via Forbes : At the outset, let me clarify that Bitcoin itself is not a scam, but how Bitcoin is being sold is a scam. More about that below.
To start out, it is important to understand what Bitcoin really is. It would be easy to bore you with a discussion of the technology, about peer-to-peer servers and sophisticated algorithms, but that is not what you need to know.
What you need to know about Bitcoin is that distilled to its technological essence, each Bitcoin is simply a number. That’s it: A number. It is simply a series of digits, with each number being assigned to each Bitcoin.
To illustrate, I’ll randomly pull a $1 bill from my wallet, which bears No. L88793293J. Assuming some minimal level of competency by the U.S. Treasury, no other bill bears that number.
The face value of a $1 bill is, of course, just $1 dollar. It is simply a unit of exchange, printed on what many folks would consider to be ugly paper.
But two people could privately agree that No. L88793293J is actually worth $5,000. To illustrate Fred wants to buy Joe’s golf clubs, but Fred doesn’t want his wife to know — at least just yet — that he spent $5,000 for golf clubs. So, Fred and Joe agree that No. L88793293J is worth $5,000 and Fred gives No. L88793293J to Joe. Fred then tells his wife that he bought the clubs for the $1 bill. At some later time, when Fred’s wife doesn’t care so much, Fred pays $5,000 to Joe for No. L88793293J, and gets the $1 bill back.
The only difference between Bitcoin No. ABC123 and $1 Bill No. L88793293J is that at the end of the day, the $1 bill physically exists and has a face value that is worth something, i.e., Fred could take the $1 bill and buy something off the $1 menu at McDonalds.
By contrast, Bitcoin has no intrinsic value — it is just a number. The number may have an agreed value between two parties, but the number itself has no value. Consider a bank account number, such as Wells Fargo Account No. 456789. The depositor and Wells Fargo essentially agree that the account designated by No. 456789 has the value of what the depositor puts into it, less what the depositor takes out. But the number itself, No. 456789 has no value. The same situation occurs with credit card transactions, whereby the credit card processing company assigns are unique value to each transaction, but the number itself has no value.
Here, the technological difference with cybercurrencies, or crypocurrencies if you prefer, is that they don’t require a middleman such a clearing bank. Value, whatever it is, goes directly from A to B, with nobody in the middle.
Let’s now talk about uniqueness. Bitcoin does have some value because there are only a finite number of Bitcoins available, because the algorithm that is used limits Bitcoin to a particular number of units, of which there should only be somewhere in the neighborhood of 21 million that fit the algorithm.
Uniqueness certainly has value. Because there is only one Hope Diamond, it is estimated to have a value in the neighborhood of $350 million. Because there are only 100 of that 24¢ stamp with the upside down airplane, they are estimated to be worth about $1 million each. Ditto for rare coins, original Picasso paintings, etc.
But here is where the fundamental flaw in Bitcoin’s value lies: It is simply a number, and numbers are infinite — there will never be a shortage of numbers. Even if you are the world’s greatest mathematician and think that you found the largest number ever, there is always that number plus one, plus two, etc.
So, Bitcoin may be limited to 21 million numbers, but that doesn’t mean that somebody else can’t come up with a similar algorithm and thereby create their own unique set of numbers, i.e., their own cybercurrency.
For example, let’s say that somebody creates a cybercurrency that is based on known prime numbers. There are about 50 million of those, so another 50 million cybercurrency numbers could be created. Indeed, the recent boom in Bitcoin has triggered numerous companies offering their own cybercurrencies, and the amount of such numbers that they can generate is limited only by the ability of their mathematicians to create the necessary algorithms, which of course is similarly infinite.
According to that tome of all knowledge known as Wikipedia, as of November 27, 2017, there were 1,324 cybercurrencies in use. Just multiple each cybercurrency by the number of units they each support, and you get a pretty big number. And that is just the presently existing cybercurrencies, recalling that all it really takes is a sharp mathematician to come up for an algorithm for a new one.
And that brings us back to the main point: Cybercurrency units are simply numbers, and there is not a finite supply of numbers. Rather, the numbers available are infinite. This further means that the supply of cybercurrency units is likewise infinite. This has profound implications for pricing.
