Why Bitcoin changed the world... and its price will crash

[CryptoPhilanthropist]

All of us are tired of hearing the same weak arguments made against Bitcoin by reporters and mainstream economists who don't understand the fundamentals of cryptocurrency. Two weeks ago, I began my own exhaustive research into BTC valuations, because I was trying to determine whether to make a significant investment after the China-induced price dip. Unfortunately, I have come to believe that Bitcoin is significantly overvalued.

In order to understand why, we need to recognize that Bitcoin challenges two distinct aspects of the existing financial order: (1) the issuance of banknotes and (2) the use of centralized clearinghouses to transfer funds electronically. The vast majority of public attention has been focused on the first factor. The perception of Bitcoin as a deflationary alternative to fiat currencies has contributed to its ideological popularity and caused many people to drive the price up by hording it like gold.

But what is actually revolutionary about Bitcoin is the second factor: the creation of an alternative electronic network for authenticating transactions. That network has been extremely secure and reliable, while offering two giant advantages over legacy competitors like PayPal: transparency and irreversibility. For the first time ever, there is a form of online payment that is as reliable as cash. Clearly, that was an unmet need in the marketplace, and it is the most thrilling and satisfying part of conducting transactions with Bitcoin.

The problem is that in the future there will be no intrinsic reason for Bitcoin to be the unit of currency used to conduct financial transactions using distributed blockchains. Alternative cryptocurrencies like Litecoin and Peercoin offer the same advantages over traditional means of transferring funds electronically. The fact that these currencies trade like pennies compared to Bitcoin indicates that the current BTC price has more to do with the perception that BTC is a store of value than it does with its actual technological merits. This value disparity can only be justified if BTC is essentially preordained to remain the world's dominant cryptocurrency.

The primary argument in Bitcoin's favor is the network effect — i.e., that it will obtain an insurmountable advantage by being the first cryptocurrency accepted by most merchants. But once merchants understand how to integrate cryptocurrencies into their businesses, they won't have any incentive to remain loyal to BTC instead of also accepting the 2nd or 3rd most popular cryptocurrencies. That will only require a Bitpay clone to make it easy and remove most of the risk.

Worse, Bitcoin's design actually creates a sort of 'reverse network effect' in which its success makes it impossible for most miners to participate in authenticating transactions. The use of alternative proof-of-work algorithms to allow CPU mining of alternative coins will allow them to claim a potential security advantage by building diverse networks full of competing nodes. It also remains to be seen whether the absence of any proof-of-stake algorithms will come to be viewed as a significant flaw in Bitcoin. Even if Peercoin's divided block structure proves suboptimal, there may be other ways to implement proof-of-stake that increase security while also decreasing future transaction costs by limiting energy expenditures.

Some believe that the dominance of ASIC rigs in BTC mining is advantageous because it increases the expense of interfering with the BTC network. But competing currencies can make themselves attractive to the same ASIC miners simply by adopting the hashcash proof-of-work standard.

I foresee a collapse of BTC value when the first large financial institutions release cryptocurrencies of their own, which are actually backed by tangible assets like gold or by fiat currencies. Those will not be ideologically appealing to most people who post here, but the business model makes perfect sense. The fear that the public and media have about BTC is that it is an attempt to create wealth out of thin air. Having a trusted bank issue individual coins representing actual assets will allow them to be more valuable than BTC is today, making them more attractive to mine. These bank-backed cryptocurrencies would look to many like the 'best of both worlds': the guaranteed value of a traditional bank note with the transparency and irreversibility of distributed block-chain logs.

The nature of all attempts to disrupt existing power structures in society is that the elites first resist and then join and co-opt. Bitcoin will go down in history as the first proof-of-concept for distributed financial authentication, which is going to emerge as a serious competitor to PayPal and its ilk. But the financial establishment is not going to sit back and accept the idea that a bunch of anarcho-libertarian first adopters are entitled to be millionaires. The very things that attract most people on this forum to BTC, like its edginess and anti-authoritarian image, will be its downfall when it has to compete for mass market support against bank-issued cryptocurrencies that will pay miners/stakeholders handsomely for their authentication services.

