On bubble

In December 2017, the market price of Bitcoin broke through a historic level — 20000 USD per BTC, though the price dropped shortly. This is the second wave of craziness this year. The first wave, triggered mainly by the Initial Coin Offering (ICO) mania, got severely busted since the ICO ban of Chinese government. The trading of bitcoin etc. in China was also soon shut down.

Then the exchanges moved oversea, and the OTC trading of CNY/BTC made active, attracting more and more new amateur traders to enter the market. And the busting of the ICOs are actually a good thing — more technical people felt a bit safer.

I am not specialized in trading, but I knew that if you don’t want to spend too much time and energy, only hoping to gain some profits with your salaries, then you are almost destined to lose a lot in a highly volatile and largely manipulated market like the digital currencies markets today. Just think about it — It is not a 401(k) plan. It is the modern Colosseum, or a super-crypto-casino.

So if you want to invest in Bitcoin or whatever crypto-currency, I hope you can take it seriously before entering the game. Have your goals and strategies clearly defined and periodically refined. Understand it from the first principle of investing (“don’t optimize”), while taking full advantage of the possible technical edge that you might have (speed, strategy). Think it through. Understand it clearly. The market is where the wise won and the fool lost (it is not even zero-sum for players, it is negative-sum — the platform provider, or the exchange, can make a significant fortune out of fees).

Regarding its investment background, the problem is the investor in Bitcoin might not understand the difference between it and other types. Then why will you put money into it even if you don’t understand it?

Trend trading might be the answer. Stock market is a very volatile market form, which makes it super easy to speculate. When the profit goes up, a lot of people with spare money will try to enter it, hoping to take the bus and jump out before it runs off the cliff.

There are several types of differences between bitcoin and other currency-flavor actuals (like gold):

  1. The bitcoin market is very different from the traditional stock exchange
  2. The bitcoin is a network of dynamic, software-based, upgradable computers
  3. The underlying economic model of bitcoin is different from the traditional monetary system

NOTE: Bitcoin’s use as the anti-fraud tool is minimized, while its trading is maximized (why?). Too high the volatility restricts bitcoin’s use as a medium of exchange.

NOTE: This speculation around BTC today can’t deny its intrinsic value. But this level of craziness might hurt bitcoin community severely someday.

On crypto-economics

What is the fragility of modern banking system?

First, it is illusory/imaginary. It is based on the government, which is a highly centralized social structure, thus, is very powerful and can be trusted for most of the time. On top of the actual economic activities and accumulated wealth, people invent all sorts of financial tools to improve the efficiency of the economic activities, e.g. money. Bitcoin is designed to be money based on consensus as well.

But there are things more complicated than money, reflecting the people’s need when they work together in a much larger scale. Like options and futures. But to actual execute them, organization similar to the government (who issues money and bonds) has to be created and run by people.

The question comes: if we automate all these monetary/financial aspects of social life, letting trustable machines manage all the seemingly boring stuff for us, and leave no space for corruption or fraud, would the world be better? If so, then there must be a process that everyone shifts from USD o BTC, through trading maybe.

But what is ironic is that, if we ever focus on trade bitcoin with USD and begin designing and trading the derivatives etc. on the old centralized system, then there is literally nothing special about bitcoin, compared to tulip in 1637. The technology for realizing its romantic vision is still not mature enough.

In Bitcoin, the computers are the infrastructure. Before that, in the old days of digital banking, the computers are nothing but tools, replacing the human accountants. The core of banks work exactly like 100 years before. The core financial system works exactly like 100 years before. In a booming market, the real estate is still the most valuable thing since the land is where business happens and people live.

However, the crypto-currency, or in a fancier and more proper word, crypto-economics, the structure of economy and finance has been fundamentally changed. There are still human ideas in it, since human designs it and wants it to be somehow compatible with how human think, but it is still revolutionarily different. The difference lies in the how this system works.

This system, is based on computation. It is no longer tied to any people, or any social organization (e.g. corporation). It can run perfectly without current financial & economic infrastructure. It works without human. The robots can use it without any problem. The future of crypto-currency, as I believe, should start with concrete applications rooted and worked in the field of computation, like a edge-computing power sharing grid, where you can rent your computation or bandwidth power to your neighbor and gets paid in some equivalent way, without the need to trust an organization. Then gradually, someone would like to buy this with, say, dollars, for the purpose of using it. It can be traded public, but since it is very concrete and it is as difficult to hype as a hairdryer (which can be produced cheaply and without artificial limits). While at the same time, the technology for large-scale crypto-currency trading became mature, so public trading of it is also available. Then, people might use dollar to buy it, or deployed another distributed system that leverages on the same token. It might grow into a very large number of tokens, so business will get involved, and government might want to take tax from it or whatever. Then a government-controlled token might be issued as the sole legal token to be public traded with existing dollars, and this token can be traded any where with a license (since gov can control the token network to control this end).

