Bitcoin = Fine

I have been following Bitcoin pretty much since the beginning. I actually used to mine Bitcoin as a way of paying for hormones when I first started to take them. Kind of wish I had held onto the coins a little longer, but that is another story for another day. I have observed Bitcoin through the initial mining gold rush, through the exponential price increases, through the introduction of altcoins, through the rise of ASIC mining, through the Mt. Gox bankruptcy/scandal, you name it. And now, after all of this, looking at the chart, there is one inescapable conclusion. The whole thing just looks like a bubble.

Since the early days, when people asked me how Bitcoin worked, my answer was usually something like this. I would say, Bitcoin is a type of online currency that exists because someone figured out a solution to the problem of making information scarce (by solving the Byzantine Generals Problem). And when they ask, "But why are Bitcoins valuable?", I would say, because they can function as a means of exchange. You see ultimately, money is really more of a fiction than anything. It used to be backed by gold (meaning that for every dollar printed, there was an equivalent amount of gold being held by the government), but those days have long since passed. Today we have what is known as fiat currency, which is a currency that is not backed by anything in particular, other than the power of the government that prints it.

This is probably not news to anyone familiar with modern finance, but this begs the question, how can you have a currency that's not backed by anything? Not even a government? Well... what I would have said to respond to this question, is that because Bitcoins are scarce (no more than 21 million are allowed to be mined), if anyone is willing to pay for them or accept them as a means of exchange, then that means they have at least some tangible value (albeit perhaps a small one). And if they can be proven to hold any value at all, they can function as a means of exchange. And because Bitcoins offer other advantages, such as freedom from government or traditional financial institutions, this makes them all the more desirable. But right now, I would be hard pressed to advise anyone to buy and hold Bitcoins.

So what is going on? Were all those people who said Bitcoin was a Ponzi Scheme right? Sort of, but the truth is a bit more complicated. If* Bitcoin can be used as a medium of exchange for anything tangible that can be assigned a monetary value, it is inherently not worthless (*keep in mind I said if). This is unlike a Ponzi Scheme, where you are essentially stealing money from investors by promising them unsustainable returns. On paper, Bitcoin seems sustainable, as it's value is determined by what it trades at on free and open markets. No obfuscation, no hidden agendas, just a new way to exchange value. Even if Bitcoin's value fluctuates, as long as someone, somewhere, accepts it in exchange for a tangible good or service, it should be worth at least something. I mean, if everyone stopped accepting it, that would of course spell disaster, but that could never happen, right?

It's now time to ask another important question. Why would I want Bitcoins? Well, there are a few reasons. You might want to buy them under the assumption that the price would go up at some point. However, the long term trend has been pretty much down since the peak at $20,000, and it currently seems unlikely Bitcoin will hit that amount (or even close to it) again any time soon, so speculation might not be your best bet. Well, what if I want to buy things? Unfortunately, unless the kinds of things you want to buy are drugs, or other things that involve skirting the law, you are almost certainly better of paying in traditional currency, as your transaction will be faster, safer, and arguably more secure. Also, no need to worry about the value of the currency you are holding plummeting overnight. Other potential uses include money laundering, tax evasion, and online gambling.

Umm... okay, but things will get better as Bitcoin becomes more legitimate, right? I would say that while there are many places in which you can spend your Bitcoins today, it's really not much faster or easier than it was two or three years ago. The network has also gotten slower, and fees are up. Meanwhile new laws and regulations continue to block Bitcoin out, or make it generally less attractive for everyday use. I remember when I used to just be able to freely buy and sell Bitcoin on Circle.com for a reasonable price, and in a reasonable amount of time. Recently I have resorted to selling Bitcoins on LocalBitcoins.com due to my inability to find a better/faster alternative. But that's good isn't it? We are keeping the greedy financial institutions out of our business. Honestly, the last person I sold Bitcoins to was kind of bearish, and unwilling (I think unable due to regulation) to hold Bitcoins as part of his business model. Doesn't exactly inspire confidence.

That sounds... not good. Okay, maybe Bitcoins will never hit the mainstream, but I'll still use them, so that gives them value right? Enter the altcoin. An altcoin is just a variation on Bitcoin, only instead of using the same blockchain (essentially, the public ledger for all Bitcoin transactions), they use variations on the model Bitcoin provides, implementing their own separate blockchain, and often introducing changes from Bitcoin that affect how coins are mined, how transaction are done, etc. Oh, and of course, they all introduce new coins into the cryptocurrency ecosystem beyond the 21 million allocated by Bitcoin and it's developers, but we'll get to that in a bit. When altcoins like Litecoin first hit the scene, it seemed only natural that Bitcoin should have some competitors. Otherwise who else will put pressure on the Bitcoin developers/miners to compete and improve? There are now over 100 (I counted) altcoins listed on Bitfinex.

