Another oddball "investment", bitcoins

Investments come in all shapes and sizes, and only a fraction of investable items actually trade on an exchange.  I recently came across something a lot of people claim is an investment, but I view as more of a fascination, BitCoin, a digital currency.  This is probably the most oddball investable item I've ever ran across.  I stumbled on an article about bitcoins a week ago and have read a number since, the whole process is intriguing.

A bitcoin is nothing more than a tiny piece of data residing on a user's hard drive, but with that little bit of information people can purchase real goods.  The idea behind the currency was to create a digital payment system that was secure and not owned by any one country.  In theory a user in Mongolia could use bitcoins to purchase a laptop in North Carolina as easily as a user in North Carolina could use bitcoins to purchase an item from Amazon.  The problem with this is not many retailers actually accept bitcoins as payment for much of anything.

The problem with currencies and money is one of supply.  In most developed countries central banks are flooding the market with new money in the form of quantitative easing.  In the world of bitcoins money is created differently.  Money is digitally mined and created by users.  A user runs a mining program which runs some sort of creation algorithm to create new coins.  The system is built so that each new coin created costs more than the last when measured in processing time.  This means that in theory the supply is limited.

This is where things get interesting.  In the beginning of bitcoins users could run a CPU's all night long to create coins.  Eventually processing became hard enough that users would run rooms of computers, and then eventually whole networks of computers to mine coins.  As the cost to mine coins increased so did their value.  It was easier to purchase a new coin rather than create a new coin.

Besides processing power a driver to bitcoins value is the ease of obtaining the currency.  I've gleamed from threads on the subject that to link a bank account to a bitcoin account is fairly complicated.  Many of the companies involved don't exactly have glistening reputations, and they place limits on the amount of money that can be converted into bitcoins in a single day.  A few innovative students have created a bitcoin ATM where customers deposit cash and receive bitcoins in return.  The ATM seems like a dream device for a money launder, deposit cash and turn it into intractable currency.

In one article I read mentioned people buying specialzied asic processors for $1200 to mine coins.  The asic (whatever the heck that is) is specialized so that it can mine coins quickly and buyers can pay off the purchase price in a month or less.  Extrapolating this would mean that an asic buyer could potentially make $1k a month by just letting this asic run continuously.

Here is a chart showing the price of a bitcoin over the past few years:

The chart speaks volumes as to why people are interested in bitcoins as an investment, it appears to be a can't lose deal.  Buy some coins, sit and wait and the price will go up, or invest in the asic mining equipment, create coins and sell them at ever increasing prices.

As I read about bitcoins I couldn't help but draw a connection to them and gold.  In a way bitcoins are a digital version of gold.  There is a finite supply although marginal supply increases are happening at an increasingly slow rate.  Gold is still mined but it takes more time and energy to find smaller and smaller amounts.  Gone are the days when you could stumble on a gold nugget walking the California beach.  Bitcoins are the same, for the first users running a computer for a few hours could make them thousands of dollars, now specialized equipment and increasing amounts of time are required to create the same value.

The most interesting aspect of bitcoins for me is the speculation aspect.  In almost all of the articles I read about bitcoins a passing reference was made to what a bitcoin could buy, but most of the emphasis was on their investment value.  Users could supposedly buy all sorts of goods with the coins yet almost everyone buying coins is doing it because they continue to go up in value.  When buyers of an asset are all speculating the floor can fall out quickly.  Last year bitcoins reached a high of $30 per coin and quickly crashed 90%.  The price of coins has now recovered which has the market in a fervor, everyone suddenly wishes they would have purchased when the coins were at $3.  I saw a lot of comments about people buying now because they're afraid they'll miss the runup.

Ultimately with the bitcoin market composed mainly of speculators and not many users I can't imagine this digital currency gaining actual momentum.  The mark of a currency is stability, people want prices to be predictable and forcastable.

Watching bitcoins could be the modern equivalent of watching Dutch tulip prices. No matter how much market history exists humans still want to make a quick buck and let emotions rule their investment decisions.

Talk to Nate


  1. Never thought I will read about bitcoins on this I have seen everything !! ;-)

  2. "The system is built so that each new coin created costs more than the last when measured in processing time. This means that in theory the supply is limited."

    It is true that the supply is limited, but this is not the reason why. The reason that the supply is limited is this: bitcoins are created at a fixed rate and that rate will eventually drop to 0, after which no more bitcoins will be created.

    1. Ah, very important point. So then why is it taking an increased processing power to mine each new coin? It's an interesting ecosystem without a doubt.

    2. The system has been designed to limit block solving (which currently rewards 25btc to the solver) once every ten minutes.
      As more mining power joins the network and computers get faster, the system adjusts itself making it more difficult to solve a block. If people lose interest in mining the blocks get easier to solve.
      The system attempts to create an equilibrium.
      The few people who already own ASICs to mine have a big advantage as they own technology far in advance of the average user, but as more people start using them, equilibrium will be reached again.

  3. Overall a pretty good evaluation of Bitcoin especially compared to most other articles on the subject where you can't get past the first paragraph without reading something about drugs or gambling. Your analogy to gold is spot on. Bitcoins are essentially internet gold and obviously way more divisible and transportable than the yellow metal.

    I disagree with part of this statement however:
    "This means that in theory the supply is limited."

    Not in "theory" but "in fact".

    This is one of the most important aspects of Bitcoin and is hardwired into the protocol. There will only ever be a maximum of just under 21 million bitcoins mined. This prevents inflation as Bitcoin was designed to be a deflationary currency. This is important as it allows bitcoins to act as both medium of exchange and a store of value protecting one's purchasing power over the course of time. Something that the USD can't claim because of people like Bernanke and Greenspan who have robbed savers with their ridiculouly low interest rate policies.

    Bitcoin could be a game changer. We will find out soon enough.
    Full disclosure: Long bitcoins (obviously).

  4. The article is missing a mention of Silk Road or similar markets for illegal/dodgy goods, where it is a good match for the problem, and where there might be some non speculative use.

    Also the limit for mining is not just kit and time, it's also power: you can still make a few bitcoins with a desktop CPU, but they are worth less than the power consumed to mine them. Even with ASICs, people in cheap electricity places have an advantage.