Bitcoin is not a good investment, part 2

Bitcoin is not a good investment, Part 1.

Continuing to part 2 of Lyn Alden’s article 3 Reasons I’m Investing in Bitcoin

Regarding Bitcoin’s ubiquity, she writes:

An analogy is that a cryptocurrency is like a social network, except instead of being about self-expression, it’s about storing and transmitting value. It’s not hard to set up a new social network website; the code to do it is well understood at this point. Anyone can make one. However, creating the next Facebook (FB) or other billion-user network is a nearly impossible challenge, and a multi-billion-dollar reward awaits any team that somehow pulls it off. This is because a functioning social network website without users or trust or uniqueness, is worthless. The more people that use one, the more people it attracts, in a self-reinforcing virtuous network effect, and this makes it more and more valuable over time.

This is a good point, but social networks such as Facebook are also protected by intellectual property. Nothing like that exists for crypto. So this means given enough time there is nothing to stop competitors form eroding Bitcoin’s advantage, which has already happened since 2017 with the creation of competing currencies that offer features Bitcoin lacks.

Similarly, ever since Satoshi solved the hard parts of digital scarcity and published the method for the world to see, it’s easy to make a new cryptocurrency. The nearly impossible part is to make one that is trusted, secure, and with sustained demand, which are all traits that Bitcoin has.

The whole point of crypt is that it is ‘trustless,’ which means “no single entity has authority over the system and consensus is achieved between participants who do not have to trust each other.” This is irrelevant to how big or established it is. When you hand money to a bank clerk, you are entrusting the bank with your money, hence trust is required.

In comparing and contrasting Bitcoin to gold, she writes:

Of course, gold’s advantage is that it has thousands of years of international history as money, in addition to its properties that make it suitable for money, so the risk of it losing that perception is low, making it historically an extremely reliable store of value with less upside and less downside risk, but not inherently all that different.

 

The difference is mainly that Bitcoin is newer and with a smaller market capitalization, with more explosive upside and downside potential. And as the next section explains, a cryptocurrency’s security is tied to its network effect, unlike precious metals.

She misses the key advantage gold has over Bitcoin: Gold is fungible; Bitcoin, in theory, should be fungible, but in practice it is not. By definition, because Bitcoins reside on public and unique addresses, they cannot be fungible, as any Bitcoin can be tied to a unique address. Gold can be melted and mixed, making any nugget or bar of gold indistinguishable from any other, but this is not the case with Bitcoin, in which coins can be tied to specific addresses and histories. Mixers can obfuscate Bitcoin history, but exchanges have been known to blacklist coins that originate from certain mixers or associated with criminal activity. If a Bitcoin address receives stolen coins in a hack, those coins effectively become tainted and hence not as valuable. Although it is virtually impossible to censor Bitcoin transactions on the network itself, if exchanges, merchants, and users refuse to accept tainted Bitcoins (or Bitcoins that are at risk of having been tainted), then they are effectively blacklisted, so no fungibility.

Thanks to massive, extensive efforts by governments worldwide, especially since 2017, two of the features that originally made Bitcoin attractive–anonymity and fungibility–have been severely eroded, making Bitcoin less useful. The same for the rise of 3rd party analytics firms that attempt to screen cryptocurrencies for illicit history, and such coins may be rejected by exchanges, which would be impossible with gold, as gold can be mixed and has no digital paper trail. The same goes for all cryptocurrencies, including even so-called ‘privacy coins,’ that attempt to obfuscate addresses and account histories. Depositing Bitcoin into exchanges such as Binance or Coinbase and converting those coins into fiat, requires government ID. Dark markets have also been infiltrated by government agents, and the total size of dark markets has shrunk in spite of the growing size of the overall crypto market. Ironically, this makes greenbacks and precious metals the ultimate cryptocurrencies, because they are fungible and untraceable, whereas Bitcoin is neither of those.

A cryptocurrency’s security is tied to its network effect, and specifically tied to the market capitalization that the cryptocurrency has. If the network is weak, a group with enough computing power could potentially override all other participants on the network, and take control of the blockchain ledger. Cryptocurrencies with a small market capitalization have a small hash rate, meaning they have a small amount of computing power that is constantly operating to verify transactions and support the ledger.

Even if a single entity controls the majority of hashing power (a 51% attack), this does not mean the network itself is insecure, as the cryptocurrency itself cannot be compromised and is mathematically secure; rather, the chain can be altered at a superficial level, but this part of how the protocol works; for example, a hard or soft fork. But the ledger cannot be rewritten beyond certain number of blocks, so even if this single entity had 100% of the hashing power, thy could not alter histories going back more than a few blocks. This is why merchants and exchanges often require at least two confirmation before crediting deposits. Undoing confirmations becomes exponentially more difficult, and impossible beyond just 1 or 2.