Thomas Stapp

September 27, 2017

For this month’s post I wanted to discuss all the noise coming out about cryptocurrency. Cryptocurrency is a relatively new form of currency, and if you haven’t heard the news, Bitcoin – the most notable cryptocurrency – has increased in value over 4 times its starting amount at the beginning of 2017. What exactly is bitcoin? How does it and other forms of cryptocurrency work?

First, let’s take a look at the history of cryptocurrency and Bitcoin. Cryptocurrency is not as new of an innovation as it might seem. Several attempts were made in establishing cryptocurrency prior to Bitcoin. The first attempt at online coinage was in the Netherlands in the early 1980s. A crime problem was forming where petrol stations were being raided in remote areas. In response to this, employees of the petrol stations created a form of electronic cash that was put on a sort of primitive credit card. It was created as a means of lowering the risk of crime in remote areas. If the robbers stole these cards, they would not have gained anything because the cards would be unusable for them.

The next innovation in this space was DigiCash. DigiCash was the first online money transfer system in the form of encrypted currency. It was formed in the late 1980s as a way to make online money transfers from person to person secure and private. It had potential for a big future after an offer was received by Microsoft to have DigiCash function on every Windows PC. However, due to a series of bad business deals by the team behind DigiCash, it fell short of ever becoming used for its intended purpose.

Following DigiCash’s fall there were hundreds of startups working in this space trying to come up with the next online money innovation. The company that rose above the rest was PayPal. PayPal was different than DigiCash, however. Rather than forming its own currency, PayPal managed to make it possible for people to link their bank accounts online so they could transfer already existing currencies from person to person.

It appears that PayPal solved the dilemma of how to transfer money remotely, securely, and privately on an Internet channel, so what is the point of Bitcoin? The founder of Bitcoin, Satoshi Nakamoto, has stated that one of the problems he sees with banks and with online institutions such as PayPal is that the system is based on trust. Each person has to have trust that the institution where their money is held will remain in business and will not commit fraud. These are problems we have faced in the past during the Great Depression and even during the 2008 subprime crisis which involved the government having to bail out a number of banks.

Bitcoin will solve that problem by the use of blockchain. Blockchain is a digital ledger that links and secures multiple “blocks” of records together. The way the blocks are formed links them all together securely. Right now, blockchain is mainly only being used for cryptocurrencies such as bitcoin, but it is being explored in other fields such as health care and news reporting. Many think that blockchain, which is the base of Bitcoin, could become the future of the Internet.

First, we have to look at some of the setbacks that could be cause for alarm. Currently, no conventional custodian carries Bitcoin or other cryptocurrencies, so to acquire Bitcoin, you would have to set up a digital wallet somewhere like Coinbase. Coinbase does not provide tax reporting, so that would have to be done manually on the user’s side. There is also no regulation of cryptocurrencies by the SEC or by any other U.S. authority. As far as the blockchain innovation goes, Bitcoin and other
cryptocurrencies could be in the early stage of this technology change where they will shortly become surpassed by better technology in this space. Bitcoin could very well become the AOL of blockchain that becomes obsolete once more technical advances are made.

Additionally, as a source of capital we still have to realize that Bitcoin is a currency. It has no store of value in the way that a stock has. While the value of a stock is based in large part on the cash flows of the underlying company, Bitcoin’s value is completely based on investor sentiment. This means that in the next six months there is an equal chance that it could fall by 90% in value or double in value.

What should you take away from this? With the advancements in blockchain, there is a chance that cryptocurrency could become the next big thing, but it could also go the way of DigiCash and dissipate. Several exotic car lines, such as Lamborghini, have announced that they will be taking payments in the form of Bitcoin, so the utility of Bitcoin and other cryptocurrencies has been increasing. All of these events have been green lights for speculators, leading to the record high valuations in the last 6 months. On the other side, many experienced investors think that Bitcoin will have run its course in 2-3 years and is already on its way to being a sinking ship.

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