Sunday, July 2, 2017

The Confusing World of Cryptocurrencies

Cryptocurrencies have captured a lot of media attention this year as the more well known versions like Bitcoin have seen sharp increases in price even as they also see a lot of volatility. By no means do I claim to be an expert on this topic, but I do think it may be possible to discuss it in a general way that might help make it a little less confusing to most people who simply don't have much in depth knowledge of the subject.

I did publish a very long two part article here way back in 2015 that I still believe is very good for anyone who wants to dig into Bitcoin more in depth. Most of the article was written by a true global expert in payment systems who is a blog reader here. He understands Bitcoin as it was originally designed and also what he felt were some flaws in that design which he explains in the article. You can find the links to that article here.

A lot has happened since that article was published so this article will try to summarize where things stand in a more general way while admitting that it is impossible to cover all aspects of this topic. 

Below I am listing some bullet points to try and give readers a feel for where I think things stand with Bitcoin and cryptocurrencies in general along with the underlying blockchain technology that supports it. I will add that I am not intending this article to be pro or con on Bitcoin or any other similar product. I don't own any myself, but I don't wish to try and advise anyone else what they should do. The point here is to just try and help readers get a feel for where it stands now as I understand it.

- a problem that Bitcoin has struggled with for some time is the limitation of the size of the block where the data is stored. This limitation along with how Bitcoin is designed makes it harder and harder to process transactions quickly and efficiently as time goes by. Our expert explained that pretty well in our original article linked above (but its pretty technical). There has been an ongoing effort within the Bitcoin user community to try and address the problem and that continues. So long as the technology can only process 7 transactions per second, it cannot really become a mainstream payments system trying to serve a huge number of users at the same time. Traditional payment systems can process huge volumes of transactions per second. Only time will tell if this problem can be resolved successfully. It is just important to understand the issue exists and must be resolved somehow for Bitcoin to gain widespread adoption.

- Over time the underlying technology supporting Bitcoin known as the blockchain has gotten the interest and attention of the mainstream banking community and central banks around the world. All kinds of studies are underway to see if the underlying technology might be used within the banking system (both in private banks and central banks). The Bank of England is studying whether or not central banks might some day use blockchain technology to support a digital central bank currency that private citizens might be able to hold. As an example, suppose the BOE were to issue an e-pound (just the British pound but all in electronic form, maybe using blockchain technology or not). Suppose they allowed private citizens to open a bank account directly with the BOE where they could hold e-pounds if they wanted to? What would be the advantage? A bank account held directly at the BOE in e-pounds would be theoretically safer than a bank account at a local private bank if a bank run were to take place. The BOE would be there to guarantee the account while a private bank might go under. However, a possible drawback or concern that the BOE noted is that people might not keep funds at private banks if they had this choice. It's all just a study for now and nothing has been decided. But this illustrates how entities within the system are looking at all this. China and Russia are researching it as well as other nations. Private banking concerns like JP Morgan, Goldman Sachs, Citi, IBM, and many others are all studying blockchain technology as well. All kinds of possible uses have been imagined beyond just currencies. Again, only time will tell how this moves forward or not. The system has to be able to exceed its costs of operations to be sustainable over time. Blockchain technology tends to get more expensive over time.

-to understand this whole topic, it is important to understand the under the surface tension that exists between people running the present banking system and people who are distrustful of the current system and are looking for ways to keep at least some of their money outside the banking system. Many supporters of Bitcoin and other cryptocurrencies are motivated by the idea of bypassing the official banking system. Meanwhile, those running the present system are looking at ways to try and co opt the technology and keep people inside the system. They also keep a wary eye on Bitcoin etc. to make sure it does not pose a threat to the US dollar. So long as Bitcoin and other cryptocurrencies only occupy a very small niche (see this chart for perspective)*, they probably don't see it as a threat. If that ever changed, they might try to clamp down on it.  Already some nations are making it harder to use and are looking at regulations that could inhibit growth. Many nations force you to keep track of capital gains and losses if you buy and sell it or just use it to make purchases. Again, only time will tell us how that turns out.

