The Emperor’s New Coins – Don’t Let BaitCoins Lure You Down A Rabbit Hole

As the public discourse around Bitcoin reaches a crescendo, a number of learned commentators are comparing the current Bitcoin mania to the Tulip mania of the 17th century or even to the South Sea Bubble, where a great number of British people lost huge amounts of wealth in the 18th century as a result of purchasing the stock of companies that didn’t actually generate any value.

However, I beg to disagree. In the case of those who physically bought tulips (rather than the futures contracts attached to tulips), when the crash came, they at least owned a bunch of beautiful flowers. In the case of Bitcoins, people will be left with a string of 0s and 1s which will never be seen, admired, enjoyed or felt.

The Bitcoin high priests (because there is a certain level of almost theological fundamentalism one senses when one speaks with Bitcoin proponents) will argue and explain that Bitcoin is a fairer way of redistributing wealth and how it will be the currency of the world because it is free of central bank influence.

Except when you ask them to explain how:

  • There will only ever be 21 million Bitcoins – because that is the theoretical maximum limit
  • It can ever be a transparent when 1 million of those coins are owned by possibly one person or a small group of people (Satoshi Nakamoto) – who is unknown and whose origins are shrouded in mystery
  • It can be considered equitable when 40% of all Bitcoins are owned by 1,000 peoplein the world who are all linked to each other and can collude to move the Bitcoin markets at once.

There are some real fundamental problems with Bitcoins which I’m highlighting below and which I hope gives food for thought.

The real issues with Bitcoin and the arguments made by Bitcoin proponents

What is the intrinsic value of Bitcoin?

 The single biggest issue about Bitcoin is around what the intrinsic value of Bitcoin is. There will be any number of convoluted answers about what people think the inherent value of Bitcoin is, but it gained the greatest usage by merchants and purveyors of illegal merchandise on the dark web through sites like the Silk Road where you could buy anything from crack cocaine to knuckle dusters.

I was reflecting on the factors driving the valuation of Bitcoin valuation, 4 years ago in 2013 (when Silk Road was at its peak) and now and reflecting on the drivers leading to Bitcoins valuation. The figure below is my view of some of the factors driving Bitcoin valuation.

Figure 1 – Factors driving Bitcoin valuation

In the very early days, when you required a few Bitcoins to pay for pizza, the usage of Bitcoin was limited to a very small group of individuals who wanted an anonymous mode of exchange. The bearer nature of Bitcoin meant that it provided the level of anonymity that one requires in order to transact bravely in all forms of drugs (except it didn’t and a whole bunch of people were caught when Silk Road was shut down – and also because the founder of Silk Road, Ross Ulbricht aka ‘Dread Pirate Roberts’, chose to use his actual name to set up his anonymous site….and boasted about it in his LinkedIn profile!). Crime generates US$2.1 trillion worth of economic activity, or 3.6% of the world’s GDP. This suggests a sizeable market for anyone who wants to move on from transferring large amounts of US dollars physically or electronically towards a virtual, anonymous currency which can be transferred across borders through anonymous digital wallets.

There were also small groups of Libertarian vendors who were accepting Bitcoin as a means of exchange but Bitcoin’s perception, be it as a commodity or currency, was fairly limited. However, through the hype generated through the valid use cases of the underlying technology driving Bitcoin, Blockchain, Bitcoin hit the public domain in a much bigger way and a small group of individuals started creating the hype around it, which increased people’s perception of what the value of each Bitcoin should be.

That is what figure 1 above suggests – the value of Bitcoin has been driven by the irrational and exuberant perception of some of the market around what the value of Bitcoin ought to be, rather than on any sound fundamentals or basis.

This then leads to my original question: What is then the inherent value of Bitcoin?

Why should anyone consider it as a store of value and the most fundamental question of them all is, when all is said and done, what is a Bitcoin backed by?

Paul Krugman said it best when he explained that, “To be successful, money must be both a medium of exchange and a reasonably stable store of value. And it remains completely unclear why Bitcoin should be a stable store of value.”Krugman’s interview with BusinessInsider is also hugely instructive for those interested in learning more about his thoughts on Bitcoin.

‘Ah,’ the Bitcoin high priests will exclaim, ‘what then is any currency in the world backed by?’ and use that as an argument to argue the value of Bitcoin.

