having cashed out and actual received that value as a realized gains.