I investigated launching a Bitcoin exchange traded product (ETP) about a year ago. One of the issues was the market cap of BTC - an ETP would not be profitable with under $25 million under management. That is still 10% of the market cap.
More pressing is float, i.e. volume being traded or sitting on the sidelines able to be traded. The concern is that BTC is like the diamond or Facebook private stock markets - a tiny float, bid up by a few zealots, unable to sustain a broader liquidation event without a significantly impairing its price.
BTC is still of tremendous interest, e.g. practically uncorrelated with the U.S. money markets, though that will get eroded as it plugs into the financial system. But the complexity of the BTC microstructure is holding back the development of deeper, more sophisticated markets.
I like the idea of bitcoins but I do not understand what the purpose of a btc ETP would be? It seems that an ETP would have all the risk associated with buying BTC but none of the benefits. I'm a finance noob so this is not criticism, I'm curious.
It offers liquid BTC exposure on a trusted platform.
There are more investors and market makers with deeper pockets on stock than Bitcoin exchanges. They prefer trading there because of there is a lower chance of one's balance vaporising at JPMorgan than at Mt Gox.
so I'll say it here -- yes, an exchange-traded derivative of bitcoin would certainly benefit from higher liquidity. But why would its liquidity there necessarily be any different (or quicker to get your money in/out for amateurs) from the existing BTC exchanges? The interest in the BTC ETF depends on demand to trade in BTC in general, already captured on exchange sites.
Or is there some reason market makers would find it attractive to provide the liquidity?
Gold was traded in spot commodity markets long before GLD came along, yet there is demand for GLD apart from gold. Similarly, demand for Bitcoin on BTC exchanges is constrained by (1) trust issues regarding the exchanges, (2) the energy it takes to connect to those exchanges, and (3) fund mandates limiting their assets to listed securities.
(1) Counterparty risk. The probability of the U.S. equities clearing system collapsing is infintesimal compared to the odds of (a) a dick at Mt Gox running away with the money, (b) a dick hacking Mt Gox and running away with the money, or (c) any number of technical or personnel problems that could limit the ability of a customer to withdraw their funds in a timely manner. This is still my #1 concern regarding setting up a Bitcoin market making operation.
(2) Barriers to entry. Everyone in finance is already plugged into the majour stock exchanges. Connecting to a new exchange involves investments of time and technology.
(3) Mandates. Many funds are required to trade only listed products).
A Bitcoin ETP would require active hedging in the Bitcoin spot markets. Thus, think of the ETP as a liquidity gate. I do not believe the BTC markets are ready for the flood gates yet.
Edit: I see that you edited your response. I guess the selling point is the trust factor and that is certainly attractive. How much trust do you think is placed in JPM that is not due to regulatory oversight?
I have been following bitcoin since they were less than a penny each, and got my first coins at about .20 each. I have written articles (really the only thing I have ever written that has been widely read) about bitcoin, and I want to see it succeed, both because it will change my financial situation and because I believe central bank issued currency that flows through the hands of banks is a mechanism for control over people.
All that being said, I think we are in the middle of the next big bitcoin surge, and I don't want to see "bitcoin reaches all time high xxxx" posts everyday.
I made the HN submission; and you know what? I agree with you. On a second thought I would have rather not posted it. I much prefer a slow and steady increase of value, instead of another Bitcoin valuation bubble made even more rapid by publicizing it all the time.
"I believe central bank issued currency that flows through the hands of banks is a mechanism for control over people."
Only to the extent that laws are a mechanism for controlling people. I have argued elsewhere that laws are what give money its value, and that Bitcoin still requires the existence of fiat currencies to be useful to anyone (put simply, most people still have taxes to pay and debts to settle, and so they only accept Bitcoin because they believe they can exchange it for another currency; even you speak of Bitcoin in terms of another currency).
I would argue, though, that laws and fiat money are not necessarily ways to control people, but that they are necessary tools for any large society. Sometimes people disagree and require a third party to settle their dispute. Laws help give third parties (also known as judges) legitimacy in their judgments -- they can point to laws that were written before the dispute, so that there are fewer questions about bias or personal sentiments affecting the verdict. When people fail to use laws and court systems to settle their disputes, they turn to their weapons and civil wars ensue.
At the very least, the operation of a court must be paid for. A person whose job is to mediate disputes all day -- and even a society with only a few thousand people will require such a person -- is not producing food or maintaining infrastructure. We would not be satisfied with a system where the parties in some dispute were directly paying the judge. At the very least, some sort of tax system is needed to pay for a court system, and humans discovered that using animals or crops as taxes does not really satisfy the needs of society. Currency makes taxation fair (do judges need wheat, or do they need cattle?) and reduces the expense of collecting taxes (tax collectors no longer need to decide if one cow is of the same quality as another).