Let’s be clear, a Bitcoin has no underlying value. It generates no value, except in its own exchange, and there is nothing to back the price of a Bitcoin, except only the trust of the purveyors of Bitcoins, which in turn is backed by nothing but hope and the promise that there will be another sucker who will come along to buy the coin at a price higher than they were duped into buying.

Other fiat currencies, say the US dollar, the Chinese renminbi, or any other national currency are essentially backed by the underlying economic output of the country. Governments are able to defend and protect a currency on the back of the strength of its reserves or economy. These currencies are accepted as a means of exchange and faith in the economic system is implicit.

If Bitcoin goes into a free fall, what authority or government is going to step in to prop it up and ensure the confidence within the underlying asset? What economic output does Bitcoin generate that underpins its value?

No underlying value – not like a fiat currency backed by the underlying economic output and governments are able to defend and protect a currency on the back of the strength of its reserves and the currency is accepted as a means of exchange and faith in the economic system is implicit.

The naiveté of Bitcoin high priests

Bitcoin enthusiasts proclaim how Bitcoin will become the de facto currency of the world.

Let’s be clear. The moment anyone or anything comes close to threatening the national sovereignty of a country, they will be shut down and shut out.

Over time, I foresee national economies and regulators killing Bitcoin outright (the way China banned it outright) or killing it through a thousand cuts (or regulatory burdens such as considering Bitcoins to be commodities rather than currencies and taxing holders of Bitcoins for capital gains – as the IRS are seeking to do in the US). The IRS in the US is also hunting down Bitcoin users and breaking their shield of anonymity so as to find them and tax them.

The British government, through the UK Treasury, is also looking at greater regulation of Bitcoin in an effort to bolster anti money laundering or the countering of the financing of terrorism (AML/CFT). Australia is following suit in a similar vein, and it’s a matter of time this becomes a wider campaign, driven by concerted regulatory authorities.

The moment governments introduce sufficiently high capital gains taxes – and they will because they will be able to justify it as a tax on something that has been made purely through speculative channels and with no underlying economic activity – and over time, this will destroy Bitcoin’s value?

The reason why governments will, over time, not allow for Bitcoin’s operations is because it threatens the sovereignty and integrity of their national borders. Governments will never cede their ability to use monetary policy to control and influence economic activity. This is precisely what Bitcoins do as they fall beyond the reaches of central banks and regulators and how can a country aim to control inflation, employment, underlying economic activity, if a currency that they cannot control is influencing their economy? This is the challenge economies like Vietnam or Indonesia face because of the pervasive influence of the US dollar on their economy and they are unable to exercise monetary policy tools.

The race to regulate Bitcoin has begun, and ultimately, this is what will lead to the moderation or possibly the demise of a currency that is not backed by underlying value, economic activity or output.

It’s all about finding the next sucker

The way the Bitcoin market is moving now, nobody is actually using Bitcoin as a medium of exchange or as a currency. It is a commodity or an asset that people are holding on to, and hopefully selling it off to somebody else before the whole thing implodes.

Since the start of the year, Bitcoin’s price has jumped more than 1,000 percent since the start of the year, and Bitcoin futures just began trading at the Chicago Board Options Exchange (what happens when you bring together a fake currency and a financial weapon of mass destruction??)

The shadowy nature of Bitcoin’s true controllers

The other real issue with Bitcoin is the completely opaque structure of Bitcoin’s ownership structure. Satoshi Nakamoto, the founder of Bitcoin, allegedly owns up to 1 million Bitcoins, or roughly 5% of the theoretical maximum number of Bitcoins (21 million). If and when Nakamoto chooses to cash out, it will lead to a collapse of the currency as we have it.

Another estimated 1,000 people own up to 40% of the total Bitcoins in circulation – most of them who are connected to each other. There is a persistent, and reasonable concern, that if these Bitcoin owners choose to ‘pump and dump’ the Bitcoins (given the lack of any real governance or regulation around Bitcoin trading at present), then those shouldering the fallout will be the investors who came in without understanding what it is and without an ability to influence the market or hope for some form of regulatory/governance mechanism to support them.

Collusion, which is generally illegal for almost any other asset class, can take place with impunity amongst the Bitcoin community (the majority of coins which are controlled by a very small group of individuals). The Bitcoin whales (or those who control significant portions of the Bitcoin world) are under (currently) no regulation, there is little anonymity, and there is no oversight – so how will this lead to the type of transparency that one requires in order to be the de facto currency of the world?

