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Sunday, Mar 30, 2014 - 23:51 SGT
Posted By: Gilbert

Story Of A Bit

Mr. Ham: With April almost upon us, it is time to look back at the development of Bitcoin over the last four months, starting with December's recommendation, by the firm of H.L. Ham, to wait and see if its price would plunge back to "US$200 to US$400 by February or March". Mr. Robo, up the slides!

[Click to enlarge]
(Source: bitcoincharts.com Market API for exchange data,
xe.com for Chinese yuan to US dollar exchange rate)

Mr. Ham: The chart above details the price movements of Bitcoin on the major known exchanges, and while the averages today have dipped just below US$500, slightly above the range, it is clear that interested buyers would have had multiple opportunities to buy in within the US$200-400 specified, with lows of below US$400 already recorded on all exchanges due to fluctuations - and they're what savvy investors, like you, should be after! This once more proves the rock-solid market research capabilities of H.L. Ham...

Me: Erm, were you the ones who said that...?

Mr. Ham: Human, you should feel honoured that the analysts over at H.L. Ham have concurred with you after their completely independent studies, instead of nitpicking! Right, my totally autonomous finance whiz, Mr. Robo?

Me: Yeah, yeah. Hmm, there appear to be some anomalies...

Mr. Ham: Yes, for those, my, uh, vice-president of financial analytics Mr. Robo will provide the run-down.

Mr. Robo: *whispers* Huh, I'm a VP now?! I thought I was an adjunct assistant temp intern, second grade.

Mr. Ham: *whispers back* Think of it as a field promotion. And get on with it before I change my mind.

Mr. Robo: Great! And so we begin the story...

We pick up after the latest short missive on the topic that we had, on December 15 last year. By then, the price had already fallen from its peak of around US$1200 to around US$900, and just three days later, the major exchanges were seeing trades bottoming out at US$330 to US$460. Less dignified research houses might have claimed a successful forecast then, but as the chart above shows, most trades still took place at somewhat above that level - about US$600.

Prices than began a slow climb back, with Mt.Gox surpassing the US$1000 barrier again after the new year. If you look at the chart closely, however, you will note that although the major exchanges' movements largely mirrored each other (as they have to, assuming arbitrage), the price on Mt.Gox remained significantly above other exchanges going into February. As noted in our December notes, this was due to Gox not disbursing currency in a timely manner, which should have been a red flag - but we will return to this shortly.

Quite a few people had picked up on Bitcoin likely being in a hype cycle, so we were hardly alone in plumping for a moderate crash. Despite that, the ecosystem was certainly expanding, with helpful utilities such as real-time aggregators popping up all over, as well as (fairly) major retailers such as Overstock and TigerDirect accepting Bitcoin for payment. By late February, no less than the state of California made a step towards classifying it as legal money.

All this is, however, the pretty side. It is perhaps too easily forgotten that Bitcoin found much of its initial utility in some less-than-savoury corners of electronic commerce (which it is still involved in). And, let us be honest, many - perhaps most - participants don't have lofty ideals about free exchange, or creating a stable next-generation currency, or making a statement against Big Brother's control over money, as their primary motivation; it's all about getting filthy rich, man!

That, and some philanthropy
(Source: imgur.com)

In this environment, it was perhaps inevitable that less-than-forthright acts would find a foothold, and December 21 saw China's second-largest exchange accused of faking trade volume, doubtless aided by 0% trading fees (recall our warning about possible price manipulation in such cases). The support from China, which spearheaded the price explosion (as a way of evading capital controls), would however splutter out as authorities sought to reassert themselves, severing the yuan inflow by outright bans, recently augmented by a prohibition on dealing directly in cryptocurrencies.

For Singapore, the government has decided on a hands-off approach (financial hub, remember?)... as long as they can tax it (big surprise) - which seems to be the attitude Japan and the United States are adopting towards the upstart. February saw the first Bitcoin ATMs hit our shores (which one of my high school classmates seems to have taken an interest in - small world), to complement the new exchanges (conveniently dealing in local dollars) that have sprung up, as the MAS continues to figure out how to take its cut. It wasn't all fun and games, however, as the darker underbelly showed too.

Top among the numerous Bitcoin scandals must, however, be the collapse of Mt.Gox, the quite-unlikely leading exchange for much of Bitcoin's existence. It wasn't even meant for Bitcoin in the first place, but collectible cards (hence Magic: The Gathering Online eXchange). Despite a slightly chequered history, many users still kept with it... until early Feburary this year, when they halted Bitcoin withdrawals due to an obscure bug known as "transaction malleability". With this, prices on Mt.Gox began freefalling, and by the time they closed for good on Feburary 24, they had gone below US$200.

