by Robert DeVoe
“Never invest in a business you do not understand.” That’s the opener to an article that appeared on the Houston Chronicle on December 12. The article, titled “Bitcoins offer virtual wealth but very real risk” by author Chris Tomlinson details a number of reasons why he feels investors should stay far, far away from bitcoin and other cryptocurrencies. But how much truth is in this article, and how much of it is just fear mongering?
“If Something Appears [too] Good to be True, it Probably Is.”
This piece of advice has held true for generations. It is a maxim that can be applied to Ponzi schemes, lottery scams, and Nigerian e-mail scams. But is bitcoin “too good to be true?” According to Tomlinson, yes, bitcoin is too good to be true and should be avoided. Specifically, Tomlinson says that if you follow this sage advice, then “you’ll stay far, far away from cryptocurrencies like bitcoin.”
Tomlinson’s first claim is that “strings of computer code will never become a true currency.” While this assertion is debatable, to say the least, let’s move on to why he feels this way.
Tomlinson states that because the US dollar is released by the Federal Reserve (a private bank, which may prioritize vested interests and not the public at large) at a variable rate, and can take money off the market if necessary, it is intrinsically superior. Bitcoin, on the other hand, releases units onto the market at a set rate that cannot be manually adjusted. Furthur, he makes the classic claim that bitcoin is not “backed” by anything.
Backed by Nothing
Let us unpack these statements for a moment. The private Federal Reserve bank was created at the end of 1913. $1 in 1913 dollars would be worth just about $25 in purchasing power today. That means in just over a hundred years, the US dollar has faced an inflation of 2,391 percent. US dollars and essentially all fiat currencies are designed to drop in value over time. The only way to protect yourself from inflation is to rely on the banking industry to give you a pittance in interest, or the stock market which has its own fluctuations and risks.
In 1971, the US dollar became a true fiat currency, meaning that it was no longer “backed” by anything. So by Tomlinson’s own definition, fiat currency, which is also backed by nothing, and can be printed at any rate that a private bank chooses and consequently inflates by orders of magnitude over time, is somehow better than bitcoin.
With this in mind, let us keep moving forward. Tomlinson then makes several technical errors, demonstrating a lack of understanding of how Bitcoin works. He makes two such errors, specifically “Bitcoins only exist on the shared ledger, where hackers can and have stolen it…” and “you can’t bury bitcoins in the backyard.”
The cryptocurrency has never been stolen directly from the Bitcoin ledger, which has so far proven to be completely impossible. Perhaps someday this might happen, but so far all theft of bitcoin has been a result of hacking an intermediary like an exchange, or through phishing or other social engineering forms of theft; not because of the protocol.
Second, you can bury bitcoin in your backyard. A laminated and properly stored paper wallet could easily accomplish this. Granted, Tomlinson was only making this claim in an attempt to bolster his argument that bitcoin, unlike gold or dollars, isn’t “real.” However, it demonstrates that Tomlinson again does not fully understand the technology or principles that Bitcoin operates on.
Bitcoin: Speculators Heaven
The article concludes with a section on the rampant speculation that bitcoin is seeing. This is really the only part that Tomlinson gets right. Bitcoin absolutely sees a large amount of speculative activity. But does this make the cryptocurrency dangerous, and something that should be absolutely avoided?
This is up to the individual investor. Members of the Bitcoin community have an oft-repeated maxim of their own; only invest what you are willing to lose. Bitcoin may be $17,000 one day, but it could very well be $1,000 the next. Since bitcoin and other cryptocurrencies are an entirely new asset class, we cannot reasonably expect to understand the valuation of something that has existed for less than a decade. We also cannot expect to compare its market behavior to an asset like gold or dollars.
While Tomlinson may not fully understand the technology or even the philosophy behind Bitcoin, he does have one good point. One should always approach a new investment with great caution. One should also not invest in something they do not understand. If an individual wants to invest in bitcoin, they should absolutely take the time to understand it before getting their feet wet.
The same is true for you, Mr. Tomlinson. One should understand Bitcoin before they declare it nonsense.