Bitcoin’s widespread acceptability isn’t all that it is cracked out to be

Bitcoin enthusiasts will claim that Bitcoin is going to be the new digital gold that will overhaul the existing global monetary system – overhaul to what exactly is not something they are able to answer. They will cite it’s widening acceptability as a medium of exchange – but it ain’t.

Bitcoin’s acceptance as a mode of exchange is still hugely limited. Last year, 1% (or 5) of the top 500 online businesses accepted Bitcoin as a medium of exchange. Given the fanfare Bitcoin has had, you would expect there to be an increase in its acceptability. But actually, only 3 of the top 500 (or less than a percent) online retailers are now accepting Bitcoin – so the number has fallen.

The single biggest traded commodity each given day, is oil. It is oil that drives the strength and value of the US dollar. There is almost never going to be a time where anyone will sell oil in Bitcoin. Nobody (sane) will seek to sell their home or property in Bitcoins. Everyday life will rarely include Bitcoin in its path – and it is not going to become the ‘de facto currency of the world’ which is part of the excuse individuals use to explain the current price levels.

Furthermore, it is also important to note that, even in the world of cryptocurrencies, Bitcoin isn’t the only non-value generating currency or show in town. There are numerous other cryptocurrencies (including DarkCoin – which has increased in value exponentially over the last few months, Litecoin, Ethereum, etc), all with the same level of vulnerabilities and issues. Why should any of the currencies be THE cryptocurrency of choice?

This is remarkably similar to the conditions that led to the South Sea Bubble, a period of history where even Sir Isaac Newton lost a fortune which led to his famous quote, “I can calculate the movement of the stars, but not the madness of men.”

Incidentally, Venezuela just launched Petro, their own national cryptocurrency – and to be fair, at least Petro is backed (allegedly) by the national oil reserves of Venezuela, which is more than can be said for Bitcoin.

It’s a secure trading currency

 The Bitcoin enthusiasts argue about the security Bitcoin offers. It doesn’t.

South Korean Bitcoin exchange was hacked and has gone bust in recent days – with North Korean hackers being blamed. There is a continuous stream of reports of digital wallets and coins being stolen and with little recourse for individuals who have lost their earnings. This is what happens in a world without regulation.

These are not isolated incidents either. In a report delivered in 2016, Reuters argued that a third of all cryptocurrency exchanges have been hacked.

The fact that authorities are routinely seizing Bitcoins (see examples of SwedenBulgariaUS) suggests that a concerted drive by determined individuals can also take control of the Bitcoins you think you own.

Beware and be careful

From the time I started on this article 3 days ago, to the current time, I note that the Bitcoin valuation has gone from close to US$20,000 to just over US$13,000, with no real change in underlying world economic conditions in those 3 days.

It just goes to prove my point that a currency based on nothing, will move due to anything.

Ultimately, one should never buy what one doesn’t understand. Of course, the likes of the Winklevoss brothers will argue that Bitcoin will grow by twenty times – but that’s of course only because they own a huge chunk of Bitcoins and will only benefit from a price increase.

I worry greatly when I see young people take out credit card debt to buy these coins or in some insane cases, take out second mortgages!As I’ve said earlier, nobody’s going to sell their homes for Bitcoins, so why bet your savings on it?

People are going to be at the mercy of forces they can never hope to control or understand, and should not be investing in what essentially a fad based on no real underlying value or economics. Aswath Damodaran’s (Professor at NYU Stern School of Business) warning about it being a potentially lucrative but dangerous pricing game with no good ending is one that people should do well to heed.

People also often make a mistake in assuming a paper profit translates to actual cash surplus. We already are reading about the lack of liquidity in the market place alongside cases of individuals who are unable to liquidate their Bitcoins for cash, especially during a downturn.

Nobel Prize winner Joe Stiglitz argues that Bitcoin should be outlawed because it doesn’t serve any real useful function but ultimately it may not require any legislative forms of control because it will disappear into the margins of society where it began once people realise the lack of substance or value that one can attach to it and after people realise in the end, it comes down to a bunch of digital bits they can never see or touch and which is not backed by anything real.

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Ethics and making a mockery of the Hippocratic Oath

Reading this case of an unprofessional and unethical doctor in Singapore provided me with some food for thought, particularly around the increasing role of ethics and professionalism, particularly in a world of increasing inequality.