On history

Upon now, I want to review the history of big events in the crypto-currency community, trying to understand their roles.

  • In 2008, the foundational paper, Bitcoin: A Peer-to-Peer Electronic Cash System was published.
  • In 2009, the bitcoin software implementation was released. (The first transaction, or genesis block transaction, carries it with such a piece of information “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.”. The representational meaning of this line looks actually more important then its actual use. This system is designed to revolutionize the banking/monetary system. Whenever we discuss about the flaws or merits of bitcoin system, we should keep this in mind.)
  • On May 22, 2010, a developer bought two pizzas using 10,000 units of a then little-known digital currency called bitcoin.
  • On October 7, 2011, a “fork” of bitcoin, Litecoin, was created
  • In July 2010, Mt.Gox was launched
  • On June 9, 2011, Mt.Gox’s first hack
  • In June 2012, coinbase (GDAX) was founded
  • In May 2013, Silk Road was taken down and FBI seized some bitcoins
  • On August 24, 2017, SegWit was activated
  • On September 4, 2017, the Chinese government banned ICO
  • In December 2017, the BTC/USD price touched $20000

The China gov shut down the bitcoin exchange, forbidding BTC/CNY from being traded publicly. What does the Chinese government fear about?

The instability of bitcoin price, if traded against CNY, might cause social problems (similar to the stock crash in 2015 China).

Then why did the USD/BTC price go higher and higher even after this, totaling in more than 1400% rise in 2017? This is a bubble for sure, and 99% participants are just speculators. Chinese citizen fought to buy bitcoins from U.S. or OTC platforms even after the ban. And if someone bought BTC in china and sell as dollars in U.S., then some CNY became USD and flowed back to China. If bitcoin’s value decreases, then it is equivalent to China’s bitcoin pool uses Chinese electricity to produce waste that can’t be exported to U.S. So you can naturally understand that Chinese gov will take more actions someday, but before that became a reality, everyone wants to win and go — the fear, could contribute to the bubble today.

On compatibility

“Banks are scared to deal with bitcoin companies, even if they really want to”.

Plans were announced to include a bitcoin futures option on the Chicago Mercantile Exchange in 2017. I think this is an important thing, meaning that institutional investors might enter this market with less risk.

Bitcoin is ultimately just another form of financial instrument. If so, then the banks, by definition, can take advantage of it and make money from services based on that. But they hate risks. Many crypto-currencies are in fact controlled by a small group of individuals, and none of the current institutional power can make sure that, say, Ethereum will not crash tomorrow for either human or machine problems.

On Bitcoin itself, more questions than answers

How to interpret the fork economically? What is its impact?

Two points on the reality of actual bitcoin software:

  1. You can erase a transaction log from the blockchain
  2. The bitcoin nodes are not really decentralized

“A bitcoin has value only to the extent that its users agree that it does.” — user-defined tokens.

“The fact that bitcoin’s software guarantees that there will be a finite supply has added to the fear of missing out for some investors.”

Statement on Cryptocurrencies and Initial Coin Offerings from U.S. SEC: https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11

Someone asks our team about the use of blockchain in his application scenario. The idea is that, the transactions happened on the supply chain will be recorded on the public chain, so the trust problems between different parties can be settled with relative ease, since the balance history became consensus. But it costs something — putting transactions on the public chain requires you to pay the fee to miners who helped verifying and persisting your information on the his copy of chain. In this way, you can’t avoid the overhead, and it is significantly huge when you depend on the general public to oversee it.

Conclusion

I don’t think Bitcoin is of substantial real value now — but the infrastructure built around it and the whole ecosystem might be of some. If Bitcoin is really practical for the normal audience in the current society, we will NOT say that an investor’s net value dropped 1% because BTC/USD dropped. Will any Chinese citizen’s net value dropped 1% simply because CNY/USD dropped 1%?

However, it is always business that drives the technology to meet industrial-level requirements. For any tech, it will be either announced death, or widely applied and integrated into our daily life, becoming a reality. But first it must be integrated, and second, it must be practical enough, which involves many non-technical factors like human, capital, policies etc. I think crypto-currency will continue to grow, but it is simply too early and naive to think that bitcoin will be the answer.