18/12/17: Of Winners and Whiners: Bitcoin's Path to Value

One of the key Bitcoin issues is concentration of miners. Concentration in Bitcoin markets occurs primarily due to high cost of energy used in mining. Bitfury, one of the largest miners on the market today already holds roughly 11 percent of the total mining power and is planning a major expansion. In mining equipment, Bitmain is estimated to hold some 70 percent of the market share worldwide. Here is the map - by country - of Bitcoin and other cryptos mining operations:

Source: http://www.scmp.com/tech/start-ups/article/2120373/chinas-bitcoin-miners-wary-tighter-government-scrutiny-make-plans.

The above shows not only the traditional concentration risk (with China and Georgia dominating the market), but also the unsavoury nature of geopolitical risks links. China is a highly unregulated, non-transparent market with production of miners linked closely to access to energy that can be easily shut down by the Government, were it to decide to pull the plug on cryptos and their potential distortion of the markets for Renminbi. Georgia is a country with archaic energy grid and political regime with low degree of predictability.

Current market structure for Bitcoin is skewed, in terms of financial returns, in favour of a small number of large miners, mining equipment makers, exchanges trading Bitcoin and Bitcoin payments processors. The second tier of earners - due to high transactions costs - are local dealers, a handful of leveraged investment funds and earliest holders of Bitcoin (who are, predominantly, early stage BTC companies principals).

Which means that BTC’s primary function is transfer of money from investors to intermediaries and miners.

Current technology behind the Bitcoin is also skewed. Miners - who hold their own wallets and require no exchanges - are secure in their asset holding to the point of their own security. Exchanges are security pressure points for smaller investors who cannot efficiently transfer BTC to their own wallets (due to time lags and costs involved). Intermediaries are secure only to the point of holdings transferred to own wallets, and are not secured for any trading accounts held on exchanges. In fact, they are in the worst possible state, because their exchange accounts are larger in volume (more lucrative target for attacks).

Which means that BTC’s secondary function is transfer of funds from retail investors and traders to cyber criminals.

In neither part of the transactions chain there is any value added created, except for those ‘investors’ using BTC to launder money or evade capital controls. Other returns are pure speculation on BTC’s volatility and its trend (separately for both). As information/data storage and processing platform, BTC is useless: mining - which in theory supports both functions - happens irrespective of meaningful information arrival, which means that any blockchain functionality of BTC is ad hoc, or put differently, at best accidental. This is one of the key reasons why BTC is the worst thing that could have happened to blockchain and also why it is the best thing that could have happened to private blockchain.

Because BTC has no value-added component to it, there is also no possibility for price gains (capital gains) over and above those warranted by its function as illicit money transfer mechanism. Otherwise, BTC would have had an effect of creating financial value out of zero real value-added. Which is impossible outside pure behavioural hype and speculation.

When someone compares the BTC, in the above terms, to stock markets, they are simply revealing massive degree of ignorance. Stock markets have two functions: (1) Primary issuance that raises capital for the firms, and (2) Secondary trading that determines future Weighted Average Cost of Capital for the firm. As such, stock market creates value-added. It might be not exactly what drives stocks valuations all of the time, but in the long run, it is what determines these valuations to a large extent. Stock is a claim against current and future dividends and/or sale/M&A value of the firm assets. Speculation overlays the fundamentals for BTC. In the BTC case, speculation is the only fundamental.

So you can bet on BTC at any valuations you fancy for yourself, but be aware: if you are betting on it speculatively, you are facing a severe liquidity risk. If you are betting on its fundamentals, your bet is that more people around the world will embrace it as a vehicle for tax evasion, capital controls evasion and/or money laundering. Which might be fine in theory, except that theory assumes status quo ante of zero regulation, enforcement and oversight over BTC. Which, of course, is rapidly changing, as the countries like France are calling on G20 to impose global oversight over BTC, and countries like Japan, China, U.S. et al are either imposing increasing degree of tax and regulatory controls over investors in BTC or considering imposition of such. At any rate, does global drugs trade need a USD300 billion payments technology?..

But, hey, don’t just take my word for it. Read this: http://www.businessinsider.com/one-of-the-co-founders-of-bitcoincom-has-sold-all-of-his-bitcoin-2017-12?r=UK&IR=T.

16/12/17: Remember the Russian Attack on the Internet?

In 2016, a bot, named Mirai, wrecked havoc over the global internet with massive waves of DoS attacks on anything, from French telecoms, to U.S. web services, to Russian banks, to African airports and beyond. Per Wired, "As the 2016 US presidential election drew near, fears began to mount that the so-called Mirai botnet might be the work of a nation-state practicing for an attack that would cripple the country as voters went to the polls."

