Investment risks of holding bitcoins

[marekknowak]

Hi,

I have been reading quite a while regarding bitcoins, and I keep reading that one advantage of using bitcoins, as opposed to traditional electronic money such as e-gold, is that the government can't shut it down, being a de-centralized, peer to peer network.

I though of different objections:

1) Since you can't spend bitcoins to buy food at the grocery (the same way you can't use euros to buy food at at US store, you must first sell euros in exchange of dollars), you need bitcoin-dollar exchanges - and those are centralized organization that the government can shut down.

What government can do too, is forbit payments from credit card companies to those organizations, so it become very hard to be able to sell bitcoins for dollars.

2) Even though it's true that government can never entirely shutdown bitcoin, the same way that it can't entirely eliminate bit-torrent and peer to peer networks, it not necessary to completely eliminate the bitcoin network in order to destroy the monetary value of the bitcoin.

Basically, if the bitcoin network were to be banned, or bitcoin exchanges were to be banned, people would have to go to the black market to exchange bitcoins for dollars, which would become much more difficult that it is now, and premiums on trades would rise so significantly to wipe out any advantage bitcoin would have over other currencies, so that it will effectively destroy bitcoin's exchange value.

I hear the argument that because the government bans drugs, prostitution, gambling, etc ...  and it still exist a thriving market for those goods is the proof that the government can't destroy bitcoin.

The problem, is that those things have a demand that will always exist for: some people want to use drugs, prostitute, and gamble, even though its illegal, because there's no direct substitute.

In the case of bitcoin, there's no demand for it to back up its monetary demand, so as soon and it becomes impractical to use, or too expensive compared to the existing financial markets, its value will go down to practically 0.

Basically, existing fiat money demand is based in the obligation of the population to use it for normal transactions (taxes, banking, etc...) and legal tender laws.

Traditional commodity money (gold, silver) demand, on the other hand, is based on its non-monetary demand, so even when owning gold was made illegal in 1933, it's exchange value didn't disappeared, since it always had that fall back to hold it up (plus, it was held as reserves).

Bitcoin, on the other hand, doesn't have any non-monetary base to support its exchange value, so that it makes investment in it particularly risky, since any obstacle on its use as money (it takes only few cases of fraud for the DOJ to ban bitcoin exchanges) will render it worthless.

What do you guys think?

[davout]

I don't really see on what legal grounds there could be a ban on exchanging numbers and information.

[marekknowak]

I don't really see on what legal grounds there could be a ban on exchanging numbers and information.

e-gold was destroyed on money laundering charges by the DOJ.

bitcoin network and exchanges clearly violates money laundering regulations as well.

And that's only 1 thing.

I'm not saying those laws are good, but you have to be very naive not to be aware of them, and the risk they pose to bitcoin speculators and investors.

[davout]

Let's wait and see
But, as you said there's a lot less the governement can do about bitcoins than about e-gold.

[davout]

And also, such a thing would be lots of free PR for the bitcoin concept XD

[caveden]

Traditional commodity money (gold, silver) demand, on the other hand, is based on its non-monetary demand, so even when owning gold was made illegal in 1933, it's exchange value didn't disappeared, since it always had that fall back to hold it up (plus, it was held as reserves).

Did the value of gold drop sharply after the ban in 1933? (I really don't know)

If the value kept, it means that people kept "hoarding" it as a "store of value". Maybe even if all exchanges are outlawed, people will still keep bitcoins just to protect their money against Bernake's gang.

And, by the way, bitcoin is international... such ban would have to be orchestrated by most governments of the world to be that serious, otherwise it would be just "free advertising" as someone just said.

[marekknowak]

Traditional commodity money (gold, silver) demand, on the other hand, is based on its non-monetary demand, so even when owning gold was made illegal in 1933, it's exchange value didn't disappeared, since it always had that fall back to hold it up (plus, it was held as reserves).

Did the value of gold drop sharply after the ban in 1933? (I really don't know)

No, the opposite, FDR devalued the dollar, so gold went from 20$/ oz to 35$/oz.

Again, bitcoin is not like gold - there's no non-monetary demand to back up its monetary value.

If the value kept, it means that people kept "hoarding" it as a "store of value". Maybe even if all exchanges are outlawed, people will still keep bitcoins just to protect their money against Bernake's gang.

And, by the way, bitcoin is international... such ban would have to be orchestrated by most governments of the world to be that serious, otherwise it would be just "free advertising" as someone just said.

Advertising is not good in itself, you have to advertise something positive about a product.  If what's advertised in the news is that:

Bitcoin is an "illegal ponzi scheme" by "internet terrorists" to "launder money, fund terrorism, defraud elderly granny, and enable crack smuggling", and people now face "10 years in prison for trading bitcoin" plus 100000$ fine.