Of course, the moment you introduce a tax law that requires people to make payments with money, you have created a fiat currency: you have created a law that fuels demand for money (and thus gives money value), and it makes no difference whether that money is made of clay, gold, paper, or even if that money is nothing more than information stored on computers.
So while I can understand the dissatisfaction with what today's banks and governments do with money, I do not think fiat money itself is the problem. Fiat money is a consequence of any appreciably large human society; without it, we would be living in tiny groups in the wilderness, jabbing each other with spears whenever we had a disagreement, or we would be trying to convince government officials that our sheep are of high enough quality to be accepted as a tax payment.
I'm quite ecstatic about this. I invested in bitcoin early on when it was around $1-3 a coin. I try to buy goods with it at legitimate places like bitcoinstore when it's up, and buy more when it's down. I just, you know, actually believe it's a great alternative and want to see it succeed.
I do have concerns about it scaling to handle massive amounts of transactions, and what will happen with transaction fees and mining rigs as the mining reward is reduced, but it's step in the right direction for currencies.
Of course, Bitcoin does not really have offline transactions, so this may not be all that relevant (though lacking offline transactions is a pretty serious limitation).
Correct me if I am wrong, but the prevailing thought when that article was written (1992) was that digital currency would resemble more of a transferred digital coin, with signatures representing each transaction. So if I had coin #12345, and I transferred it to you, I would digitally sign it to you giving your private key the spend capability.
With those architectures, a central authority would be required to prevent the double-spend. And with those architectures, the coins grow with each spend.
The difference with Bitcoin (which I think is totally misnamed) is that it's not a coin architecture, it's a ledger architecture. So no matter how many times the amount 1BTC is transferred, each transfer could be just the same length - the sender's address, the recipient's address, and an appropriate signature. Even 50 years from now and ten thousand transfers of that "coin" later, the "coin" doesn't get larger.
The ledger gets larger, but the coin does not (since really there's no such thing as a "bit COIN" - really what you have is a series of account numbers in the giant shared ledger.)
"With those architectures, a central authority would be required to prevent the double-spend"
Not necessarily; another approach, which is common in protocols that allow offline transactions, is to force cheaters (i.e. people who double spend their tokens) to reveal their identity. It helps to think of the nonce in DSA: if that nonce is used for one signature, the secret key remains secret, but if the nonce is reused in another signature then the two signatures can be used to compute the secret key. Similarly, in a digital cash system, if the same token is used in two different transactions, then the two resulting tokens can be used to compute the identity of the person who spent that token in the two transactions (and hopefully, whoever computes this will warn everyone else about it).
"with those architectures, the coins grow with each spend."
Chaum's result applies to any secure offline electronic transactions, regardless of the internal workings of the transaction. The argument is basically this: to maintain the security of the transactions, the amount of information being transferred per transaction must increase in the number of offline transactions that involved a particular "unit" or its "derived" units (e.g. if the system supports splitting the currency, as Bitcoin does). It does not make a difference whether or not the system has a central authority; all that matters is that the system allows some value to be securely transferred in an offline/peer-to-peer fashion i.e. that a transaction do not require any communication with any parties not involved in the transaction itself.
"The difference with Bitcoin (which I think is totally misnamed) is that it's not a coin architecture, it's a ledger architecture"
I read this as saying basically this: there are no offline transactions in Bitcoin; every transaction involves communicating with other nodes in the Bitcoin network. Which is well-aligned with Chaum's result, because Chaum's result boils down to a trade-off: either you support offline transactions and incur a scalability penalty (which a central authority can fix by trading "old" tokens for "new" tokens), or you only allow online transactions (or something in the middle, like "receipts," which Chaum discussed). I would call the lack of offline transactions a major technical shortcoming of Bitcoin that severely limits its utility, but I suppose not everyone agrees with that statement.
A bitcoin is just a signature, a string that you use to demonstrate ability to transfer it. You can hand someone a physical copy of a bitcoin signature. Of course you won't be able to verify the transaction yourself, but trusted third parties are using things like scratch off holograms to access them.
I have a question about bitcoin -- let's assume that it actually starts becoming popular. What stops any country that's adopting it from simply forking their own version? Specifically, why is everyone investing in this particular instance of bitcoin?
People have mentioned perceived value; i.e. a fork of bitcoin would only be worth something if people generally agreed it was. However, there's also another reason, and that is that the security of bitcoin is directly related to how many people are using it. In order to double-spend, you need 50% of the CPU of the system, so the more CPU power you have on the network, the more secure you are from double-spending.
Nothing stops them from doing that. It's already been done a few times, in fact.
What generally prevents tons of fracturing is the same thing that always has for currencies with no backing- perceived value of the currency. Your bitcoins are only worth what other people think they are worth.
"What generally prevents tons of fracturing is the same thing that always has- perceived value of the currency."