It is critical that the vulnerable segments of society are given the appropriate levels of care and support because where unethical and unprofessional behaviours exist, they tend to exacerbate the suffering upon the vulnerable. Kudos also to the Humanitarian Organisation for Migration Economics (HOME) for pursuing this vigorously on behalf of the victim.

The case itself was interesting. Here was a doctor, Dr. David Wong Him Choon, a noted orthopaedic surgeon at Raffles Hospital, who chose to give only two days of medical leave for a foreign worker who had fractured his hand and had undergone surgery. There is increasing concern that there are doctors who are acting in collusion with construction companies to minimise the time off taken by their workers and to also limit their liabilities for compensation.

What is even more interesting/bizarre, is that previously (between June and December 2015) a Disciplinary Tribunal had acquitted Dr Wong of professional misconduct for giving insufficient hospitalisation leave despite the following findings:

  • The tribunal agreed that the appropriate time off (conservatively) for someone with a distal radius fracture was two weeks of medial leave. (Wong had given two days.)
  • The tribunal also agreed that Wong had failed in his duty to discuss with the patient to understand if there were adequate conditions for his rest and rehabilitation.

Despite the above, the Tribunal chose to acquit Wong on the basis of insufficient proof!

This led the Singapore Medical Council (SMC) (to their great credit) to file an appeal to the High Court which subsequently overturned the tribunal’s acquittal of Wong and convicted him of professional misconduct and sentenced him to suspension of medical practice for a period of six months.

Wong’s behaviour is morally reprehensible and runs counter to the Hippocratic Oath which states: “I will remember that there is art to medicine as well as science, and that warmth, sympathy, and understanding may outweigh the surgeon’s knife or the chemist’s drug.”

This raised a few questions for me, namely:

  • What was the composition of the Disciplinary Tribunal that showed such flagrant disregard to evidence, common sense and conventional wisdom and what is their justification for their acquittal of Wong?
  • Whilst Wong has been ordered to pay for the SMC legal and tribunal costs, will Wong also be responsible for the worker’s additional injuries and damages caused as a result of Wong’s unethical and negligent behaviour?
  • Is a six-month suspension/sabbatical a sufficient deterrence? Perhaps in addition to the six-months suspension, there should be a clear statement which suggests he will be struck off permanently for another violation and also be ordered to perform pro-bono activities for migratory workers in Singapore for a period of time. This will be not dissimilar to the Correct Work Orders (CWOs) imposed for a number of other offences in Singapore.
  • In addition to punishment meted out to the doctors, companies and firms, that also are responsible for the prevalence of such despicable practices must also be brought to account and be made an example of.

How a society supports and treats its most vulnerable, its most helpless and its most needy, is an indication of the society’s progress and humanity. A society that is materially wealthy but neglects to look after the concerns of its most helpless is but a poor and miserable one.

 

 

 

 

The Singapore Budget 2016 in a nutshell

The Singapore Budget 2016 was announced on the 24th of March 2016 by Finance Minister, Heng Swee Keat.

Below is a simple view of the budget (please click here to download high resolution version):

budget 2016
A summary of the Singapore Budget 2016

Some have claimed that this budget represents a ‘game plan for the next 50 years’ but my view is that this is a very functional budget that sets out a 5-year planning approach.

The budget itself can be split across five areas: support for small and medium sized enterprises (SMEs); Economic Transformation; Social support; Infrastructure Investment; and Individual Taxation.

The main focus of the budget has been primarily around partnership (particularly between government and industry), internationalisation (and support for companies that seek to establish Singapore as a trusted brand) and a transformation of the economy, towards greater efficiency and focus on high value drivers.

Theme of the 2016 Budget: Clarity, Consistency and Compassion

The aims of the government seems to be very much around providing clarity to businesses across a number of areas (from finding relevant grants, to addressing their pressing issues and providing them with the right information to ensure their alignment to the government’s wider aims).

There is also significant consistency with previous policies and measures and little deviation to what has already been established. This includes buttressing of existing policies around SkillsFuture or other social policies.

It is the final theme of compassion that strikes me the most. There is a tacit acknowledgement that social mobility is a critical matter that needs to be addressed urgently. The Deputy Finance Minister in a speech has indicated as much.

Looking at the slew of social-focused policies and support pillars designed to help the underprivileged and support social mobility is important as Singapore enters her 51st year.

