Saturday, 2 December 2017

OF HOLY WATER AND CRYPTOCURRENCIES


Holy Water definition - (noun) Water that has been blessed by a priest for use in "symbolic" rituals of purification

A month ago, I found out that the babysitter had been giving Holy Water to our 3-year old. A devout Catholic and extremely fond of our lad, she was upset about him getting unwell very often, and so she reckoned that it was only wise to have sought a little divine intervention to help him stay safe. Needless to say, I was left aghast. Make no mistake, I am not an atheist. But in today's age of science and technology, it is kinda silly to seek recourse to religious (and largely symbolic) articles, instead of medicine. Moreover, it would have probably been acceptable if the water was fresh - holy water is usually distributed during Easter, which means that the water is usually stored for almost a year before it is changed. The philosophies behind religious symbolism are not commonly understood.

Speaking of things that are not commonly understood, there's something else that's setting the popularity charts ablaze in the world of investment, and yet is very poorly comprehended. Say hello to cryptocurrency!

One of the most popular descriptions of cryptocurrency is 'a form of digital money that is designed to be secure and, in many cases, anonymous.' It is a currency associated with the internet that uses cryptography to track purchases and transfers. The first cryptocurrency was bitcoin (2009) and to date it remains the most popular. Since then, a plethora of cryptocurrencies have made an appearance over the past decade, with more than 900 now being available on the internet.

Contrary to the name, however, cryptocurrency has not yet gained acceptance as legal tender. Till date, Japan remains the only large economy to have officially recognised cryptocurrency (bitcoin) at par with fiat currency. Although many countries do consider cryptocurrencies as legal, most of them only consider them as a trade-able commodity or as property for tax purposes. In fact, some countries like China, South Korea, Hong Kong and Britain, among others, have all moved to either ban or restrict the use o cryptocurrencies. Closer home, the RBI had made known its position on bitcoins by stating that they were not to be used for payments and settlements, although the use of the underlying blockchain technology could be explored.


What is it that makes economies wary of using cryptocurrencies as legal tender? Let’s see how cryptocurrencies match up against the generally-accepted characteristics of a currency: -

  • Fungible – Advocates of cryptocurrencies vouch for their high fungibility on the basis of the argument that digital 1s and 0s that represent units of bitcoin on the blockchain are absolutely like each other. However, cryptocurrencies are not really fungible in the traditional sense. Some bitcoins, for instance, are not clean, in that they leave a trace on the blockchain. In such a scenario, clean bitcoins tend to command a better price than their counterparts. Moreover, it is possible for service providers or exchanges to blacklist specific bitcoin wallet addresses, which would then render any transactions with such bitcoins worthless. The tracing and monitoring of cryptocurrencies, therefore, does not make it any more fungible than fiat currencies.
  • Non-consumable – Bitcoins, being virtual currency, are inherent non-consumable, and possess value in themselves. Like fiat currency, they can be used to procure other commodities/services, without being used themselves, unlike commodities like gold and diamonds.
  • Portable - It can be argued that cryptocurrencies are easy to transport/transmit and literally weigh nothing. In fact, it comes with its own global teleportation system. However, it is worthwhile to consider the fact that heavy investment and a great degree of skill is required to keep digital money secure. Also, since cryptocurrencies are decentralised and unregulated, there is absolutely no hope of remedy or legal recourse in case hackers make away with your cryptocurrency. To cut a long story short, cryptocurrency once lost is truly lost forever.
  • Durable - Cryptocurrencies edge out fiat currency and precious metals when it comes to durability. However, there is the risk of a huge problem in case you lose the private key. Imagine a crashed hard drive - this is not necessarily a remote possibility.
  • Divisible - Cryptocurrencies score high on the divisibility parameter. Bitcoins, for instance, are divisible down to 8 decimal places (1 Satoshi = 0.00000001 BTC).
  • Secure - Being in digital form does not make cryptocurrency any more secure than physical assets. In fact, it probably is even tougher to secure something that is virtual and extremely vulnerable to attacks from hackers.
  • Easily Transactable - Being decentralised, cryptocurrencies require absolutely no intervention by middlemen and are not bound by bank branch office hours. This makes them theoretically low-cost and easily transactable.
  • Scarce - Most cryptocurrencies have designed to be limited in number. Hence, in the long run, they are scarce. Physical assets derive their intrinsic value from a combination of their scarcity and their utility outside the purview of currency. In the case of cryptocurrencies, they have no other use apart from that of a currency. However, it must be noted that bitcoins can be mined (it serves as a price discovery mechanism). Thus, it is their scarcity and mine-ability that determines their intrinsic value.

As we can see, cryptocurrencies have their sets of pros and cons vis-a-vis fiat currencies and physical assets. However, the pace at which bitcoin prices have risen in the past year alone sets warning bells ringing. It would not be unfair to say that the phenomenon of rising prices of cryptocurrencies point towards a bubble in the making.

Some aspects that add to the skepticism are: -

  • The fact that cryptocurrencies are traded anonymously means that they are traded in an ecosystem that is largely shrouded in mystery
  • The decentralisation and lack of regulation makes systems like the blockchain a highly risky and potentially investor-unfriendly place
  • There seems to be a great gap between the intrinsic value of cryptocurrencies and the prices they command; what's worse is that this gap is impossible to quantify, unlike in the case of physical assets
  • Unlike commodities, investors do not really have anything to hold at the end of a transaction. At least in the case of physical assets, investors can hope to cut their losses by salvaging some value through the sale of an asset that has lost its value. In the case of cryptocurrencies, there is no middle path; it's usually 'all or nothing'.
  • In this market, the innovators and early adopters have made huge gains, Late adopters and laggards stare at the possibility of humongous losses in case cryptocurrencies end up failing or turn out to be a widespread fraud like some detractors fear that they might be

In conclusion, I think that unless investors possess the kind of money to purchase infrastructure capable of mining cryptocurrencies and keeping them secure from the threat of hacking and system crashes, they should avoid cryptocurrencies like the devil avoids holy water.

Speaking of Holy Water - last week I saw the babysitter making my son drink holy water yet again. 

This time though, I smiled nonchalantly...because every morning since the past month, I have been refilling the bottle with RO-purified water.

6 comments:

  1. That was an awesome post CRD. I have been racking my brain trying to read up more on this topic. Everyone says we should buy Bitcoin. I didn't want to jump in without the research. Your post really helped!

    ReplyDelete
    Replies
    1. I had originally written this article on LinkedIn. Didn't get any response there, and so that I'd try this channel. Glad you found this article useful.

      So glad to hear from you after a long time Preeti. How's life? Do keep me posted. Btw are you on LinkedIn?

      Keep writing. Cheers.
      - CRD

      Delete
  2. I am clueless in matters of finance. I have no idea what Bitcoin is - thank you for this! It's simple and easy to understand. Thank you :-)

    ReplyDelete
    Replies
    1. Glad you liked this. This happens to be one of the trending topics these days, and might soon be an integral part of everyday life.

      Thanks :)

      Delete
  3. Interesting post! I love it:)

    irinathayer.com

    ReplyDelete
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    ReplyDelete

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