Except that "perceived value" is not what prevents fiat currencies from fracturing. A government could, at any time, issue a new currency that competes with or replaces its old one. The reason governments almost never do this is that it amounts to defaulting on a loan, at a fundamental level.
To put it another way, if a government decides to issue some new, incompatible currency, and whatever currency you had previously lost some or all of its value, would you trust that the new currency would not also be replaced by yet another currency later on?
Money does not just magically get its value; the "perception" that money has value is, like the perception that anything else has value, based on supply and demand. We are all familiar with the money supply; money demand is generally driven by the legal structure that surrounds that money. Money demand comes from things like tax codes, debt/bankruptcy laws, torts (which often deal in monetary terms when speaking of damages), civil fines, etc. Another way to look at it is that laws allow you to use money to cancel debts of some kind, and thus the demand for money can be traced to the need people have to cancel various debts (and thus people with no debt can trade money for the goods or services of people who must cancel some debt).
Bitcoin is unique in having no legal structure surrounding it, and its demand comes principally from technical features (primarily one feature, which is secure online payments). Unsurprisingly, this demand does little to help Bitcoin survive on its own, hence the overwhelming important of Bitcoin exchanges (were these to vanish, Bitcoin would die overnight; on the other hand, the Ruble had some value in Russia even during the period of time when it lacked easy convertibility with other currencies).
To put it another way, if a government decides to issue some new, incompatible currency, and whatever currency you had previously lost some or all of its value, would you trust that the new currency would not also be replaced by yet another currency later on?
And that's not just a hypothetical, as it's precisely what happened with the Myanma (Burmese) kyat:
Perhaps the initial demand for something like USD was due to legal effects like tax codes and bankruptcy laws, but I would think the primary demand today is network-effects. If I want to participate in a transaction within the US borders, almost any transaction, I must use USD. Therefore I need USD. Most of my transactions have nothing to do with said legal structures.
I think it's hard to say that Bitcoin's demand principally comes from technical features (without proof). Certainly there are those that want secure online payments and so buy BTC but there are others that buy BTC because they think it will be more valuable in the future (relative to USD) if it gains more traction. Additional demand: low transaction costs for international exchange (I remember reading an article about Iranian nationals using BTC to sidestep export/import restrictions).
But I definitely share the frustration of explaining perceived value. From an economics stand-point, "perceived value" is redundant. Value is by definition an abstract concept that humans (or other creatures) attach to something based on how much they desire it.
"Perhaps the initial demand for something like USD was due to legal effects like tax codes and bankruptcy laws, but I would think the primary demand today is network-effects"
Those network effects start somewhere, in the present; otherwise, it would be hard to explain why US dollars are hard to spend in Canada, Europe, and other countries. The answer is that in Canada, the Canadian dollar can legally cancel debts; in Europe, Euros and the remaining national currencies do it; other countries have their own currencies, or adopt the currencies of more powerful nations like the United States.
Laws about money remain the driving force of the demand for money. Failure to pay taxes is a serious crime; the US government only accepts US dollars for tax purposes. Failure to repay a private loan can result in your property being given to the lender -- and you could be arrested for trying to keep that property (formerly yours). These are legal matters that affect our daily lives, even if we do not actively think about them, and the demand for US dollars in the US, Canadian dollars in Canada, and Euros in Europe follows. If you want to be a law-abiding citizen or business in the US, you must get your hands on enough US money to at least pay your taxes; even if you participate in a barter exchange, the law requires you to pay taxes on that trade. Even if your plan is to live off the land, you will still have to pay Uncle Sam at some point: hunting and trapping fees, fishing fees, fees for felling trees, etc. Other countries have similar fees and taxes, except that the requirements are for a different currency. Network effects are secondary: People know there is demand for US dollars in the US and in a few other countries, and so they may deal in US dollars even if they have no debts in US, much like a shopkeeper will buy and sell goods he may not have personal use for.
"I think it's hard to say that Bitcoin's demand principally comes from technical features (without proof)."
Can you point to any other sources of demand? There are no laws about Bitcoin; if you issue a Bitcoin loan to me and I fail to repay it, what are you going to do? Even if you took me to court, the first thing the judge would do is to convert whatever Bitcoin amount you name to the currency of your country. No country will accept Bitcoin for tax purposes. Those reasons alone are enough to conclude that without Bitcoin exchanges, Bitcoin would probably not survive at all -- merchants will only accept Bitcoin because they are aware of a way to trade Bitcoin for their country's currency (and the lack of stability in the exchange rate really puts a damper on that). Even people who use Bitcoin for black market transactions rely on the existence of Bitcoin exchanges.