These are realities that people on Wall Street know and believe. But they aren't being priced into BTC right now because there is no real way to short the currency's value, at least not with the scale and reliability that hedge funds demand. If there were, I guarantee there would be a significant amount of money willing to take the opposite side of bets against the BTC community's true believers.

Ultimately, the entire Bitcoin story will reinforce the truest aphorism of all: "Nothing is ever as good or as bad as it seems."

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[MikeH]

there have been many technologies that have won out against competitors not because they are the best but simply because everyone else used it.. as long as bitcoin adapts to changing requirements I don't see a huge move to alternatives.

oh and the main reason bitcoin is so popular is because there is no trust for financial institutes so that prediction is way off.

[Peter R]

Well written post, CryptoPhilanthropist.

Some questions, though:  You mentioned that the bank's crypto-currency would be backed by gold or fiat currencies.  How exactly would they be backed?  Would the banks maintain a peg, such that I could exchange 10 of my JPMorgan coins for $10 USD?

Secondly, you mentioned that the coin would still use decentralized mining (you mentioned CPU mining).  Does this coin still have a block reward to entice miners to mine?  Now, if the coins are backed like you said by fiat currency, where does the fiat currency come from to back the newly mined coins?  Or does the bank just adjust the peg in order to revalue the coin as needed?

Thirdly, do you think if banks were in control of such systems, then they may be required by law to add AML/KYC features such that irreversibility and world-wide transfers are difficult/impossible?  For some reason, I just have this gut feel that any "controlled coin" would not be nearly as free as bitcoin, because there is a central point that governments could regulate in order to extract fees/taxes and reverse "bad" transactions.  

[MikeH]

Some questions, though:  You mentioned that the bank's crypto-currency would be backed by gold or fiat currencies.  How exactly would they be backed?  Would the banks maintain a peg, such that I could exchange 10 of my JPMorgan coins for $10 USD?

they would say it's backed by gold but will refuse to be audited - it'll never happen, there'd be no support because most bitcoin holders know these pricks should be in jail.

[ak84]

The problem is that in the future there will be no intrinsic reason for Bitcoin to be the unit of currency used to conduct financial transactions using distributed blockchains. Alternative cryptocurrencies like Litecoin and Peercoin offer the same advantages over traditional means of transferring funds electronically. The fact that these currencies trade like pennies compared to Bitcoin indicates that the current BTC price has more to do with the perception that BTC is a store of value than it does with its actual technological merits. This value disparity can only be justified if BTC is essentially preordained to remain the world's dominant cryptocurrency.

This is a specious argument. There are other cryptocurrencies that COULD offer the same functionality, but without bitcoin's marketing, brand name, momentum, and established infrastructure in its miners and its holders. So then they don't really offer the same advantage after all. A currency 's value is not solely determined by its technology and features.

[BTCisthefuture]

Only read the first couple sentences but   1) I would agree that right now bitcoin is overvalued in comparssion to how much adoption and usage it currently  has .... however......  2) Bitcoin has a ton of potential in the future and it's still in such it's early stages that I don't think it's unreasonable to think in coming years bitcoin could be more properly   valued and still be quite a bit higher than it is currently.

So even if it is overvalued currently, a lot of people would argue they don't care because they are investing based on it's valued 5-20 years down the road.

[BTCisthefuture]

The problem is that in the future there will be no intrinsic reason for Bitcoin to be the unit of currency used to conduct financial transactions using distributed blockchains. Alternative cryptocurrencies like Litecoin and Peercoin offer the same advantages over traditional means of transferring funds electronically. The fact that these currencies trade like pennies compared to Bitcoin indicates that the current BTC price has more to do with the perception that BTC is a store of value than it does with its actual technological merits. This value disparity can only be justified if BTC is essentially preordained to remain the world's dominant cryptocurrency.

