Saturday, January 25, 2014

Questions About Bitcoin

The hype about Bitcoins is reminiscent of some of the early hype about the Internet.  Long, long ago, in the Paleolithic times of 20 years ago, the Internet was seen as an idyllic world where all would be equal and a person could accomplish anything with a computer and just a little effort.  The wide open nature of the Net allowed anyone, however anonymous and humble, to speak out and be heard, create and be seen, reach out and touch untold millions, all with just a few keystrokes.  Wondrous things would happen; lead would be turned into gold; a veritable digital Eden would arise and everyone who entered would attain nirvana.

Well, it didn't quite work out that way.  Gigantic corporations now dominate the Internet, and powerful government agencies lurk in the background, spying high and low, leaving no server unmolested.  Bad people from around the world seek to victimize, defraud and destroy; and the wide open nature of the Net allows them to do so with just a few keystrokes.  The free-standing individual who was supposed to have been the pillar of the digital community has shrunk into an online sheep, waiting helplessly to be fleeced of all personal information, browsing habits, bank funds, and credit lines.

The Norman Rockwellian narrative of Bitcoins would have us believe that they are a pure form of value, unmarred by the pock marks of central bank policy.  "Mined" by solving mathematical problems, transacted anonymously on a peer-to-peer basis, Bitcoins would be finite in amount and invulnerable to inflation since no one, supposedly, would control them.  Those who held Bitcoins would be liberated from the oppression of governments and the highway robbery of fee-charging financial institutions that handle transactions in fiat currencies.  A brave new monetary system would supersede the corrupt, degenerative fiat currencies of yore, the clouds would part and the sun would shine forever.

But reality is turning out to be blemished.  It seems that the use of Bitcoins for payment made an online market for illegal drugs called Silk Road attractive to denizens of dark corners of the Net.  The anonymity of Bitcoin transactions is a godsend for scoundrels and knaves of every variety, with government crime fighters largely unable to figure out who to put on the Ten Most Wanted List.  It's now clear that Bitcoins will attract criminals, organized criminals, terrorists, tax evaders, and other miscreants with something to hide.

But, are there bigger monsters lurking in the shadows?  Rogue nations, which may be facing sanctions in financial systems denominated in fiat currencies, might find Bitcoins a convenient way to get back in business.  And business could be nefarious indeed, with weapons, equipment for processing radioactive materials, drugs, and other suspect cargo changing hands.  Intelligence services--foreign and domestic--would have many reasons to use Bitcoins.  Undercover operatives need to be funded.  Bribes need to be paid.  Deniability would be enhanced.  Detectability--and accountability--would be reduced. 

Then, there's the market for Bitcoins.  Unregulated and opaque, it's ideal for manipulators and fraudsters.  The mining process is getting harder and harder, as the mathematical problems that need to be solved become increasingly difficult.  More and more computing power is needed to solve them.  That means bigger, more complex and more expensive computers must be used. The advantage goes to those that are well-capitalized.  Yet the price of Bitcoins is notoriously volatile.  Who can afford to invest in the massive computing power that it now takes to operate a successful mining operation while withstanding the wild price swings in Bitcoin prices?  Wealthy speculators, rogue nations, organized crime, and financiers operating from secrecy jurisdictions might all see an opportunity to make a fast Bitcoin or two--or maybe a lot more--off of the naive true believers who buy and transact at the retail level.  Trading anonymously, these big boys could bid prices up using multiple accounts they control to trade back and forth with themselves.  They could pay for online ads hyping Bitcoins as they walk the price up, provoking an investment frenzy among the sheep.  Then, as the price reaches meteoric levels, they dump the coins that they've mined, and then walk away, leaving the price to move whichever way it will (which is likely to be down). 

The biggest potential problem for Bitcoins may well be that the big players will move in.  And, as with the Internet, the little people will suffer.  Invest at your peril.

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