Income disparity and social mobility remain the biggest threat to our social systems and to any country’s progress. Putting into place the pillars to enhance mobility is an important investment to ensure the harmonious development of society and nation.

Climate change

One area that could have been addressed in more detail is the impact of climate change and the government’s wider approach to addressing this important area – particularly given the severe consequences this has on Singapore. In time to come, I suspect, governments around the world will start devoting more of the government budget and resources towards addressing this and report on the developments.

The government touched on tax rebates for companies for CSR practices. I hope over time this extends to wider sustainability measures adopted by companies to reduce their carbon footprint.

Big Data and Planning

Another interesting development is the development of the National Trade Platform (NTP) that seeks to integrate all business and finance data of companies. This is going to support the predictive ability of the government in understanding the various levers of economy and also develop more timely and appropriate interventions to support businesses. If done right, the type of data and the insights gained from this initiative could be hugely  influential and something other nations will sit up and take note of in order to have a better handle on their wider economic affairs.

 

Banks – the regulations that govern them – and what happens when they are not governed.

In addition to my Facebook posting previously on the issues that have been faced in the aluminum markets, banks are generally now increasingly involved in a number of markets from energy to aluminum.

I was reading an excellent article in Bloomberg which very neatly explained the connections. Banks are now subsidized by the government. The Federal Deposit Insurance Corporation and the Federal Reserve (both backed by the taxpayers) provide a subsidy to banks – allowing them to draw on reserves during times of market instability.

 

This means that the banks which are too big to fail (and can cause catastrophic consequences should they go under) are effectively allowed to borrow at low or cheap rates.

 

What this means is that banks who can borrow at a lower rate than most other corporations, start investing in markets such as energy or the metal markets such as the aluminum markets, create stockpiles and cut supply which in turn creates a higher price from which they benefit from when they then sell the commodities in the open market.

In the event they bet wrongly, and the prices of the commodities they are stockpiling drop and lead to financial distress at the banks, then the government (and taxpayers) are obliged to provide emerging funding reserves to tide them through.

This creates similar risk-incentive situations which caused the 2008 financial crisis in the first place.

It will be also useful to learn about some of the existing regulations which are in place or which have been lifted but which may need to be considered to prevent the type of problems we had/have now.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Link: in full here) –

This is an act that has polarised America with one faction arguing that the Act does little to prevent another financial crisis or stop risky behaviour that will lead to another bailout whilst another faction argued that it was too restrictive and draconian.

The volcker Rule – Within this Act, under the section of “Improvement to Regulation” is the Volcker Rule – which essentially restricts US banks from making a number of speculative investments that do not benefit their customers and only seeks to boost the banks and bonus payouts of senior management at the banks.

With the aim of reducing the amount of speculative investments on large firms’ balance sheets, it limits banking entities to owning no more in a hedge fund or private equity fund than 3% of the total ownership interest.The total of all of the banking entity’s interests in hedge funds or private equity funds cannot exceed 3% of the Tier 1 capital of the banking entity. Furthermore no bank that has a direct or indirect relationship with a hedge fund or private equity fund, “may enter into a transaction with the fund, or with any other hedge fund or private equity fund that is controlled by such fund” without disclosing the full extent of the relationship to the regulating entity, and assuring that there are no conflict of interest

 

Glass-Steagall Act (Link to Act here)

This was an Act that was around from the time of the Great Depression in the 1930s until the Clinton Administration repealed it at the turn of the century.

Established as a part of President Franklin D. Roosevelt’s New Deal following the Great Depression, the Glass-Steagall Act actually refers to a handful of provisions sponsored by Sen. Carter Glass and Rep. Henry B. Steagall, which were a part of the larger Banking Act of 1933.

These provisions accomplished a number of things, but most notably prohibited commercial banks from participating in investment banking; this includes activities such as underwriting securities (except for certain treasuries), providing services by brokers or dealers in transactions in the secondary market, as well as facilitating mergers, acquisitions and other forms of restructuring. Investment banks were likewise prohibited from accepting deposits.

The ending of Glass-Steagall removed the distinction between investment banks and commercial banks, leading to a scenario where banks started making risky investments with government-guaranteed deposits.

However, in the last few months, a bipartisan group of senators put forward a proposal for new Glass-Steagall legislation that would restore a strict separation between commercial banks and speculative trading. It is argued that this will inhibit the excessively risky behaviours demonstrated by a number of banks and help prevent the next financial catastrophe.