Sorry CNBC, Bitcoin Won’t Make You Fabulously Wealthy, But You’ll Probably Lose Your Shirt

Bitcoin, the world’s cashless crypto-currency, narrowly avoided death in 2016, and has now rebounded to a high of around $2,200 as of Monday.

CNBC breathlessly reported “If you bought $100 of bitcoin 7 years ago, you’d be sitting on $75 million now.”

They based their jaw-dropping calculation on the initial value of a valueless mathematics-based “currency” set seven years ago on “Bitcoin Pizza Day,” when Laszlo Hanyecz bought two Papa John’s pizzas for Ƀ10,000, fixing the value at about $0.003.

Technically, CNBC is right. If you bought Ƀ33,333 for $100 in 2010, your wallet would be worth $75,052,916.13. But probably (almost certainly) not.

SIMPLE ECONOMICS

There are several reasons for this, the first being simple economics.

Bitcoin is a cyber-currency, which is mathematically limited to a money supply of Ƀ15.2 million. New currency isn’t created by a government or a bank, it’s “mined” by computers. The mining process makes new Bitcoin harder to mine as more is in circulation. Currently, you have to run a pretty serious mining rig (and pay for it) to get a decent return.

Mostly these days, it’s large investors running server farms and selling slices getting the mining done. Every day, there are approximately Ƀ1,440 mined worldwide, with a value of $3,242,318 at current rates. The mathematically-capped value of all Bitcoin at current rates is a bit over $34 billion.

Basic economics informs us that there’s simply not enough value to the currency to make anyone except the very early investors rich. In fact, Bitcoin could be the world’s greatest Ponzi scheme, but for the fact that the Japanese government has taken a gamble on using it for retail transactions. The current bump is mostly due to that one event.

TECHNICAL LIMITATIONS

The other reason you’re not a Bitcoin millionaire is that the technology is not fully mature, and may never be. The currency was designed to be an anonymous cryptography-based system, using a “blockchain” to record transactions between highly encrypted “wallets.”

With no hard currency, Bitcoin is dependent on a single, revisionless, blockchain to record every transaction in the world. That means there’s a non-theoretical transactions-per-second limit to do business with Bitcoin (making the fees to use and exchange the currency with “real” currencies fairly high). The companies that do the mining also handle the transactions. This can lead to massive fraud and malfeasance.

Actually, it has.

FRAUD AND SECURITY BREACHES

If you’ve heard of the Mt. Gox disaster, you probably know all this already. Mt. Gox was a Japanese Bitcoin exchange, that famously went bankrupt, taking with it at least $460 million (at the time in 2014) of missing funds. Hackers got a good portion of the loot. From a Wired piece in 2014:

Last week, after a leaked corporate document said that hackers had raided the Mt. Gox exchange, Karpeles confirmed that a huge portion of the money controlled by the company was gone. “We had weaknesses in our system, and our bitcoins vanished. We’ve caused trouble and inconvenience to many people, and I feel deeply sorry for what has happened,” Karpeles said, speaking at a Tokyo press conference called to announce the company’s bankruptcy. This would be the second time the exchange was hacked. In June 2011, attackers lifted the equivalent of $8.75 million.

In 2014, when Mt. Gox failed, Bitcoin had peaked at about $1,200, half of its current value–at today’s value, the failure have cost $863 million.

If any of those Ƀ33,333 in your wallet found their way into Mt. Gox, you may have lost them right then. Or you might have sold off early to get out.

A BROKER’S MARKET

Selling (like doing anything with Bitcoin) has a cost. Depending on volume, you’re going to pay 0.1 to 0.25 percent to an exchange to get your transaction recorded in the blockchain. Some exchanges charge in excess of 0.3 percent. To get your Bitcoin exchanged for real currency (say, dollars), you’ll also pay another load to get your cash (a percentage or a fixed fee).

If this sounds like a commodities futures market, it’s because–it is. Mt. Gox was a hopelessly financially inexperienced enterprise, but the current crop of exchanges (such as Bitfinex) operate like sophisticated brokers. Terms like “margin funding” and “open positions” are bandied about, with interest rates and margin calls all well-documented.

In essence, buying and selling Bitcoin is an investment in a commodity with a known finite supply, a known rate of delivery and cost of production, and a known load for transactional security. This is all good news for the mining and exchange companies, that can scale their operations to make a steady return.

It’s bad news for you, the small investor, at the mercy of market makers, governments, hackers, and confidence peaks/valleys.

Just because Bitcoin has a record value right now doesn’t make it a good investment long-term. In fact, it’s not. Even if it catches on, a currency with a limit of under $100 billion when fully mined (at the current mining rate, in about 10 years) is never going to produce a long term gain for anyone except the exchanges and brokers.

Sure, theoretically, if you were a computer geek and set up a mining operation in your basement in 2010, and mined Ƀ33,333 (less the cost of those computers, the electricity to run them, and the opportunity cost of other investments), that would be worth $75 million today. But more likely, you’d have lost most of that over the last 7 years, and spent the rest on pizza, or something less legal than pizza.

IT WILL PROBABLY COLLAPSE

In the end, the bulk of the value of an anonymous and largely untraceable crypto-currency will inevitably land in the hands of criminals. Then when everyone legitimate realizes the money is gone, it will collapse. It’s inevitable.

If you have Bitcoin, enjoy the high values (and I’d advise to sell) while they last. Unless/until more actual governments sign on the Bitcoin wagon, the high will only last until the next huge drop.

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