Bitcoin - an interesting experiment for suckers

By DAVID MOON, Moon Capital Management, LLC
March 9, 2014

On February 28, 2014, Mt. Gox, the world's largest bitcoin exchange, filed for bankruptcy protection. The company's CEO claims that it somehow "misplaced" 850,000 bitcoins, worth more than half a billion dollars.

Don't bother sending me emails telling me I am not a bitcoin expert; I already know that. I don't even know where to buy my own hashtag.

But I know how to read and I’ve been around money a while.

Bitcoin is a peer-to-peer payment system and digital currency that is bought and sold independent of any central control. Hundreds of computers around the world (called "miners") process bitcoin transactions, earning bitcoins based on the speed at which they clear transactions. These miners then introduce the currency into the hands of others by selling them for hard currency, such as dollars or euros.

The system of issuing new bitcoins to miners limits the maximum number of bitcoins that can ever be created to 21 million, compared to the current float of about 7 million bitcoins currently in circulation.

The currency was created by a developer (or developers) who uses the cyber-pseudonym Satoshi Nakamoro, although no one knows his/her true identity.

Seriously.

On the surface bitcoin sounds just a little bit like Visa or Paypal. A major difference is that while Visa and Paypal effectively create a derivative currency, the buyers and sellers who swap “visas” or “paypals” are linked by a fiat currency.

A fiat currency is one that has value simply because a government says it has value. Bitcoins have value because the buyers and sellers say it has value.

The problem with that type of system, however, is that not only do we not know who the buyers and sellers are, we don’t even know who created bitcoins.

I may distrust certain aspects of my government, but I trust it infinitely more than I trust Satoshi Nakamoro.

The financial system depends on trust. Everyone knows that a bank typically makes more loans than it has in deposits. That is, all of a bank’s depositors couldn’t withdraw all of their money at the same time. We trust that the bank could eventually meet the demand for withdrawals, even if it had to depend on help from the government.

Cue the gold bugs.

An effective currency doesn’t necessarily require the backing of a government, but it has to be backed by something or someone trustworthy. It could be backed by gold or oil. It could be backed by shares of Coca Cola or Tesla stock.

It could be backed by the promise of Warren Buffett or the Pope.

But there is an inverse relationship between the trustworthiness of a currency’s sponsor and the risks associated with the currency.

Bitcoin is an interesting experiment, one that has suckered even presumably sophisticated investors, even if on a small scale. Investment giant Fortress invested $20 million in bitcoins, an embarrassing decision, even though miniscule compared to its $62 billion under management.

Another presumably sophisticated investor, Berkshire Hathaway’s Charlie Munger recently described bitcoin as rat poison. Mr. Munger likely defamed rat poison.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

Click here to subscribe to MCM commentary.

MCM website