The true value of any widget is determined by the aggregate street price of the item, i.e., the sum total of what all units could be purchased for today, divided by the number of additional units which are available for sale. This is where uniqueness comes into play. There is only one Hope Diamond, which means that you take its estimated value of $350 million and divide by one, yielding $350 million. Collectively, those 24¢ stamps with the upside-down airplane are worth $100 million, but there are 100 of them, so they are worth about $1 million each. Or think of it simply in common-sense terms: The more there are of something, the less valuable each one is; if the market is flooded with something, they each have little value. Consumers see this every day at the gas pump, as the price of fuel varies primarily based upon available oil supplies.
Herein lies the problem with cybercurrency, which is that there are an infinite number of cybercurrency units available. Divide anything by infinity, and you get a number that is almost zero — not quite zero — but as close as you can get to it as possible. This is true even if we assign a current aggregate value of all the existing cybercurrency units at $500 billion. Because it is not quite zero, we can assign it a value of 1¢, not because it is necessarily worth 1¢, but simply because that is the smallest unit by which we can designate value in our currency.
Actually, it is some number larger than zero, and thus 1¢, mainly because the Bitcoin folks have put in a lot of effort to keep each number unique and assignable to a given owner, and there are some merchants who will accept Bitcoin as if it were a government-issued currency. But how much does that really add, and how unique are those features as other cybercurrencies take hold? Suffice it to say that the answer is much closer to 1¢ than $15,000 per unit.
This now brings us to the economic law of supply and demand, by which value is determined by what a willing seller will let a unit go for, and what a willing buyer will pay for that unit, at a particular moment in time. Take the 24¢ stamp with the upside-down airplane as an example. Presumably, the U.S. Postal Service would honor the stamp only for 24¢, which is its face value. Otherwise, the stamp creates no other value. But collectors of stamps and other valuables would offer $1 million or more for such a stamp, due to its rarity, and their belief that the value of the stamp will increase over time.
And now for something completely different: Tulip bulbs.
Tulip bulbs have no intrinsic value, other than that they can produce a pretty tulip flower. Yet, beginning in 1636, the price of tulip bulbs in Holland began to skyrocket, as buyers started believing that — with demand driven by exports to the apparently then tulip bulb hungry French — the price of tulip bulbs would keep appreciating. They were right. Eventually, the price of a single tulip bulb hit many multiples of the average Dutchman’s average wages, and reportedly 12 valuable acres of land were traded for one particular tulip bulb. Individual tulip bulbs were traded for many times each day, with the price increasing with each trade. Then, one day in February of the following year, 1637, the price of tulip bulbs quit going up, and by May 1, the price for tulip bulbs had fallen back to their original value. Thus, was tulip mania the first recorded bubble.
Many centuries later, more specifically in November, 2013, the President of the Dutch Central Bank, Nout Wellink, reflected on the tulip bulb bubble with the following: “At least then you got a tulip, now you get nothing.” He was referring to Bitcoin.
But Wellink wasn’t exactly right, since with Bitcoin you get a unique number. What that unique number is worth, as discussed above, is something pretty close to zero, which makes Wellink’s statement much closer to the truth.
All of which means that the value of Bitcoin, and any other cybercurrency, is established by agreement of the willing sellers and willing buyers as to what point they would be willing to let go of or buy up Bitcoins as the case may be. This means that an investment in Bitcoins is purely speculative — it is utterly no different than investing in gold, social-media stocks, or tulip bulbs. So long as the number of buyers outnumbers the sellers, the price will go up, but when the sellers outnumber the buyers the price will go down.
You’d think that folks would be able to spot bubbles by now, since we have three in the last 20 years, being the Dot.com (or, maybe more accurately, Dot.con) bubble of the late 1990s, and of course the housing bubble that ended in the crash of 2007, and then the instant Bitcoin bubble. These bubbles illustrate that they occur not because of sophisticated Wall Street traders looking a business fundamentals, but because the less sophisticated investors who start taking money out of their nice, safe FDIC-insured deposit accounts and money-market IRAs, and start trying to shoot-the-moon with investments that they barely understand. Yet, they see other folks making money overnight and want to do so too. Ask about anybody what the key to successful investing is, and they’ll repeat the old mantra “Buy low and sell high”. The problem with people chasing investments which are already hot is that they will end up buying high and selling low.
