Why the End of Bitcoin is a Matter of Time

Is Bitcoin a good investment? Photo Credit Pixabay

A recent Survey Monkey poll found that 60% of Americans have now heard of Bitcoin and  21% are considering buying it. These numbers are a big jump from just a few years ago, but no surprise given the media attention Bitcoin has garnered.  Additionally, The Student Loan Report found that 21% of students reported using part of their financial aid to buy Bitcoin or other digital currencies and some people have taken out loans on their homes to buy it.

First of All, What Is It?

Bitcoin was designed to be used as an alternative to regular currency. The idea being that governments control the value of their money through various tactics like printing more of it and that this control over the value of money was bad for the people using it.  Bitcoin doesn’t have a central bank or central command or any single entity controlling it.

It is a “currency” that exists only in digital form so there are no physical Bitcoin, even though you’ve seen artists’ renderings like the one above. Bitcoin exists on a digital network of volunteer computers. These computers are used to process Bitcoin transactions and update the digital records on the Bitcoin network. The owners of these computers are rewarded with transaction fees and Bitcoin of their own. Each group of transaction records added to the network is called a Block. Each Block contains information which links it to the previous Block on the network creating the Blockchain. Because the Blockchain exists on a network of independent computers, it is virtually impossible to hack or falsify. Even if one of the computers was compromised, the records stored on the rest of the network would quickly invalidate any inaccurate or manipulated Blockchain data.

Why Is the Price So High?

The number of Bitcoin that will ever be available is capped at about 21 million. This means if the number of people who want to own Bitcoin increases, the only way they could acquire it is by paying more for it. A limited supply plus growing demand, equals rising prices.

Last year the price of a Bitcoin skyrocketed from about $1,000 early in the year to nearly $20,000 in December. The value of a Bitcoin is based solely on what someone else is willing to pay for it.  When someone buys Bitcoin, they are hoping that someone else will come along later who is willing to buy it from them for a higher price. When the selling price of Bitcoin broke through the $1,000 level, more people started to notice the digital currency.

As more people saw that the price of Bitcoin rising, more of them thought it was a good opportunity to profit. This created a sort of reverse panic. Speculators started to believe that there was no limit to how high the price could go and that if they didn’t buy Bitcoin as soon as possible, they would regret it for the rest of their lives.  Today the price of a Bitcoin is around $7,000. Bitcoin is not an investment, but a bet that you can find someone willing to pay more for your Bitcoin than you did.

Why the Long Term Future of Bitcoin is Not Great

There are still industry experts that are predicting the price of Bitcoin could hit $50,000 or more this year.  In all honesty, that is a possibility. There is no  reasonable way to calculate a value for Bitcoin, so anything could happen. Its price is driven by what people hope it might do someday, but it’s getting harder to come up with what it may ever actually do. The long term problem for Bitcoin is that other than the possibility of being able to sell it to someone else for more than you paid, there is virtually no use for it. Here are a few reasons why it’s unlikely Bitcoin will catch on:

It’s Not Very Good for Making Purchases:  One of the original intents of Bitcoin was for it to be used as an alternative currency. Unfortunately, hardly anyone wants to accept Bitcoin and those who do accept it are usually only doing so for publicity.  Processing Bitcoin payments is complicated and expensive. The Bitcoin network can currently process three transactions per second. Compare that to the Visa network which can process up to 56,000 in a second, and you can start to see how far behind Bitcoin is as a payment system.

In January this year, the North American Bitcoin Conference ironically announced that it would no longer accept Bitcoin as a form of payment from attendees who wanted to purchase tickets citing high costs and complications with accepting the digital currency. There are now fewer major entities accepting Bitcoin than just one year ago and only four of the top 500 online retailers accept Bitcoin as a form of payment.

Not a Great Way to Transfer Money: This too seems an unlikely use for Bitcoin. Due to the way Bitcoin transactions are processed, the more people who want to exchange Bitcoin at a given time, the more expensive the processing fees are. Late last year when Bitcoin transactions were peaking, the cost to process a Bitcoin transaction in a reasonable amount of time was around $35! That kind of fee might be a good deal if you are transferring $10,000 to a friend in the Philippines, but it certainly won’t work for paying the babysitter.

Unfortunately for Bitcoin, the banking industry is advancing as well. The development of Zelle which makes transfers between U.S. bank accounts simple, fast and free is one example as to why there will be no reason for people to utilize Bitcoin for person to person transfers.

The IRS is Just Getting Started Taxing Bitcoin: A company called Coinbase is one of the largest US platforms used for exchanging Bitcoin. Although Coinbase has close to 12 million users, the IRS reported that only 800-900 taxpayers per year from 2013-2015 reported gains from Bitcoin on their tax returns.

As a result of a lawsuit last November, Coinbase was ordered to hand over account and transaction details to the IRS from its users going all the way back to 2013. This account information will likely result in thousands of IRS audits signaling the beginning of the end for the use of Bitcoin as a tax dodge.

Even after the stepped up IRS scrutiny, a survey conducted by TeamBlind days before this year’s Tax filing deadline found that nearly 50% of those who profited from Bitcoin planned to or had already filed fraudulent tax returns to exclude their gains from income.

Regulation is a Double-Edged Sword:  Presently, Bitcoin is substantially less regulated than traditional currency and investments.  Bitcoin proponents are correct when they say more regulation of the digital currency is a good thing. Regulating Bitcoin elevates its legitimacy and boosts public confidence.

Unfortunately, more regulation will also add to the difficulties and costs for dealing in Bitcoin. Additionally, most of the original allure of Bitcoin was that it was “off the grid,” anonymous, and not part of the traditional money system. The regulation of Bitcoin will expand in step with its relevance and ultimately eliminate everything Bitcoin adopters liked about it.

Overestimated/Underestimated: The desire for a new currency or payment system is overestimated. “If it were only easier to spend my money,” is a lament I’ve never heard. Generally people are satisfied with the current money system and want a currency that is managed by more than market forces.

It’s also been underestimated how much resistance leading governments would put up to maintain control on their money supply.  America in particular, who has massive amounts of government and personal debts relies on it’s ability to borrow today and pay off the debt later with inflated, less valuable dollars. If Bitcoin became an actual threat to the U.S . Dollar, the government would simply make it illegal or nearly impossible to use. Former head of the Federal Reserve, Ben Bernake remarked that, eventually governments will “take any action they need” to prevent Bitcoin from challenging their currencies.

Closing

Some of the shortcomings I’ve covered are unique to Bitcoin and others are challenges for all digital currencies.  While it seems unlikely that Bitcoin has a long-term future, there are still plenty of people who are looking to risk their money in hopes of a quick profit and that speculation may not go away for years. Additionally, while Bitcoin seems destined to fail, other digital currencies (of which there are over 1,000) may solve some usability shortcomings of Bitcoin and become more widely adopted.

Digital currencies may play a larger roll in developing countries where access to traditional banking is limited. Over the past several decades, developing countries have been able to adopt modern technologies by leapfrogging out-dated systems. For example, many African countries never developed extensive landline phone infrastructure, but went straight to cell phone adoption.  Digital currencies may provide an opportunity for developing countries to leapfrog traditional banking systems in a similar fashion. However, many experts believe that current central banks will link blockchain technology to  their existing currencies. This would essentially eliminate the need for private digital currencies.

Should you invest in Bitcoin or other digital currencies? If you own Bitcoin, should you sell it? There’s not much difference between the two of those questions and asking for advice on which number to pick on a roulette wheel.