- there is kind of a friendly battle that goes on between the older generation that tends to think of precious metals like gold and silver as better assets to hold outside the banking system and a younger generation that tends to favor the cryptocurrencies like Bitcoin. All kinds of debates and discussions take place over that. People like Jim Rickards tend to be more inclined to favor gold (see this video interview) while some of his younger followers are more inclined towards things like Bitcoin. They agree that people should hold some money outside the system, but disagree on what is best to hold. Although some people like both about the same. Some of the arguments back and forth get pretty technical and hard to follow for the average person. 

Summary: The main point I would make in this article is that at this point the future for cryptocurrencies and blockchain technology is still very much an unknown. Right now the number people of owning Bitcoin is still a very tiny % of the population even though it is still a growing number. Since Bitcoin has limited supply, it can see demand exceed supply even with a relatively small number of users and price can certainly go up (and down when sentiment reverses). Whether Bitcoin can overcome its block size issues and somehow gain much broader mainstream acceptance is simply an unknown. There are other potential issues with Bitcoin that were pointed out in our earlier two part article related to privacy and security, but the article is too long to go into those here.

As we can see, there are a lot of pieces to this puzzle (that I will just call The Confusing World of Cryptocurrencies) as we have banking entities inside the system also possibly looking to compete with things like Bitcoin or perhaps find other ways to commercialize the blockchain technology. Then we have nations and central banks looking at it as well. Any or all of these entities might move forward or they may not.

I don't see how anyone can know for sure how all this will turn out. If we do get another major global financial crisis that will be another factor to consider. Does that drive millions (or tens of millions if its really bad) more people to look outside the banking system due to lost confidence? If so, do they move into things like Bitcoin or more traditional safe havens like gold and silver? How would the central banks respond to all that? Try to crush alternatives to their currencies? Try to compete with their own versions?

Lots of questions for now, but no clear answers yet. Hopefully, this will at least give you some idea of where things stand today and some various ways things could play out in the future.

* note: at the time the chart above was produced, Bitcoin had a smaller market cap than it does now, but it is still tiny compared to all the other forms of money shown on the chart. Note that there are individual private citizens who have a larger fortune than Bitcoin's market cap. One expert that reviewed a preview draft of this article gave me this comment regarding market cap:

"It is always worth reminding readers of the difference between payment technologies (blockchains) and money (Bitcoin, gold, USD). You might also note that Ethereum has almost caught up with Bitcoin in market capitalization."

Added notes: Here are some other related articles that may be of interest on this topic. 

Jim Rickards in depth discussion of basics and risks (interview text)

PBOC Researcher - Can Cryptocurrency & Central Banks Co-exist?

Cryptocurrencies are Pyramid Schemes? (negative article on cryptocurrencies)

Blockchain chart

China not yet ready to issue national digital currency

IBM Joins Major banks in New Blockchain rollout - I find this one particularly of interest

Added note: Here is a followup article that looks at a new IMF paper on central bank digital currencies. The paper has some interesting comments in it that relate to things we have covered here.

News note 7-5-17: Update on Andrew Maguire prediction that a significant event would arrive this week impacting the gold market. Today would be 26 days from when the King World News interview took place where Mr. Maguire said to watch for the event in 26 days.

I contacted a representative for Mr. Maguire and was told that there will be a slight delay in the timing for the event he was anticipating, but that Andrew Maguire has issued an update on his Twitter feed to provide more information. Here are the links to those tweets:

If you follow the link he provides in his first tweet above, it takes you to a web page announcing that a new type of gold product is about to launch. He describes this new product as "1st ever institutional grade Gold/Silver cryptocurreny" 

It appears Mr. Maguire believes that the launch of this new product will be accompanied by "billions (of dollars) of physical orders" for gold. So, we will continue to monitor events to see how this impacts gold prices in the coming days.

Update 7-7-17: King World News issues this brief update in which Maguire says 250 tons of orders for physical gold are coming. He says he expected them on July 5th. They did not come on that date and now he says he is "100% sure" they are coming soon.


  1. Great summary Larry. One of the best I've seen. Thanks

  2. Thank you. I had 3 experts look at this article so I feel comfortable the information is solid. I am interested in the new blockchain project IBM just announced with 7 major banks (see link above).

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