So why all the altcoins? At least one early justification was the advent of ASIC mining. Originally Bitcoin was mined by everyday geeks on their computers, and this provided them with a stable stream of income, while maintaining the Bitcoin networks stability and security. This is of course the primary purpose of mining, and without miners actively using computers to mine Bitcoins, the Bitcoin network could be taken over in it's entirety by a single person who could essentially do whatever they wanted to any Bitcoin that had ever or would ever exist. Yeah, not the kind of thing you want happening in your ultra-secure new form of currency. Initially mining was just done on your standard computer's central processing unit (CPU), making it accessible and profitable for virtually anyone (assuming you even knew Bitcoin existed, which most of us did not). I got involved around the time when GPU mining stated to take over. GPU mining started when people figured out how to use recently developed frameworks CUDA and OpenCL to implement the hashing algorithms necessary to mine Bitcoins. It was around this time I bought an AMD graphics card to mine Bitcoins, as AMD cards were notably more efficient for mining than their contemporaries developed by NVIDIA. This incidentally, led to fairly serious supply issues for people actually interested in using AMD cards for gaming, as miners would pay a premium for these cards. For a brief time, an expensive AMD GPU was essentially a license to print money. But then came the ASICs.

In the Bitcoin would "ASICs" typically refers to the integrated circuits specifically designed and manufactured to mine Bitcoins. Even in the early days of ASICs, they were decidedly more profitable to run than a GPU. When ASICs hit the scene with their off the chart performance (at least on a per watt basis), it quickly became unprofitable to mine Bitcoin on anything that wasn't a ASIC. This is because Bitcoin mining profitability is determined by difficulty (a measure of how much hashing computation needs to be done to earn Bitcoins by mining), and the difficulty increases as the total speed of all miners increases. Difficulty limits the total amount of Bitcoin that can be mined in a given time period, which means that you are essentially competing for a limited supply of coins when you mine, and more efficient mining will gradually push less efficient miners out of the market. You will note on the chart above (chart is logarithmically scaled), while mining difficulty remained stable from mid 2011 to the beginning of 2013, starting in 2013 there was a significant difficulty increase, forcing many GPU miners out of the market.  Many insisted this was not a problem, and that it was just a natural stage in the evolution of Bitcoin. But there actually was a problem, and a fairly big one at that. Prior to this event, Bitcoin mining had been a reasonably democratic process, with mining being distributed over a fairly large amount of miners. But when ASICS took over that number got smaller, and it only continued to shrink as profitable ASIC mining became more competitive. Further consolidation of mining pools has led to a situation where there is now a single entity, Bitmain, gradually moving towards majority control of Bitcoin.

Litecoin had already been on the scene since 2011. It's major differences from Bitcoin were that it provided faster transactions than Bitcoin, and used a different mining algorithm that required large amounts of memory to mine efficiently. Since ASICs relied better hashing efficiency for their edge, algorithms that were memory dependent could not be optimized as well by ASICSs. This was an important differentiation, because that mean Litecoin mining for profit would remain accessible to people who couldn't afford their own chip fabrication for longer than Bitcoin would. This created a niche for Litecoin, and helped to keep GPU miners in the game a bit longer. During this period, increased democratization alone was justification enough for Litecoin (and other altcoins) to exist. Other reasons include, fancy features with questionable real world utility (Ethereum's smart contracts), increased anonymity (Monero), or cute memes (Dogecoin).

However, while it may be nice to have diversity in terms of offerings, it is highly debatable there is any utility in have over 100 alternatives to Bitcoin. And those are just the alternatives you can trade on Bitfinex, let alone any other alternatives people might come up with which never gain traction. And then there are the splits. Splits happen when there is disagreement in how a cryptocurrency should operate, using driven by disagreements between the people who maintain the software or the large stakeholders involved with the mining. This has led to altcoins like Bitcoin Cash, which was derived from Bitcoin, and then Bitcoin Cash ABC/Bitcoin Cash SV, which were both derived from Bitcoin Cash. And yes, when these splits occur, all of a sudden there are 21 million new coins created out of thin air. But, since anyone holding the coin being split at the time of the split would effectively be holding the exact same amount of the new coin being created, in theory no value is lost. Unless you happen to be storing your coins in a wallet controlled by a third party entity that doesn't want to give you a stake in the new currency, in which case it sucks to be you I guess?