This is a specious argument. There are other cryptocurrencies that COULD offer the same functionality, but without bitcoin's marketing, brand name, momentum, and established infrastructure in its miners and its holders. So then they don't really offer the same advantage after all. A currency 's value is not solely determined by its technology and features.

Very well said.... when bitcoin already has the brand name,  literally hundreds of millions are being invested into startups and building out infrastructure and adoption.  It's doesn't seem all that likely bitcoin would suddenly dissappear and everyone takes all that time and effort spent growing out bitcoin only to do it a second time around for something that isn't that much different.

On the flipside of things one could argue that if a large company like say a Google was to step in and create their own world cryptocurrency it could still have the potential of over shadowing bitcoin if it was done soon enough that bitcoin is still so small. Based on the same reasons you mentioned, the brand name and in the case of google actually having the finincally and technical and business support to actually make adoption happen much quicker than the more grass roots bitcoin community.  Of course something like tht would probably have to happen sooner than later. Once bitcoin adoption grows to a certain level it would be very hard to switch to something else.

[jonanon]

Very interesting read although I would have to disagree with some of the main fundamentals of the arguments you have put forward.

However only time will tell.

 

[epcritmo]

I agree strongly with the arguments about infrastructure. Just to add in another analogy and comparison; currently, facebook has such a large userbase and guaranteed infrastructure that even the internet giant Google is finding it very hard to implement its Google+ to compete. I'm sure I'm like many more; I'm on facebook, everyone I know uses it, it does the job I need it to do, why would I choose to move to google+. Mybe the same will be true for bitcoin.

[ISAWHIM]

The value of the coin is irrelevant, as long as everyone agrees it has value and can be exchanged. (Agrees to "a value", for an exchange.)

But I agree, for me, that the current value people are asking for is too high. If you believe that too, feel free to give me your coins for half the price they say it is worth. I will take all you have to offer, up to $30,000,000 worth.

Money is nothing more than credit, backed by nothing more than a promise from a bank, that promise is, "I will be happy to take this from you, and give you less than you gave me, after I tell your government that you are in possession of these funds."

They will also happily give your money to some stranger, in the hope that the stranger gives them back more than the bank let them borrow. Thus, extending the promise of, "I will be happy to take more of this from you, then what we had originally given you." (Slightly modified, but it is still the same promise.)

The future of BTC is also over-rated, since BTC is not the only digital-coin with the same "limited" individual attributes. So, the illusion that digital-coins are limited in quantity, is just that. Only the specific coins are limited, but just like a bank, endless coins can be created by just making another coin to split the value or hide the value. So in that aspect, BTC is a failure. (That was one of the many issues/flaws with the coin from the beginning.)

Will it replace money? No, just as credit-cards and ATM cards have not replaced money. Because you can easily launder money, and hide it, and keep its transactions anonymous. BTC transactions are not anonymous, only the individuals identity of ownership is anonymous. It is not the same thing. You can actually send physical money anonymously, and no-one would ever know you sent it to anyone, or who sent it, other than you. Well, the person who gets it, would know they got it, and might record it, but they would not know who it came from. As opposed to sending a BTC, which records the send and the receive.

Loved reading what you wrote, all of you. Great perceptions.

BTC (digital-coins), with limited production, have a purpose in society. To that, BTC is a 100% winner. Even with all the short-falls. Every currency has a short-fall. So it is right up on par with the rest.

[BittBurger]

Alternative cryptocurrencies like Litecoin and Peercoin offer the same advantages over traditional means of transferring funds electronically. The fact that these currencies trade like pennies compared to Bitcoin indicates that the current BTC price has more to do with the perception that BTC is a store of value than it does with its actual technological merits.

