Rubber Bands and Private Keys, a critique of two articles on Bitcoin

Rubber Bands and Private Keys
by Thomas J Connolly
November 30, 2018

I love imagination. Since I was a little boy I think my most precious moments have been when I let my mind wander, to imagine a world that is similar to today, but somehow different. A world that is better. It makes me happy inside to take that type of walk in a world that represents the future.

For a moment I want you to join me and pause, to remember. You are between the ages of 18 and 25. Last night you were out with your mates, in a bar listening to music. You were drinking and putting money on the bar. You can still feel the beer-soaked paper money crumpled in your pocket that spent an evening on the wet wooden bar that was the platform of beers and shots, money that you sort the next morning back into smoothed out bills.

Now think of a round of golf in Arizona. We are comparing cards and settling bets. Money is exchanged across the table, who has a fiver or a ten? Richard asks, “Did you give me the $400”.

Now think of our children. Do you see them doing the same thing? In a world of Venmo?

Karen and I ask Justin and Sydney when they are home and are heading out for a night with friends, “Do you have enough money with you”? They look at us quizzically, laugh, and say they do not need money. Everything for them is digital.

What about your children? More importantly, what about you? We are used to Gary’s security of a Rubber Band, but in truth how often do each of us reach into our pocket and pay for things with paper notes or coins? Has our world become different than what it was when we were at that bar so many years ago? I think the answer is yes, and in that difference are the seeds of a world that is coming, a world that is borderless in terms of “money” flow, one that does not have exchange fees or movement that has the friction of delay. It is inevitable, and we will not need rubber bands (but you and I will still use them to our children’s delight and mockery because they reflect our time when we were young) but we will need Private Keys.

Now that I have your mind in the right place, let’s look at the articles that John shared with us. The prestigious Washington Post and the LA Times. The key points I discern from the writers’ crafted words are these:

• There was a frenzy of buying that included “Grandma’s and Grandpa’s cashing in on the action”

• It is pitched by its promoters as an alternative to “Fiat” currencies

• “To put it another way, the money in your bank account, wallet or mattress shouldn’t fluctuate widely or unpredictably”

• “Bitcoin trading systems couldn’t enforce their ostensible safeguards against counterfeiting.”

• Bitcoin possess value only as long as the expectation exists “that they will continue to be accepted by others”

• Bitcoin trading is cumbersome and would require super computers to scale like VISA and Mastercard.

• As an investment asset, Bitcoins price has come down by roughly 80% from its peak in just under a year. The Bitcoin crash should all but exterminate the currency.

• “Bitcoin has been around for ten years, but we still haven’t found one use for it.”

• Bitcoin Miners are middlemen that take a fee just like a bank

• The rise in the price of Bitcoin creates hoarding behavior and that price rise means it will only be adopted by the most fervent believers

• Since the end of last year the Euro and the Turkish Lira have outperformed Bitcoin, while Bitcoin has only modestly outperformed the Venezuela Bolivar. “So maybe some sort of congratulations are in order: Bitcoin is a better store of value than the worst store of value there is.”

I think the above about covers the two writers’ main points for concluding why Bitcoin is and will be a failure. Let me do what they did not, which is to go deep vs shallow. On a point by point response, let’s see where they may be correct and where they may be a bit off the mark. Ready? Here we go………

• There was a frenzy of buying that included “Grandma’s and Grandpa’s cashing in on the action”

The point the author seems to be making here is that there was a buying frenzy that included a mass entry into buying Bitcoin by people with little understanding of what they were doing, even by the least likely people, Grandma and Grandpa. How true is that statement?

Well a report released in July 2018 reveals the following:

22 Million Bitcoin Wallets

Currently, there are almost 22 million bitcoin wallets according to data compiled by Bitinfocharts.com. However, most bitcoin users have several bitcoin wallets and use multiple wallet addresses to increase their financial privacy when transacting in bitcoin. Hence, the number of bitcoin users is likely less than 22 million.

2.9 to 5.8 Million Active Users

A 2017 study by the Cambridge Centre for Alternative Finance suggests that “current number of unique active users of cryptocurrency wallets is estimated to be between 2.9 and 5.8 million.” It is important to note that this study focuses on active users as opposed to bitcoin “hodlers”. This gives us insight into how many individuals are actual users as opposed to only buy-and-hold investors.

The Cambridge University study collected data from over 100 cryptocurrency companies in 38 countries, which is estimated to encapsulate 75 percent of the blockchain industry. Hence, we can expect the number of active users to be on the higher end of the study’s estimate or perhaps even higher.