What would you think will happen to the demand for bitcoin, and hence its exchange value?

[nelisky]

Advertising is not good in itself, you have to advertise something positive about a product.  If what's advertised in the news is that:

Bitcoin is an "illegal ponzi scheme" by "internet terrorists" to "launder money, fund terrorism, defraud elderly granny, and enable crack smuggling", and people now face "10 years in prison for trading bitcoin" plus 100000$ fine.

What would you think will happen to the demand for bitcoin, and hence its exchange value?

For what target audience? Sure, it would probably be a major set back on getting the general public to get on board, but I'm pretty sure it would make the bitcoins already in the market much MUCH more valuable, though cashing in would be heaps harder, I guess.

[davout]

Advertising is not good in itself, you have to advertise something positive about a product.  If what's advertised in the news is that:

Bitcoin is an "illegal ponzi scheme" by "internet terrorists" to "launder money, fund terrorism, defraud elderly granny, and enable crack smuggling", and people now face "10 years in prison for trading bitcoin" plus 100000$ fine.

What would you think will happen to the demand for bitcoin, and hence its exchange value?

For what target audience? Sure, it would probably be a major set back on getting the general public to get on board, but I'm pretty sure it would make the bitcoins already in the market much MUCH more valuable, though cashing in would be heaps harder, I guess.

And it would also advertise strongly that bitcoins are immune to government regulations.

[ribuck]

And it would also advertise strongly that bitcoins are immune to government regulations.

And that would be false advertising.

The traders at my local market only sell for cash, but the taxman knows how to get at least some tax out of them all.

[davout]

And it would also advertise strongly that bitcoins are immune to government regulations.

And that would be false advertising.

The traders at my local market only sell for cash, but the taxman knows how to get at least some tax out of them all.

What do you mean ?

[chickenado]

As long as a Bitcoin exchange a) requires proof of identity from its customers and b) reports large transactions to the authorities, there is no legal basis to shut it down, at least not for money laundering.

[ribuck]

What do you mean ?

I mean that cash is anonymous but not exempt from government regulations (such as taxation). Similarly, bitcoin can be anonymous but not exempt from government regulations.

For me, the essential difference between cash and bitcoin isn't anything to do with regulations, it's that the government can't inflate the number of bitcoins.

[davout]

What do you mean ?

I mean that cash is anonymous but not exempt from government regulations (such as taxation). Similarly, bitcoin can be anonymous but not exempt from government regulations.

For me, the essential difference between cash and bitcoin isn't anything to do with regulations, it's that the government can't inflate the number of bitcoins.

Yea, I agree, also it's much harder to confiscate bitcoins

[RHorning]

In terms of the use of credit cards to buy Bitcoins, most people who exchange Bitcoins for government currencies including all of the "major exchanges" for Bitcoins simply refuse to use credit cards or worse yet PayPal for financial transactions.  For those who did for a short time got burned real bad and gave up right away.  Seriously, a credit card is one of the worst possible "financial instruments" that I can possibly imagine and it hurts both the purchaser and the merchant in more ways than I can count right now.  About the only people who stand to gain from credit cards are scam artists who "work the bank", "identity thieves", and the banks themselves.

If there was some legislation that would prohibit the exchange of Bitcoins for U.S. Dollars through a credit card at the moment, it would have zero impact of any kind upon the Bitcoin economy and most people who use Bitcions would say "duh, you shouldn't be using them anyway".  The only reason as a merchant you might want to accept credit cards is strictly on the hope that you might get more customers that way by having more options to pay.  If most customers to a store stopped using credit cards and paid cash instead, a typical merchant would drop the credit card option like yesterday's bad news.

As far as buying groceries for any monetary unit, most grocers that I know are willing to try just about anything as long as they can get something for it and run their business.  I think a solid business plan and rationale can be made for a grocer to use Bitcions for the purchase of their product, provided there might be farmers or other food producers who would accept Bitcoins as payment for product (you might be surprised!) and if any of their employees might take Bitcions as a wage.  The primary motivation factor however would simply be if there are customers who have Bitcoins and are willing to spend them in a store that accepts them as opposed to a competitor who doesn't.  If a grocer can get several hundred or thousand dollar equivalent in Bitcoins per day, it would be a no-brainer and they would even put advertising "We accept Bitcoins" on their door and newspaper ads.  Grocery sales are such a low margin business that any kind of competitive business advantage would be huge.  The only reason you don't see that now is simply because the customers don't exist... yet.