Disagree.  BTC's current value relates to the accurate prediction that it was first on the scene, is currently the most widely adopted, and is slated to have hundreds of millions more poured into it, in the future.  The mere existence of copycats doesn't mean the first version is automatically the same value as the copycat.  That logic doesn't resonate with me at all.  

That would be like saying a Led Zeppelin cover band could sell the same number of albums as Led Zeppelin.  

This value disparity can only be justified if BTC is essentially preordained to remain the world's dominant cryptocurrency.

That's exactly why its justified.  Not sure what predordained has to do with it.  What really matters is moreso adoption.

-Burger-

[jaked]

I foresee a collapse of BTC value when the first large financial institutions release cryptocurrencies of their own, which are actually backed by tangible assets like gold or by fiat currencies.

What do you mean by "backed"?
Backing a virtual currency by a physical commodity implicitly means that the "backer" has the power to generate coins as he wishes.
Cryptocurrencies don't need any tangible backing, as they're backed by mathematics.

Sure, financial & political institution will try to ride Bitcoin's success, and create their own versions of "crypto" "currencies", but it won't be nor "crypto" nor "currencies".
As soon as people understand the difference between trust and proof, they'll say goodbye to the fiat schemes.

[marcus_of_augustus]

OP ... wants to buy in cheaper?

[Michael Robinson]

Blah blah blah, Bitcoin is finished, blah blah blah, Bitcoin is inevitably going to fail, blah blah blah...

Why do so many random people suddenly have an "epiphany" and post crap like this over and over and over and over and over again, it got tiresome 4 years ago.  

[marcus_of_augustus]

Blah blah blah, Bitcoin is finished, blah blah blah, Bitcoin is inevitably going to fail, blah blah blah...

Why do so many random people suddenly have an "epiphany" and post crap like this over and over and over and over and over again, it got tiresome 4 years ago.  

... economic incentives are strong ... we get a fresh wave of them after every "bubble crash", i.e new 10-folding adoption spike.

Sometimes the variations on the theme can be entertaining, depending on the personalities involved, the latest batch seem quite banal (might be the banksters, accountants and lawyers showing up?)

[pening]

I foresee a collapse of BTC value when the first large financial institutions release cryptocurrencies of their own, which are actually backed by tangible assets like gold or by fiat currencies.

What do you mean by "backed"?
Backing a virtual currency by a physical commodity implicitly means that the "backer" has the power to generate coins as he wishes.
Cryptocurrencies don't need any tangible backing, as they're backed by mathematics.

Sure, financial & political institution will try to ride Bitcoin's success, and create their own versions of "crypto" "currencies", but it won't be nor "crypto" nor "currencies".
As soon as people understand the difference between trust and proof, they'll say goodbye to the fiat schemes.

If institution X created a cryptographically secured proxy for gold, $, wheat futures or whatever, and its widely available and accepted, its a cryptocurrency.  Thats the OP's premise, that the primary advantage of Bitcoin is the secure, trusted, transfer of funds.  Now, many would not agree this is the only purpose and say there are alot of other reasons, but its a fair point it is one of the major advantages.  Take that advantage and replicate it in to some thing that is trusted and easy to access/obtain/reimburse etc and you have something which will possibly have larger mainstream acceptance than Bitcoin.  A large amount of the value is based on speculation that Bitcoin is destined to become common use and therefore highly valuable (due to limited supply) and you lose that speculative value if a common replacement is in use.  

[waxwing]

I foresee a collapse of BTC value when the first large financial institutions release cryptocurrencies of their own, which are actually backed by tangible assets like gold or by fiat currencies.

I'm afraid you still don't quite get it (you're not alone!) You cannot back a cryptocurrency with gold or fiat. You can create an electronic form of money backed by gold or fiat. We already have that. Just open your internet banking software to see it.

The whole reason a cryptocurrency is attractive is because it has no third party. That is what brings its cost down to near zero and, more importantly, makes it essentially impossible to control or regulate.

