In-depth Analysis: Is Bitcoin the Future?

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search volumes have moderated, the trend in broad public interest is rising.

Source: Google Trends

And while the price of Bitcoin has continued its downward trend, it seems that the network continues to deepen and mature.

Over time, many investors have realized that it was not a problem with the Bitcoin protocol that allowed the security breach at Mt. Gox or the frequent theft of unsecured bitcoins, it was inadequate security – basically, poor business practices – at the exchanges and wallet providers. Rather than exposing some flaw in Bitcoin, the collapse of Mt. Gox revealed the desperate need for better management and the opportunity for improving the services that surround the Bitcoin network. And the venture capital community has certainly responded.

This year, by the end of Q3 2014, over $290 million of venture investments had flowed into Bitcoin-related businesses, compared to the $250 million that poured into internet-related businesses in 1995.

Source: CoinDesk

And the trend toward greater average daily trading volume has continued to rise.

Source: Blockchain.info

Not only is real money starting to flow into the growth industries surrounding Bitcoin, but real businesses are starting to accept bitcoins as payment. At the end of Q3 2014, the top eight companies accepting payments in Bitcoin had annual revenues totaling more than $85 billion, and among them was Dell.

Source: CoinDesk

The price of Bitcoin may swing dramatically in the coming days, months, quarters, and years. The currency may not survive in its current form… but the technology underpinning it is not going away any time soon.

Thoughts on Bitcoin from John

If you ask me whether I truly believe that in 2050 the main medium of exchange will be paper money, the very quick answer is that I don’t. I also think there is a better than reasonable chance that it won’t be a fiat currency. But will it be Bitcoin? My best guess is that it will not be Bitcoin as currently constructed but rather an evolved version.

I know the following will be somewhat controversial, but work through with me on what I hope will be a helpful way to think about money in general. The current structure of Bitcoin carries the same inherent flaw that gold does (and to some extent the euro, too): in a world of ever-increasing abundance, gold is massively deflationary and provides unreasonable “rents” to those who hold it. Even given that inherent flaw, it has been the most stable store of value for millennia.

To think about what money will be in the future you have to shake off the chains of the past and your preconceived notions of what money is. Money is not just, or should I say, is more than a medium of exchange. It is also a medium of information. It tells us what the marketplace wants and the price it is willing to pay for a particular good or service. The (often fatal) flaw in fiat currencies is that they manipulate and distort the information contained within the currency, thereby damaging the information flows involved in the exchange of goods and services. For instance, the practice of quantitative easing engaged in by major central banks has encouraged money to go into certain markets (such as stocks), distorting the information reflected in the price.

Rather than looking for the information provided by the market and adjusting our investments and purchases accordingly, we are forced to focus on the information provided by the Federal Reserve and its quantitative easing. To confuse the actions of the Federal Reserve with the actions of the market is to miss the point that the Federal Reserve is actively manipulating the market for its own purposes, however positively motivated.

Advocates of gold believe that a gold-backed currency would eliminate that price distortion, and they have a point. However, if we were to decide to use gold as the sole basis for our currency, we would have to value it at some order of magnitude higher than it is today in order not to create massive deflationary instability. I’m not sure that $10,000 or even $20,000 per ounce of gold would be nearly high enough, given the massive amount of sovereign debt in the world.

But even supposing that we (as a global system) could somehow manage to deal with the logistical nightmare of moving to a single, physical, commodity-backed currency, future growth in the world would soon overwhelm the limited supply of gold, and the prices of goods and services would deflate over time, creating their own backlash. History buffs will recall William Jennings Bryan and his famous cry, “We [mostly referring to farmers] will not be crucified on a cross of gold!”

Now some might see ever-falling prices as a good thing, but they would induce a different type of instability in the system. Given the overwhelming extent of global debt, I think the chances of moving to a physical currency based on gold are slim to none, and Slim left on the morning train. Go back and read the economic history of the latter half of the 1800s in the US. From one point of view it was a golden era of growth and prosperity driven by huge leaps in technology. But it created serious problems for many of those on the lower economic rungs. If you think income inequality is a problem today, then you won’t like what happened in the late 1800s.

The leaders of that era came together to try to create a new system that could prevent the frequent panics and crashes that were inherent in the financial system of the day, and eventually we got the Federal Reserve and other ostensible improvements. But that does not mean the current system of central banks and fiat currencies does not have its own flaws. We should not limit our thinking to the economic systems of the past or present as we think about a future economic system. How do we create a truly stable, equitable, and efficient basis for exchange?

While I think that Bitcoin as currently configured has limitations, the technology of the blockchain is one of the most potentially revolutionary developments of the last century. I think we evolve to Bitcoin 2.0 or 3.0, using the same blockchain technology, but with a way to make the new currency a truly stable medium of information that can be easily exchanged for goods and services.

Why not create a currency that is backed by a number of commodities, with gold perhaps as the backbone? Why even limit ourselves to commodities? Bitcoin as currently configured could be part of the basket. Anything that can be represented in a digital form and has a reasonably stable long-term value could be considered.

All I want from my currency is to be able to buy and sell goods and services, make investments, and have a reasonable expectation as to what my currency will be worth in terms of purchasing power if I hold it for months or years.

I think that some of the clever venture capitalists who are exploring Bitcoin will join forces with one or more large international investment banks and create something along those lines. And once someone shows the way, breaking the chains of the past, we will have a period of innovation rivaling the Cambrian explosion.

The vast majority of my purchases are electronic today. I think that percentage will continue to grow. Frankly, I really don’t care what happens inside “the system” after I wave my iPhone over the new Apple Pay device (or use my credit card). I just want to walk out of the store with my purchases. (In the not too distant future there will be an extremely tiny RFID chip embedded in my hand, or at least on my person, which will also serve 100 other purposes.)

The Bitcoin blockchain technology allows for the most secure electronic transactions ever devised. Its adoption and acceptance seem inevitable to me. It will be used to validate everything we purchase: stocks, homes, investments, airplane tickets, etc. It will be a far cheaper and much more secure way to validate your ownership of anything, from your home to your stocks.

The blockchain will form the basis for the perfect medium of information exchange (at least as perfect as we humans can create), which in turn will be the basis for whatever electronic medium of financial exchange we evolve in the future. The market (that would be you and me) will move to whatever new medium serves our purposes best.

Satoshi, as technologically brilliant as he (or she or they) was, was limited in his understanding of economic exchange. He was trying to create electronic gold. To some degree, he was confusing technology with money. He was trying to overcome the flaws of our current monetary system (a very laudable goal, I might add) but limited himself to thinking within the box in which the current monetary system placed him.

The next generation of Bitcoin developers are going to crawl out of that box and create whole new realms of possibilities. Once you realize that money is just information, and all you need to do is to provide the most stable mechanism of the transfer of information, you turn thinking about money on its head.

This is going to be massive amounts of fun to watch.

Staying Close to Home

Thanksgiving and its aftermath has been a relaxing time for me, letting me charge my batteries for the rather large amount of work that I must do before the end of the year. There is a lot to think about. While there are a few potential trips in December, I will spend the bulk of my time here in Dallas before my travel schedule picks up next year.

It’s time to hit the send button. I think I will close the letter without my usual personal comments. Have a great week!

Your excited about all the innovations coming in our future analyst,

John Mauldin

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