I should also note here that I have gone to places like Brazil and Mexico with U.S. Dollars (where clearly there is a local currency too) and as long as I was paying cash (forget the credit cards) I was able to survive completely with just the dollars.  You perhaps shouldn't expect change (as they may have none in dollar denominated currency... you may be surprised however) but as long as you pay in small bills it isn't too much.  This included buying groceries, paying taxi fare, and even renting a hotel for the night or buying a meal in a restaurant.  I also know of some places in America that also accept Euros directly, mainly in heavy tourist areas or near airports connecting to Europe, but you might be surprised there as well.  There is nothing that says you can only use Dollars in America, only that you can't counterfeit the currency.  Coining metal is a bit trickier, but you aren't coining precious metal with Bitcoins.

As for "illegal activity" with regards to money laundering, prostitution, "ponzi schemes", illegal drugs, and other kinds of "black market" financial activity, that has been going on and will continue to go on without Bitcions.  How do you think the Kennedy family in Massachusetts got their money in the first place?  Smuggling Irish Whiskey during the Prohibition Era proved to be incredibly profitable.

It may be possible to ban Bitcoins, but they would want to do that in a generic way where they would also try to keep other similar kinds of currencies being created in the future.  If they were to outlaw "cryptographically secure electronic money transfers", that would essentially ban almost all transfers of money electronically in any form.  About the only thing I can see is a government requiring you to have a license to conduct an electronic monetary transaction.  Even that would backfire by essentially making all on-line purchases illegal in any form.  Really, it would be very hard to come up with a legally tight definition of Bitcoins that would distinguish what Bitcoin is that other currencies aren't when transferred electronically.  It is like stupid attempts to outlaw peer to peer software, which almost always backfires on those legislators and ends up ignoring how TCP/IP is even set up in the first place.  An attempt to outlaw Bitcoins is essentially outlawing money altogether.

[cartman]

Regarding the initial post:

In theory, the value of a Bitcoin derives from the (anticipated) amount of Bitcoins and (anticipated) produced goods (and services) within the network. The value should therefore be independent of the possibility to change it to another currency. Imagine US$ couldn't be exchanged any longer. It wouldn't matter that much in the long run.
The crucial part might however be the anticipated amount of produces goods, since the rate of new vendors joining the network might decline when lacking the opportunity to exchange. This effect decreases considerably with the size of the network.
Counter-arguments appreciated!

[Cryptoman]

I think it's possible to craft legislation banning any unapproved payment systems or monetary instruments.  To become "approved," a system would have to be non-anonymous, with exceptions being made for national currencies (which may soon have tracking capabilities anyway).  Governments really dislike their slaves having any true freedom, and I fully expect an attempt to eradicate p2p currencies at some point.  But I think the liberty or anarchy or whatever-you-want-to-call-it movement is here to stay, and any attempt to crack down will scare a few people around the edges away but will also drive an even greater percentage of the economy underground.  This in turn will undermine the respective governments even more and only accelerate their demise. 

Another, more immediate risk of holding Bitcoins is the exchange rate fluctuation.  It's hard to convince merchants to accept Bitcoins when the value of their holdings can vary 30% over just a few weeks as has occurred recently.  It makes financial planning very difficult.

[RHorning]

I think it's possible to craft legislation banning any unapproved payment systems or monetary instruments.  To become "approved," a system would have to be non-anonymous, with exceptions being made for national currencies (which may soon have tracking capabilities anyway).  Governments really dislike their slaves having any true freedom, and I fully expect an attempt to eradicate p2p currencies at some point.  But I think the liberty or anarchy or whatever-you-want-to-call-it movement is here to stay, and any attempt to crack down will scare a few people around the edges away but will also drive an even greater percentage of the economy underground.  This in turn will undermine the respective governments even more and only accelerate their demise.

I've been involved in working with legislators who are trying to write legislation of various kind where coming up with a legal definition of something is often very difficult.  Yes, "the word" can go from legislators to law enforcement agents that essentially one particular thing is simply not wanted (aka Wikileaks) but even there you get unintended consequences that essentially outlaw.... well things that campaign donors care about so it becomes embarrassing politically when that happens.

I'll also say this:  Software developers of a small group (especially open source projects) can certainly get things to happen and change faster than any legislation.  A monarch or a totalitarian dictator may be able to get things to happen quickly, but most of us live in places where the government is by design inefficient and slow to change or adapt.  As an individuals we might get attacked but it is hard to get everybody, especially when we are in so many different jurisdictions.

[Anonymous]

The government wont like bitcoin because people can see that the government bitcoin address is the one buying all the hookers and blow. 

[RHorning]

The government wont like bitcoin because people can see that the government bitcoin address is the one buying all the hookers and blow. 

Unless of course it is the politician who is buying those hookers and trying not to get caught.  You might find some strange political allies if the government got into the game.  Not all politicians are beholden to the major banks, even if they may not be people you would want to have babysitting your children.