If you try to create an asset-backed digital instrument, you need someone or something to keep that backing stable and ensure/enforce it. You need a third party. We've already seen such systems, and they are entirely different to Bitcoin.

[marcus_of_augustus]

I foresee a collapse of BTC value when the first large financial institutions release cryptocurrencies of their own, which are actually backed by tangible assets like gold or by fiat currencies.

What do you mean by "backed"?
Backing a virtual currency by a physical commodity implicitly means that the "backer" has the power to generate coins as he wishes.
Cryptocurrencies don't need any tangible backing, as they're backed by mathematics.

Sure, financial & political institution will try to ride Bitcoin's success, and create their own versions of "crypto" "currencies", but it won't be nor "crypto" nor "currencies".
As soon as people understand the difference between trust and proof, they'll say goodbye to the fiat schemes.

If institution X created a cryptographically secured proxy for gold, $, wheat futures or whatever, and its widely available and accepted, its a cryptocurrency.  Thats the OP's premise, that the primary advantage of Bitcoin is the secure, trusted, transfer of funds.  Now, many would not agree this is the only purpose and say there are alot of other reasons, but its a fair point it is one of the major advantages.  Take that advantage and replicate it in to some thing that is trusted and easy to access/obtain/reimburse etc and you have something which will possibly have larger mainstream acceptance than Bitcoin.  A large amount of the value is based on speculation that Bitcoin is destined to become common use and therefore highly valuable (due to limited supply) and you lose that speculative value if a common replacement is in use.  

Want to quantify such speculative prognostications?

There are 12e10^6 in existence, at least 25% which are not in circulation, somewhere between 1-10 million users seems an OK approximation ... =>the average bitcoin holder has ~ $1000 in bitcoin ...

ummm doesn't sound all that speculative to me, more like pocket change found down the back of the sofa, maybe the cookie jar cash kitty has gone into bitcoin.

[jaked]

I foresee a collapse of BTC value when the first large financial institutions release cryptocurrencies of their own, which are actually backed by tangible assets like gold or by fiat currencies.

What do you mean by "backed"?
Backing a virtual currency by a physical commodity implicitly means that the "backer" has the power to generate coins as he wishes.
Cryptocurrencies don't need any tangible backing, as they're backed by mathematics.

Sure, financial & political institution will try to ride Bitcoin's success, and create their own versions of "crypto" "currencies", but it won't be nor "crypto" nor "currencies".
As soon as people understand the difference between trust and proof, they'll say goodbye to the fiat schemes.

If institution X created a cryptographically secured proxy for gold, $, wheat futures or whatever, and its widely available and accepted, its a cryptocurrency.  Thats the OP's premise, that the primary advantage of Bitcoin is the secure, trusted, transfer of funds.  Now, many would not agree this is the only purpose and say there are alot of other reasons, but its a fair point it is one of the major advantages.  Take that advantage and replicate it in to some thing that is trusted and easy to access/obtain/reimburse etc and you have something which will possibly have larger mainstream acceptance than Bitcoin.  A large amount of the value is based on speculation that Bitcoin is destined to become common use and therefore highly valuable (due to limited supply) and you lose that speculative value if a common replacement is in use.  

How can an algorithmic artifact be a proxy for physical gold?
Someone has to update the network manually on the amount of gold in existence, since the digital network can't figure it itself.

This means: trust.

Trust & cryptocurrencies don't mix.

[TTBit]

When people were connecting computers together in the 1980's, they didn't have the goal of the internet as we know it now, much less websites such as Facebook or Twitter. It was clear that the value of two computers connected together was greater than two computers not connected, so it was done. Protocols were written which are still in use today. Today, there appears to be a value in a public ledger, otherwise it wouldn't be done. The early adopters of the internet failed to see Facebook.com and Twitter.com, but that doesn't mean they didn't see value at the time.