A couple days ago I wrote about a hot investment trend, SPACs to be specific, that I won't touch. I wasn't done. I wanted to include something that was on the other extreme end of the information asymmetry spectrum. An investment that technically gives all information to everyone but I still won't touch. Now is my chance. I’m going to trash-talk Bitcoin. There's an irresistible, honey-pot quality to crypto stuff for financial writers. It gets those sweet, sweet clicks at first but it’s really easy to get stuck in the nitty-gritty. This has been on my bucket list for a while. Today I'm going to try to skip right over the pitfalls and point out something I'd bet you never noticed. | | 25-Year-Old Prodigy Reveals Secret to Soaring Stocks “Old school” folks might be skeptical of listening to financial advice from someone half their age, but this stock whiz beat out 15,000 experts to claim no. 1 title. See his next big recommendation right here, for FREE. |
If Bitcoin just doesn't make sense to you, you shouldn't feel like you're missing something. It's designed in a way that it should not make any sense. In that spirit I'll toss some parentheticals in the next several paragraphs when it seems best to keep moving along instead of breaking things down. First up, someone needs to create (in a way) these things. To do that, you need to guess (in a way) the right (technically the most efficient, in a way) solution to a devilishly hard mathematical problem. Our best and brightest haven’t figured out how to easily or consistently do this, and may never. If you could reliably find a solution, and know why you can (an important distinction, in a way), you’d almost certainly win a million bucks from one of the seven Clay Mathematics Institute Millennium Prizes. Plus you’d probably get a Nobel prize and maybe a Fields Medal too, if you’re a spring chicken. If you want to go off the deep end, feel free to check out the related P vs NP problem. I have no business attempting to explain it. Oh, and you’d break the internet and all known encryption techniques along the way. No parentheticals here. Please do not do this, two-day delivery and the entire banking system are pretty cool. Also it would wreak havoc on the value of your newly claimed million buckaroos. Getting back on track from that dark aside, I think the simplest way to explain how the whole Bitcoin scene works is to say this... No one knows how to make more money mining Bitcoin (in a math way) than anyone else. What they can do is make more money by increasing how many guesses (in a way) they make every 10 minutes and compare the cost that incurs — how much they pay for land, computer hardware, electricity, etc. — to how successful they are and hope for a net profit over time. It's a surprisingly boring and tedious business model but, in a way (natch), that means Bitcoin is working as intended! Except for the specter of the the 51% problem, so far so good, predictable and secure. Right? Not to me. Let’s get to how that gives me the heebie-jeebies... So we’re past the whole Bitcoin-creation thing (good riddance) but we immediately run into another related problem. The same processing power that drives the creation of new Bitcoins also handles all of the Bitcoin transactions (in a way). Every buy, sell, and transfer crammed in and spat out every 10 minutes. This, mixed with the underlying cost to mine, introduces a nasty downside. Why keep participating in something if you're losing your money? Here is a hypothetical parallel. Imagine that the NYSE or any other exchange were designed in a way that meant it'd lose tons of money if stock prices go below a certain threshold. Why would they make sure transactions are handled quickly and efficiently? Why wouldn’t they just turn off their servers and try to wait it out? If they were forced to take the loss, how could you justify it? This kind of shutdown happens with Bitcoin all the time at different price points for different miners. It just hasn’t happened quickly enough, or on a large enough scale, to tear the whole thing down. Yet there is no cut-off point to keep it from cascading into oblivion. There is no failsafe. We can see how this would happen because of the insane amount of transaction information that flows into a metric we can track — the hash rate — which measures (in a way) how much processing power is dedicated to keeping this whole rigmarole afloat. Look at what the hash rate does as miner revenue drops (via www.theblockcrypto.com): 
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I'm assuming you're aware, but if not, Bitcoin prices dropped by about 50%, right alongside miner revenue and the hash rate, the latter two shown in the charts above. This recent plunge coincided with a crackdown on Chinese Bitcoin mining operations, but does that matter? Price, miner revenue, hash rate, and the reliability of the entire Bitcoin blockchain are intrinsically tied together. Right as people wanted to buy in or sell off, the capacity to handle all trades dramatically fell. It wasn't the first time and it won't be the last. Negative feedback loops will always happen because miners can and will pull the plug on the whole thing if their revenue isn't net positive. Who could blame them? I won't even start on how crypto investors depend on shoddy "exchanges" to trade, adding yet another level of bad data, delays, and frustration, but you can find plenty of feedback and reviews online about how they've screwed investors over compound these kinds of problems with their own internal volume issues. And that, right there, is why I really don’t want to put any money into the rickety Bitcoin scene at all. It's got a bad foundation and it's guaranteed to break down, constantly in a partial way, and potentially in a total way. I'll close this out by saying that what a Bitcoin investment might do for us — add diversification away from stocks, something not dependent on the U.S. dollar, a contrarian play — is easier and better through other options with more potential and less pitfalls. Take care, 
Adam English  @AdamEnglishOC on Twitter
Adam's editorial talents and analysis drew the attention of senior editors at Outsider Club, which he joined in mid-2012. While he has acquired years of hands-on experience in the editorial room by working side by side with ex-brokers, options floor traders, and financial advisors, he is acutely aware of the challenges faced by retail investors after starting at the ground floor in the financial publishing field. For more on Adam, check out his editor's page. *Follow Outsider Club on Facebook and Twitter. | 
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