Bitcoin: It is Certainly the End of the Beginning

Last week’s halt, and possible collapse, of the Mt. Gox exchange may or may not prove to be the beginning of the end for Bitcoin – but to borrow Winston Churchill’s phrase, it is certainly the end of the beginning.

Mt. Gox had already lost its place as the leading Bitcoin exchange before the murky chain of events that led the Tokyo-based site to shut down. An apparently leaked internal document indicates that the site may have been the victim of a major theft, in which perhaps more than $300 million worth of Bitcoin “disappeared” from the exchange’s accounts. I put “disappeared” in quotes because, of course, Bitcoin has no physical manifestation.

As I discussed last summer, Bitcoin exists only as the product of a computer algorithm whose origins are unknown and whose ultimate purpose is unclear. It has attracted a varied collection of users, including individuals who want to keep questionable dealings private, people who may want to keep part of their wealth hidden from authorities who have access to conventional financial accounts, and end-of-the-worlders who think civilized society is on the highway to hell and that for some reason they will be better off owning bitcoins when we all arrive there.

Bitcoin enthusiasts like to call it a digital currency, or cryptocurrency because of its encrypted nature. But it is clear now, amid the wild fluctuations in Bitcoin’s price, that it is not a true currency at all. It is really a commodity whose price fluctuates according to its quality and according to supply and demand.

As of this week, there are two grades of Bitcoin. One of the Mt. Gox variety, which nobody can access while the site is down and which may no longer truly exist at all, was worth only about one-sixth of every other bitcoin yesterday.

Some people are always willing to offer value, albeit not very much value, to take a chance on a possibly worthless asset. This is why shares of companies that are obviously about to go bust can trade for a price greater than zero. But at least we know the shares exist, whether in tangible or intangible form, and there are government authorities available to vouch for their validity, if not their value. Bitcoin, sponsored by no government and outlawed by some, has no such backing. Ask any Mt. Gox user today whether that is a plus, as bitcoin holders have heretofore maintained. (Authorities from Tokyo to New York are already probing the Mt. Gox collapse, and some sort of follow-up action seems likely.)

True money serves two functions: as a store of value and as a medium of exchange. Bitcoin thus far gets only fair marks as a medium of exchange, since there are only a limited number of places where you can freely spend it. You can swap your (non-Mt. Gox) bitcoins for real money, but you can do the same with any other commodity, like diamonds or Hondas. Diamonds and Hondas are worth money, but they aren’t money.

Bitcoins utterly flunk the store of value test because their wild price fluctuations do not store value; depending on blind luck, they either create or destroy it. Collecting bitcoins is speculating, not saving. There is a big difference.

Bitcoin does address certain real-world issues, such as the sometimes exorbitant cost of exchanging currencies and the cumbersome nature of the modern banking system, which is laden with regulation to try to prevent everything from insolvency to money laundering to identity theft. But the regulations exist because insolvency, money laundering and identity theft exist, too. As Mt. Gox vividly illustrates, a system without such safeguards is prone to create problems much more serious than the ones it purports to solve.

The Mt. Gox debacle might or might not permanently undo Bitcoin’s credibility. We won’t know before we know what happened in those computers in Tokyo. The crisis should, however, strip whatever is left from the veneer of safety that Bitcoin’s supposed cryptosecurity was supposed to provide. Bitcoin is no more secure than the structure that is built to hold it. Lacking all the backstops that have evolved over time in the traditional financial system, that is not secure at all. Either we recreate those backstops in the Bitcoin world, in which case we have to wonder why we bothered with Bitcoin in the first place, or we live dangerously without them.

There will always be people who don’t trust banks and the government to secure their savings. They used to stuff cash into mattresses. Maybe some will continue to use Bitcoin instead. My own guess is that Bitcoin’s chance of becoming a mainstream form of payment, like debit cards or PayPal, is virtually zero. This may not be the beginning of Bitcoin’s end, but we have definitely seen the end of the beginning.

About Larry M. Elkin 553 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

Visit: Palisades Hudson

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