There is no denying that there is demand for Bitcoin's technical features. People want a way to make secure, peer-to-peer online payments, and they are not satisfied with solutions that rely on trusted third parties. It seems that all other demand for Bitcoin stems from this; speculators are basing their Bitcoin investments on the belief that there is some real demand for Bitcoin and that the Bitcoin market will grow, but were there no demand for Bitcoin those speculators would not be in business (speculation does not create a market). The low transactions fees for international exchange are a product of lacking third parties, and I would classify that as a technical feature of any digital cash system.
I'm interested in your third paragraph, particularly "Money demand comes from things like tax codes, debt/bankruptcy laws, torts, ...civil fines, etc."
In prison, packs of cigarettes are money and none of the things you mentioned exist. Yet in a prison I can trade a pack of smokes for a tattoo, drugs, cellphones, etc. It seems like money arises out of the need to have a reliable, constant value for exchanging good and services.
Do you differentiate between money and currency(medium of exchange)?
Prison has a lot of structure, in the form of laws,customs,and constraints imposed from without and from within. The role of money in expressing the power of the state may be distinguishable from its role as a medium of trade, but I think if anything the prison example contradicts the point you seemed to be making.
Fair point, I meant it in that prison officials don't issue the currency and in fact they actively discourage trade among prisoners. betterunix makes it seems like the state and money are essential for each others existence.
I'm not sure if there is a difference between currency and money, but there is a difference between fiat and non-fiat currencies. Cigarettes are not a fiat currency; they have inherent demand because they can be smoked.
"What stops any country that's adopting it from simply forking their own version?"
Nothing. Anyone could start their own bitcoin2. But new instances of a digital currency cannot debase other instances. So that isn't a viable way for a government to capture bitcoin, or to debase the value of the original bitcoin.
In fact, were I running a banana republic with a worthless currency, I'd be tempted to try using a new "bitcoin-space" as a currency with strong protections against being debased. But that has plusses and minuses if you are a government.
The reasons people are using this particular instance of bitcoin is that it was launched successfully enough for people to have sufficient confidence. The mining mechanism is one key element.
Why would any country want to adopt Bitcoin? What incentive does any country have to do such a thing?
A country would be more likely to introduce a Chaum-style digital cash system, where the government would act as an issuing authority for digital cash tokens.
Relevant: The Royal Canadian Mint recently invented MintChip, a fully digital crypto-currency where private keys are stored in integrated circuit chips in micro sd cards (for smartphones/tablets) and USB dongles (for computers).
They say it is able to be exchanged online AND offline fully anonymously. The details on that are yet to be released.
This makes Canada the first country in the world to explore a fully electronic currency.
Perhaps, but it would have to be adopted side-by-side with a currency that can be used (securely) for offline transactions. Why do that, when you could just adopt one currency that can be used both offline and online (especially since you can deploy a digital cash protocol for any currency, and thus you only really need one that is useful for offline payments)?
I expect we'll eventually see a new bitcoin instance for items and gold in an MMORPG. Actually it seems to me that bitcoin could govern more than that: basically any random event ("you made a wooden shield") could go into the blockchain.
The fact that people talk about the "market capitalization" of bitcoins suggests that they treat it as a speculative investment and not a currency. Maybe it is unavoidable in the adoption phase of its life (supply relatively fixed and demand fluctuating), but the price swings relative to other established currencies detract from its usefulness as a currency.
Highlights:
- scalability to Visa/Mastercast number-of-transactions is architecturally not possible currently
- as many have said: it's not anonymous
- security has numerous widely discussed issues
Your last paragraph on the link says it all: "BitTorrent is technologically complicated, infrastructure-wise inefficient, much less usable than a regular Web download, etc. But it got popular anyway, mostly because of unreasonable greed and paranoia of incumbent oligopolistic players."
After reading this (I started with reading the conclusion) I'm glad that I didn't waste my time with the remainder of the article. This doesn't seem to be an objective article, but just subjective ranting.
Castration? I don't know, whatever they do on "plain vanilla" exchanges/brokerages that allow shorting.
Although there were recent scandals about people shorting shares that didn't exist, and when they would have reaped a profit, they were told there was no record of the shares, "but we can reverse the transaction if you like".
I still feel the majority of the money that is being put into bitcoin is speculative(as opposed to having hard data). I think if you buy bitcoins now you lose money at the end of the bull's run. That could easily change if Amazon or Steam start accepting them and the money from actual uses drowns out the speculators (and therefore any growth in the value of the coin has real use backing instead of easily spooked speculators).
More pressing is float, i.e. volume being traded or sitting on the sidelines able to be traded. The concern is that BTC is like the diamond or Facebook private stock markets - a tiny float, bid up by a few zealots, unable to sustain a broader liquidation event without a significantly impairing its price.
BTC is still of tremendous interest, e.g. practically uncorrelated with the U.S. money markets, though that will get eroded as it plugs into the financial system. But the complexity of the BTC microstructure is holding back the development of deeper, more sophisticated markets.