Is It Too Late To Buy Bitcoin?

By Roger Montgomery, Montgomery Investment Management

Right now, you may be wondering: is Bitcoin a speculative bubble? And, if it's not, is it too late to buy in? Well, the answer to that is: it depends. To my mind, the price of Bitcoin is going up because people think it will keep going up. And that's pure speculation. But not everyone agrees.

Bitcoin and its peers, such as Ether, Litecoin, Zcash, Monero and perhaps even Filecoin are referred to, rightly or wrongly, as decentralised currencies. There is no central bank or entity that is involved in creating or transacting them. Instead, all that is required is a peer-to-peer network of hosts that agree on aspects of how the protocol is implemented and employed. Think of them as elements or representations of an electronic accounting system that keeps track of people's 'transactions' and hence remaining purchasing power.

Bitcoin currency transactions are simply entries on a peer-networked ledger - called the blockchain - that is simultaneously agreed by multiple hosts. And because my identity in the system is really just a series of numbers, which don't have to be tied to my physical identity, there is a level of privacy available - and taken advantage of. The latter is of particular interest to the European Union law enforcement agency, Europol, which has examined the growing role of Zcash and Monero on the darknet, and observed that: "Transactions cannot be attributed to any particular user/ address, all coins used in a transaction are 'hidden' by default, and transaction histories are kept private."

To conduct a Bitcoin transaction I need to specify three numbers. First, I have to determine how many bitcoins I want to allocate to you. Then I must specify how many bitcoins I want returned. This is because the bitcoin system requires that all of an 'output' be spent by a transaction 'input'. The output(s) are the addresses where the coins are to be sent to (effectively, how many bitcoins I want to spend) and the inputs to a transaction are the addresses that have coins that are to be spent. The third component is the 'remainder'. The reminder is the amount of coins left over when the inputs are greater than the outputs. In a bitcoin transaction, the remainder goes to the miner that confirms the block containing the transaction. That's why there needs to be a 'change' address. If you have more coins in your input addresses than you want to send to the outputs, you need to send some back to yourself otherwise you'll loose them as a new address is created.

Then there's 'mining'. Mining is the process of adding transaction records to Bitcoin's public ledger of past transactions. Mining is intentionally designed to be resource-intensive and difficult so that the number of blocks found each day by miners remains steady. While mining permits Bitcoin nodes to reach a secure, tamper-resistant consensus - essential for an effective blockchain, it's also the mechanism through which bitcoins are introduced into the system. Miners are then paid any transaction fees (see remainders above) as well as a 'subsidy' of newly created coins. This serves the purpose of disseminating new coins in a decentralized manner as well as motivating people to provide security for the system.

While crypto-currencies are being used for exchange, they aren't yet generally accepted. Therefore, a significant proportion of transactions occurring in cryptocurrencies today are not transfers for the purchase of a goods or service, but for speculation. And thanks also to limited supply, the resultant volatility brings into question their acceptance as a store-of-value.

But fiat currencies, like the Australian dollar, unbacked by gold and declared to be legal tender have no secondary use. So, in that regard, cryptocurrencies are the same - their acceptance as a conduit for payment stems from a belief that others will continue to use them to exchange goods and services in future.

And that future could be very large. Money supply multiplied by its velocity equals the price multiplied by the quantity of goods and services. In other words, the velocity of a monetary base is used to sustain an economy. If one considers the size of an economy that can be sustained by cryptocurrency transactions, and if one is aware that there are less than 500,000 wallets worldwide with more than US$10,000 of bitcoin, the potential for much higher Bitcoin prices is large.

On the other side of the fence however sit some people who are at the very centre of this digital revolution. Olaf Carlson-Wee, the first employee at Coinbase - arguably the most reputable company through which digital wallets for cryptocurrencies are created - suggests that Bitcoin will never be a substitute for the US dollar saying, "It was a big mistake that any of this was ever compared to currency."

Paying for goods and services with dollars is already seamless thanks to debit cards and the internet, and the advent of smartphone services will make transacting even more streamlined. So, according to Carlson-Wee, the world will not adopt cryptocurrencies because they and their supposed benefit of not relying on a central agency to prevent double spending - aren't needed. There are also too many legal, regulatory, and cultural hurdles on the way to mainstream adoption anyway.

That leaves just the current trading of them as an investment - like gold - as a hedge against some changing of the hegemony. But given the drivers of the currency's underlying moves are unknowable, beyond the possibility of widespread adoption, precious metal-style speculation is why Bitcoin's price is on the rise. The price is going up because people think the price will keep going up. And that is speculation, pure and simple.

Others believe that the future of Bitcoin will be similar to Myspace - ultimately a failure but an early version of something much more successful and sustainable.

Already alternative uses for decentralised networks are emerging. The Ethereum platform's digital 'tokens', function as digital versions of anything that holds value-not just money. Ethereum, for example, runs "smart contracts"- software programs that, in their simplest form, can send tokens to a friend at a future date, but could soon potentially drive entire decentralized autonomous companies.

Then, there's the Golem Project, an attempt to decentralise the world wide web. With the internet still run by central authorities like the Internet Corporation for Assigned Names and Numbers (ICANN), the world wide web still has central points of failure. Golem is an effort to create an alternative system that's completely distributed with no single person, company or government controlling it.

If it all sounds like too much to take in, leave the speculating to those who think they can predict each parabolic rise and precipitous fall. Alternatively, if you are prepared to speculate on gold, Bitcoin may turn out to be no different - providing a very similar return, which is hardly promising.

 
Roger is the Founder and Chief Investment Officer of Montgomery Investment Management. Roger brings more than two decades of investment and financial market experience, knowledge and relationships to bear in his role as Chief Investment Officer. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

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