All of this brings us to the scam element of Bitcoin. Again, as I stated at the start of this article, Bitcoin itself is not a scam. The technology behind Bitcoin and the other cybercurrencies are not a scam, and may well prove to be transformation in the much broader sense.
Now let me tell you what is a scam.
The scam in Bitcoin is in talking average man-on-the-street investors into investing in Bitcoin by intentionally obfuscating what it really is, just a number, into some super-sophisticated investment by throwing out the technical verbiage that surrounds cybercurrencies, such as Blockchain technology and peer-to-peer servers. These technologies actually accomplish only one critical thing, which is that they keep particular numbers peculiar to Bitcoin, but they sure sound like Star Trek level stuff. Yet, to those not familiar with these technologies, it makes Bitcoin sounds like it has a lot more worth than it really does.
To push Bitcoin, there are now a lot of internet gurus who claim to have inside knowledge on the ever-imminent rise of the cybercurrency, very similar to how such gurus appeared so that the Iraqi Dinar Scam (which is very similar, although Dinars at least exist in paper) was able to take off. There are also Bitcoin sellers who spin a load of bull so that they can sell Bitcoins to the unsophisticated investors who can’t seem to bring themselves to confront the question that “if something is anywhere as valuable as they say, then why are they selling it?”
The answer is that those who trade in anything make their money on their commissions for selling. It doesn’t matter what they are selling, so long as they can make a commission on it. The more trading, the more in commissions. Investments that are perceived as “hot” will generate a lot of trading, and so traders will naturally flock to those investments and try to gin up further interest among investors who heretofore had no interest in that investment at all.
What is happening with Bitcoin is fundamentally no different than what happens with the average pump’n’dump scheme or, for those who remember, Pets.com. Bitcoin units are being artificially pushed into ridiculous valuations based mostly on fluff.
Sure enough, getting away from the wealthy folks who have the spare cash to speculate in stuff, we’re now seeing pooled funds set up just so that the average mom-and-pop investors who are simply trying to set some money back for retirement, can throw their bucks in too. What these folks don’t realize is that they might as well just take their money to the nearest casino and drop it all on red for a single spin of the roulette wheel. They’ll either win or lose, just as Bitcoin is either going to go up or down.
And, at least the casino will pay if you win. I get the idea that some of these “Bitcoin funds” actually own no, or very few, Bitcoins, but are simply the next wave of Ponzi schemes.
I got into a discussion about Bitcoin with retired financial advisor Charles Padua, who expressed concern that so many small investors seemed to be falling for Bitcoin. His take was that smaller investors should be in carefully asset-allocated portfolios so as to spread and minimize their risk, and if — and this is a big if — somebody determined to invest in any speculative investment, such as Bitcoin, they should limit their portfolio exposure to no more than 2%. But, he says, better not to invest in purely speculative investments at all.
This takes up back to the fundamental rule of investing, which is simply to buy low and sell high. Bitcoin is already high, and astronomically high compared to its true value. Folks who buy into Bitcoin now are quite likely to be buying high and will end up selling low. There is also an old investment adage to the effect that “the quickest way to lose money is to invest in something which is already hot.” The idea there is that the folks who are going to profit have already made their money investing, and now are just looking for suckers to unload their investment on. Bitcoin is certainly hot; in fact, it’s now the hottest thing going. That by itself should raise a bright red flag for investors.
Will Bitcoin fall? Maybe not today, tomorrow, or next week, but eventually it will fall as the novelty wears off and folks figure out that they are really just buying a number, and the number of buyers diminish.
Will Bitcoin go away entirely? Probably not, because Bitcoin still can serve some usefulness as a unit of exchange, to the extent that it can convince merchants to accept it as currency. The caveat here is that when a bubble finally bursts, the object of the bubble usually falls into deep disrepute.
By then the scammers who prey on the little investors will have moved on to the next “big thing”. It is all a never ending cycle, limited only by the number of available suckers.
And that is a big, big number.