And let's talk about the wallet situation, while it is possible to store Bitcoins in a reasonably secure way without storing the entire blockchain by using wallets such as Electrum, if you want complete unilateral control of your Bitcoins, without any third party involved, you need a copy of the entire Bitcoin blockchain, which is currently over 187 Gigabytes in size. This could take days to download on even a relatively fast Internet connection, and would take more space than many have on their entire computer. And it's only getting bigger. And you need to leave the program running to avoid additional wait times when you start your Bitcoin client before sending any coins. And then you would have to do this for every altcoin you want to use as well. Is it any wonder people just leave their coins on exchanges and other third party websites, only to lose them when the site suddenly shuts down. Oh, and good luck if you accidentally send money to the wrong person, there's no way to undo that.

Okay, okay, so the cryptocurrency situation is far from idea, but things will get better! Well, so far, that does not seem to be the case. And there is a worrying trend starting to emerge that could spell disaster for the future of cryptocurrency. Take a look at the mining difficulty chart, when presented with a linear scale.

This wouldn't be the first time the difficulty of mining Bitcoin has dropped, but the extent of the drop is actually kind of unprecedented. What this means is, a significant amount of mining was shut down, most likely due to miners being unable to make a profit by selling Bitcoin at the going market rate. But even more than that, one might infer that they also don't want to be holding Bitcoins, or else they might be willing to take a short term loss under the assumption the price of Bitcoin would rebound. This drop in mining directly coincides with the recent drop in Bitcoin price, which had been hovering above $6000 for quite some time, to below $4000. It has now rebounded back above $4000, but considering that expectations for Bitcoin have typically been bullish in the holiday season, this situation does not look promising.

But let's play out this scenario even a bit further, and ask ourselves what might happen if Bitcoin continues trending down. If mining is not profitable, even more miners will just ship, until only the most profitable ASIC miners will continue to mine Bitcoin. In this (fairly likely) scenario, a single organization would end up with full control of Bitcoin. And even if said organization had the best of intentions for the currency, even they would not continue to mine it if they couldn't make a profit, and then this would lead Bitcoin vulnerable to a hostile takeover from anyone who could amass a sufficient supply of ASICs. Bad news all around.

But it gets worse. Let's ask ourselves now, given that Bitcoin has peaked for the foreseeable future, and we may realistically never see have a sustained upward trend again, who is going to hold Bitcoins? Someone has to, because if no one is willing to hold them for even a little while, the market would completely collapse. But no one is going to want to hold an asset that just decreases in value, and given the volatility in the mining situation, it's very hard to trust Bitcoin has a future. So altcoins to the rescue? Except altcoins have not been able to demonstrate a resistance to the ASICs which led to mining consolidation either. If any given cryptocurrency is doomed to be controlled by a single entity, then why should anyone have confidence that the same thing that happened to Bitcoin would not happen again?

What makes this situation even worse, is that there is a ridiculous amount of liquidity between different cryptocurrencies, meaning you really have no incentive to hold anything that won't go up. Even if you have to exchange your altcoin for Bitcoin to actually buy something, this can be done at a moment's notice, meaning that there is no incentive to ever hold Bitcoin for any longer than it takes to complete a transaction. So if everyone is just shuffling money between altcoins, and no one wants to hold something that won't go up in value, the whole situation just turns into a ridiculous game of whack-a-mole, and anyone who doesn't want to be taken for a ride would be best advised to just hold in traditional currency. And the longer this goes on, the more altcoins will be introduced, and the more diluted the market will get. And even if an altcoin were to usurp Bitcoin's throne, it would likely just lead to a smaller bubble with the same result. And a smaller one. And a smaller one. Until the whole cryptocurrency market starts to flat-line.

One you lose people's trust in such a catastrophic way, it's almost impossible to get it back. No one will want to be the only left holding Bitcoins, and exchanges will collapse, markets will shut down, and we will be back to square one. It kind of gives you pause, when you consider the case of Satoshi Nakamura. The infamous and anonymous founder of Bitcoin, who has sat by the sidelines during this entire escapade, holding his coins tightly to his chest. He mined Bitcoins worth billions of dollars at their peak, and he never sold a single coin. It makes one wonder what his true intents were, and if he ever accomplished them.