Musings on Blockchain and Bitcoin

Blockchain and Bitcoin: A Short Primer


Over the last few weeks, there has been a kot news on Bitcoin and blockchain. We’ve had many clients ask us about news about the price increases of Bitcoin and what it is. We have decided to create a short primer on blockchain technology, how the technology is disrupting industries across the world, and the recent events associated with the dramatic rise in Bitcoin’s price.

Blockchain

The blockchain works by recording transactions among a network and securing those transactions in a block. These blocks are linked with the preceding and following block into a public ledger of all transactions. Bitcoin is one example of a cryptocurrency that utilized blockchain technology to facilitate and record transaction on its network.

Currently, all settling of purchases and sales of goods and services are done either through a bank, a transaction company such as Visa or PayPal, or through the transaction of cash.  With the internet, the ability to make or settle transactions became more complex as you need to make sure that there is little counter-party risk (i.e. that the person you are transacting with and the system you are using are trustworthy).

At the beginning of the internet era, the invention of PayPal helped to facilitate transactions between online consumers and allowed e-commerce to expand around the world. Over the last quarter century, credit card companies such as Visa and Mastercard have also entered the space to be the middle man in most e-commerce transactions.

Bitcoin looks to disrupt this industry by using blockchain technology to create a decentralized network that records all transactions within Bitcoin’s community. By having the ledger encrypted and public, Bitcoin allows for the public verification of all transactions whilst providing the network security from hacks and providing the community with further trust in the currency and the counterparties with which they are interacting. IBM has created a good video explaining the difference between Bitcoin and blockchain technology. (https://www.youtube.com/watch?v=MKwa-BqnJDg)

Overall, blockchain technology can be used by more than just Bitcoin and has a space in all industries by providing a centralized ledger for transactions along a supply chain. The video below from IBM uses the diamond industry as an example of how the blockchain will be able to disrupt but also make the industry more secure. See https://www.youtube.com/watch?v=lD9KAnkZUjU.

Bitcoin

Bitcoin is the most widely known crypto-currency in the world today and is characterized by being providing its users with complete anonymity. Due to this anonymity, Bitcoin can be used for a multitude of transactions ranging from international money transfers, purchasing of goods and services to more nefarious uses.

In the early days of Bitcoin, the currency was popularized by news stories that featured the currency being used to facilitate everything from purchasing narcotics to black market activities.

Today, Bitcoin is being used in everything from remittance payments of overseas workers (instead of going to a company such as Western Union which may charge fees of 7-10%), to international money laundering, to purchasing goods online, to the black market.


Bitcoin Bubble

As you probably already know, Bitcoin has been in the news a lot recently based upon the crazy price volatility over the last few months. Our personal opinion is that there is a lot of value in the blockchain technology as it has the ability to make transactions more trustworthy, provide better records and be more transparent.

As with Bitcoin, we believe that the price action has gone crazy and is completely speculative as people ranging from retirees to institutional proprietary trading desks are transfixed on the price increase and want to get in on the action.

As fundamental investors, we find it extremely hard to put a value on Bitcoin and do not advise our clients to place any significant amount of funds into Bitcoin. In our view, Bitcoin’s price movement appears to be a bubble and, much like the dot-com bubble and the tulip bubble in 17th century, there is a possibility the bubble will pop at any moment.

Furthermore, there have been many stories of retail investors leveraging themselves by taking out loans and reverse mortgages to get in on the Bitcoin action. We believe that this is absurd behaviour. A currency that is as volatile as Bitcoin and can increase exponentially can also correct suddenly.

Up until earlier this week, there was only one way to speculate on Bitcoin, either buying the currency or sitting on the sidelines. On Monday, the Chicago Board Options Exchange allowed for futures contracts to be traded on the value of Bitcoin, allowing for institutional investors to take short positions in the currency.

Conclusion

The market for Bitcoin is still rapidly developing and will continue to remain volatile; and we do not recommend that you invest in Bitcoin. Bitcoin is a completely unregulated market with very little regulation where prices have reached a euphoria which has only been seen a few times in the modern monetary era.

Blockchain technology possesses the ability to completely disrupt markets and participants while allowing for more transparency, less fraud and more trust between participants – something the world can always use more of.


If you would like to learn more about blockchain technology and Bitcoin, we recommend:

• a TED talk by Bettina Warbug on “How the Blockchain will Radically Transform the Economy” (https://www.youtube.com/watch?v=RplnSVTzvnU) which provides a good summary of the technology which is more in-depth than the IBM videos.

• a TED talk by Don Tapscott on “How the Blockchain is Changing Money and Business” (https://www.youtube.com/watch?v=Pl8OlkkwRpc) which is a brief summary of his book with his son Alex Tapscott called “The Blockchain Revolution” (http://a.co/fqrjB10)