Apparently, Mt.Gox had managed to lose - completely without any of their employees noticing - over 740000 of customers' Bitcoins, and 100000 of their own, i.e. some 4% of Bitcoins that will ever be produced, with a value of near half a billion (realistically, somewhat less). Of course, this had a knock-on global effect, with prices elsewhere dropping from about US$800 to US$600 in that period.

Obviously, many customers were not amused, with more than a few suspecting hanky-panky, and given that Mt.Gox later found 200000 Bitcoins under the equivalent of a sofa, they have good cause to be skeptical. That said, this news probably comes as little consolation to those who had funds locked in, and will now have to wait for bankruptcy investigations.

Yes, rub it in.
(Source: explosm.net)

This was hardly the only snafu, with attempted system attacks (which local exchanges capitalised on) and a flash crash on BTC-e taking prices to nearly US$100 for a moment, and if one can say nothing else about Bitcoin's future - with Goldman Sachs seemingly noncommital and doomsayers aplenty - it is surely going to be as exciting as always.

Mr. Robo: ...and that concludes the telling.

Mr. Ham: Well done, good and faithful inte... vice-president. As you have no doubt noticed, our firm has got the general price trend exactly right, and with the downtrend continuing, we may yet see sub-US$400 average prices in weeks. So, *whips out notebook* any new thoughts?

Me: *shrugs* Not much has changed. If you're in this for what I think you are, the key question would be "does this dog have at least one last big boom left in it?". If so, I would stick to US$200 to US$400 - maybe a bit more if you're impatient - as a good time to pile back in. Yes, it's a bit of a gamble, but nothing's certain in life, and if you think the chips are stacked towards your side, there's no need to be too cautious. As Loeb put it, "All investment is speculation. The only difference is that some people admit it, and some don't."

The lesson from Gox's collapse would be to withdraw Bitcoin assets and store them offline as far as is possible, but this is like the advice to back up important data - many know it, but few do it, only to regret it later. It can be noted that over-concentration remains a problem for Bitcoin, partly reflected by how Gox's dominant position allowed it to shuffle coins opaquely, so assuming that those coins are truly lost, it could wind up as a net benefit if trust issues are resolved.

Mr. Ham: *scribbles away* Any price targets?

Me: If you're willing to wait a few years, I'd say that we will very likely see US$1000 again. To put that in perspective, a 30% annual return from most other vehicles would be grabbed without hesitation, but with cryptos it somehow feels almost... mundane. Again, it should be kept in mind that one could conceivably lose it all, so don't try it with any funds you need. More than that is, of course, not out of the question.

Here, let me mention the Zurich Axioms (summary), which has some sound advice, which can be compressed into a single sentence - don't diversify, cash out early, cut losses early, back intuition with data, don't follow the herd, and don't get attached to investments. That said, the axiom that the future cannot be predicted needs qualification, since if that were absolutely true then the only other admissable advice would be "buy randomly". More accurately, nobody can be sure - but some behaviours are simply more probable.

On this note, I have a personal theory that ideal investors are those who don't need, or even really want, the money. Take two moderately well-off guys, except that one has a wife, three kids, a mortgage and a car to pay off - which of them has the freedom to engage in ventures with favourable risk?

There have been reasoned criticisms, such as this one by an NYU business professor in the MIT Technology Review that rejects Bitcoin as lacking the properties of a real currency. His key concerns appear to be volatility - which I partly concur with, thus the stated emphasis on "long-term store of value" previously - but also some less-qualified arguments such as Bitcoin not being depositable, which I regard as largely invalid.

In fact, as and when cryptocurrencies become more mainstream, I expect many of the conveniences provided for normal currencies, such as intermediaries and credit providers, to be replicated for them. It is merely that the option to "go dark" with transactions without these go-betweens always remains, in theory.

Mr. Robo: What about the technical side?

Me: Ah yes, we come to that. Well, there has been no lack of extensions such as Zerocoin, but in my opinion users will remain the weak link in such privacy efforts. Put another way, the best lock in the world is useless if one continues to keep his key under the welcome mat in practice. Satoshi Nakamoto knows a thing or two about that - Newsweek thought they had the inventor of Bitcoin, but they're almost certainly mistaken. Quite fitting, in retrospect.

There's more to say about the nuts and bolts, but I would rather save it, seeing as there could be a little something to be done in the area... say, Mr. Robo, might you be interested?

Mr. Robo: Sounds interesting, I...

Mr. Ham: Hey, hey, it'll cost you to borrow my executive director of financial operations.

Me: Wasn't he a VP?

Mr. Ham: Fellow got promoted again.

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Next: Riding The Current

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