Those are relatively small numbers in a global population of over 7 billion people. While many people became aware of Bitcoin as the media focused on it in late 2017 and into 2018, the actual number who spent the time to figure out how to buy it and to commit money to it was very small. Think of us as a group, we likely have only 1% to 3% of us that own BTC. Fairly representative of the overall population in the current market of BTC (22/7,000 or 3%) and the estimated 5% of the US population that own BTC. Compare the US BTC holders to the percentage of the US population that own stocks (52%), and you can see the author’s stated frenzy for BTC has actually been very narrow. I think the author here was trying to bring emotion to drive a point home, but his point is less than factual.

• It is pitched by its promoters as an alternative to “Fiat” currencies

The original paper by Satoshi Nakamoto that introduced Bitcoin is nine pages long (if you would like me to send you a copy, just ask). I have read it. It does speak of developing a network to enable payments, but it does not suggest that Bitcoin will or should replace Fiat currencies. The introduction of the paper reads as follows:

“1. Introduction
Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments. While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust based model. Completely non-reversible transactions are not really possible, since financial institutions cannot avoid mediating disputes. The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions, and there is a broader cost in the loss of ability to make non-reversible payments for nonreversible services. With the possibility of reversal, the need for trust spreads. Merchants must be wary of their customers, hassling them for more information than they would otherwise need. A certain percentage of fraud is accepted as unavoidable. These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party.

What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party. Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers. In this paper, we propose a solution to the double-spending problem using a peer-to-peer distributed timestamp server to generate computational proof of the chronological order of transactions. The system is secure as long as honest nodes collectively control more CPU power than any cooperating group of attacker nodes.”

While there are those that get headlines by proposing that BTC will replace Fiat currencies, the truth of the matter is that this view is a minority view and not connected to the concept of BTC or the actual existence of BTC. The author has once again chosen to make an inflammatory comment that is shallow and without real substance.

• “To put it another way, the money in your bank account, wallet or mattress shouldn’t fluctuate widely or unpredictably”

We would all like this to be true. However, as we know from simply watching the movement of the British pound during George Soros billion dollar move against the UK Pound or the impact of Brexit, that volatility in Fiat currencies is present. What about the EURO vs the USD? How do 50% point moves sound? In August of 2002 the EURO made its debut. It was valued at less than 1 USD. Between then and now, the EURO has soared in value to 1.58 USD and has fallen from that level to 1.05 USD. Volatility is a natural occurring event when normal supply and demand factors exist for all assets. BTC is no different. To highlight the volatility is factually accurate, but it is not a reason to demean any asset that moves based on market dynamics (think of the price of oil). Once again the author seeks to win an argument based on emotion, not facts.

• “Bitcoin trading systems couldn’t enforce their ostensible safeguards against counterfeiting.”

This comment made me laugh. I know of not one case where BTC has been counterfeited. In fact, it is impossible simply based on the structure of the Blockchain network on which it resides. This is the most foolish statement of all.

• Bitcoin possess value only as long as the expectation exists “that they will continue to be accepted by others”

I believe this is true. Just like any asset, its value is predicated on demand. I think this is an obvious fact of all assets and wonder why the author positioned it as unique to BTC? I guess he needed to meet a word count requirement to fit the paper’s column structure.

• Bitcoin trading is cumbersome and would require super computers to scale like VISA and Mastercard.

This statement is both somewhat accurate and wildly wrong. Trading in BTC is fast, almost instantaneous. Try it on Coinbase. I think the author was trying to make the point that as a means of payment it has a low transaction per second metric due to the network requirements for validating the blocks that make up the BTC Blockchain. That is true. It is a young technology that continues to advance, seeking to solve the inefficiencies that it was conceived with. For example there is the Lightning Network that has been developed which is designed to sit on top of the BTC Network. It is currently in testing at 60,000 transactions per second, with the expectation that it will scale to millions of transactions per second. Even the internet use by normal everyday people went through this phase. Can you not remember the modem hooked to your computer and connected to your phone line with all the screeching and noise as it connected to the internet at incredibly slow speeds? Everything does evolve does it not? I wonder why the author would not speak to the way technology is evolving, versus concluding it is a failure when compared to VISA or Mastercard? Shallow reporting if you ask me. Oh, by the way, there is no need for a supercomputer, as the network runs on normal computers in a shared peer to peer network. Talk about sensationalism.

• As an investment asset, Bitcoins price has come down by roughly 80% from its peak in just under a year. The Bitcoin crash should all but exterminate the currency.

So which is it? Is it an asset or a currency? Seems the author lost his way for a second.

If an 80% price drop was enough to conclude that an asset should be exterminated, then the world would look a bit different today as Amazon would be gone for it fell by 98.7% between the year 2000 and 2001/02 (high split adjusted share price of $75.25 and a low of $5.51. Bet you wish you bought AMZN at $5.51). What about Cisco systems? Fell by 86.5%. Corning Glass works by 99%; Priceline by 99.4%; Yahoo by 96.4%, etc. You get the picture.

• “Bitcoin has been around for ten years, but we still haven’t found one use for it.”

Really? I think one of the most significant things you would highlight is that BTC can be used to pay taxes:

US State of Ohio Accepts Bitcoin for 23 Types of Taxes

The U.S. state of Ohio has set up a cryptocurrency payment portal and reportedly starts accepting payments in bitcoin for 23 types of taxes this week. “Ohio has become the first state in the United States, and one of the first governments in the world, to accept cryptocurrency,” the Treasurer’s Office wrote.

How can an author/writer for these prestigious news organizations be allowed to print for mass consumption false statements? Dare I say it, “Fake News”………

• Bitcoin Miners are middlemen that take a fee just like a bank

A bank charges us for maintaining deposits with them of our own money, paying us less than 1% interest while using our money to loan to credit card users charging them 19% interest, charges us for international transfers, and delays for days sizeable deposits that are mere transfers between financial institutions. As to BTC miners, they are compensated for mining BTC which is adding new blocks to the Blockchain. They are not paid by you or me. The BTC they receive is new BTC, that is why they call it mining.

There is a fee for transactions, but it is nominal and significantly less than our current banking system. For example, earlier this week, Binance, the world’s largest cryptocurrency exchange, sent $600 million with a $7 fee. To send a $1 million through a bank in an international wire transfer, it could cost institutions nearly $10,000 in fees.

Taking a fee just like a bank is a partially true statement by the author, but it is misleading in substance and for me amounts to no more than a big lie buried in a small truth.

• The rise in the price of Bitcoin creates hoarding behavior and that price rise means it will only be adopted by the most fervent believers

Which is it? Earlier the first author posited that the price rise brought Grandma and Grandpa into the BTC market as buyers of the asset. Now writer number two says that only the possessed few will come into the market. Who is right? Are not these statements foolish?

Simple fact of life, new technologies are embraced early on by the “believers”. It is not until later that the masses come on board once the technology has proven its value. I imagine you have heard of the S curve in the adoption of new technologies? We are today at the beginning of the curve. BTC has not proven its value yet in a way that would lead to mass adoption, but that in no way means it won’t. The fact of the matter is that the Blockchain is expanding rapidly into every business, and the most comprehensive and developed Blockchain at this point is the BTC Blockchain. The ease with which it enables the transference of capital from one geography to another in a seamless and timely manner indicates to me that the day is coming when mass adoption will happen, and not as a replacement of the USD, the Pound, the EURO or the YUAN, but as a compliment to them that changes the financial industry in a dramatic and significant way.

• Since the end of last year the Euro and the Turkish Lira have outperformed Bitcoin, while Bitcoin has only modestly outperformed the Venezuela Bolivar. “So maybe some sort of congratulations are in order: Bitcoin is a better store of value than the worst store of value there is.”

What is it they say about statistics?

Mark Twain (among others), who attributed it to the British prime minister Benjamin Disraeli: “There are three kinds of lies: lies, damned lies, and statistics.”

Choosing to make a statement comparing the price of BTC to the named currencies is so misleading that I shake my head in sadness that journalism has fallen to such lows. The writer is accurate in their statement for they searched for the period in time where the statistics aligned with their theory. What if they compared the values between 2010 and now? BTC was valued at $.08 in 2010. What might the increase in value be to now at $4,000 per BTC? Lies, Damned lies, and Statistics, is what I say. Shame on these writers and the editors that allowed such biased and misleading journalism to flourish on their pages.

Well I guess I am done for now. I hope in the future a better more balanced presentation of the Crypto-Asset world emerges. I imagine it will be written only after the horse has left the barn. But remember, I began this discussion speaking about imagination. I think John Lennon got it right and was prescient in imagining a world without borders as being attainable one day. Maybe we are moving there ever so slowly. I do hope so……

Author: Thomas Connolly

Tom possesses a rich and diverse background that includes deep investing experience, senior corporate executive positions, and roles as a Regional Managing Partner and Global Industry Leader within Ernst & Young. He has advised executives on some of the largest acquisitions and dispositions in the Media and Entertainment industry, including clients such as Comcast, Citibank, Sony, Dalian Wanda and Publicis. Tom is a Certified Public Accountant with a Masters Degree from Columbia University. His skills are further accompanied by a personal passion for the study of economic trends and evolving market dynamics.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.