Of course, the minute there is any suspicion of the 'nation-state' actors behind the attack, we know that is the code word for 'the Russians'. And, of course, given the sheer number of 'security research' lackeys eagerly awaiting for the U.S. or UK or EU dollars/pounds/euros in grants and subsidies, the 'Russian' spectre loomed large in the wake of Mirai havoc. Here's a snapshot:

• http://www.itsecurityguru.org/2016/10/12/research-shows-russian-hackers-could-be-behind-the-mirai-botnet/
• https://www.nbcnews.com/news/us-news/who-shut-down-u-s-internet-friday-n671011
• https://twitter.com/hackerfantastic/status/782840355116969984
• https://www.networkworld.com/article/3130504/security/record-iot-ddos-attacks-raise-bar-for-defenders.html
• https://www.csoonline.com/article/3144200/security/expect-more-iot-botnet-attacks-mirai-source-code-now-freely-available.html
• https://www.nytimes.com/2016/10/22/business/internet-problems-attack.html

But, in the end, the famous DoS attack was down to just three U.S. students: https://www.wired.com/story/mirai-botnet-minecraft-scam-brought-down-the-internet/?mbid=social_twitter. Which, sort of, begs a question: how many 'security experts' of the 'Russian spectre looms large over everything' variety have lost their lucrative contracts with the Government, the media and the think tanks that provide platforms to the endless Russophobic hysteria? My bet is: none. Like in the good old days of the Soviet empire, you can't get fired for lying in Pravda... 

16/12/17: Dancing towards the end of QE

My article on the Super Thursday: monetary policy decisions by ECB, the Fed, PBOC, Norges Bank, SNB et al for Sunday Business Post:
https://www.businesspost.ie/opinion/dancing-towards-end-qe-405054.

16/12/17: Long-Term Stock Market Volatility and the Influence of Terrorist Attacks in Europe

Our paper

Corbet, Shaen and Gurdgiev, Constantin and Meegan, Andrew, Long-Term Stock Market Volatility and the Influence of Terrorist Attacks in Europe (August 2017). Available in working paper format at SSRN: https://ssrn.com/abstract=3033951

Was published in the Quarterly Review of Economics and Finance, https://www.sciencedirect.com/science/article/pii/S1062976917302958.

13/12/17: Why cryptos might not prevail? Because of their supporters...

Why cryptos might not prevail? Because of this:

Or, put differently, because the entire hype around cryptocurrencies, and increasing also blockchain technology, is based on myths.

Let's tackle the above, shall we?

Are cryptos a liquid market? No. In fact, the markets are illiquid (see here: http://trueeconomics.blogspot.com/2017/12/81217-coinbase-to-bitcoin-flippers-you.html) and worse, transactions costs for even basic movement of Bitcoin across accounts are atrocious today (in markets without a direct liquidity squeeze, amounting, sometimes to 15%). See https://www.bloomberg.com/view/articles/2017-11-14/bitcoin-s-high-transaction-fees-show-its-limits and https://www.bloomberg.com/news/articles/2017-09-29/paying-15-to-send-25-has-bitcoin-users-rethinking-practicality. Imagine what these can balloon to in a liquidity squeeze event. And then there is concentration issue: http://www.zerohedge.com/news/2017-12-08/bulgaria-government-shocked-discover-it-owns-3-billion-bitcoin and the 1,000 'whales' problem. Oh, no, these are not liquid markets.

Are cryptos global? Yes, if you consider Venezuela, China, Japan and other places where either hype or regulatory evasion or hyperinflation are driving demand for BTC. Yes, if you consider markets for illicit funds flows to be global. No, if you consider usability of BTC in standard sense of money (as a medium of exchange). See https://www.bloomberg.com/gadfly/articles/2017-12-01/bitcoin-is-hot-until-you-actually-try-to-spend-some. It turns out that as a medium of exchange (one function of money) it is utterly useless. It is also useless as a unit of accounting, which is another function of money (no one accepts 'bitcoin-priced accounts' and its volatility makes any attempt at preparing bitcoin-based accounts futile). And bitcoin is horror who as a store of wealth (third function of money), because so far, it has a combination of sky-high volatility, positive correlation with interest rates and upward trend, while also having sky-high volatility to the downside, which suggests that any trend reversal will be really ugly. Now, you do not store wealth over one month (as arguments in favour of bitcoin go), but you store it over the years. And here, bitcoin is untested at best, recklessly dangerous at worst. Take you 'happy middle' pick.

Are cryptos less susceptible to corruption? You need your head examined to believe in this: cryptos are subject to waves and rounds of pump-and-dump scams, potential insider theft, and insider hacks. Worse, they are clearly being used (at least to some extent) to sustain illicit trade and finance flows, and to launder money. Cryptos 'whales' can collude at any point in time to fix the markets in their favour. If bitcoin is susceptible to corruption, a free-for-all unregulated bazar crossed with the Silk Road would be a 'well functioning exchange'.

Possibility of a fractional ownership is clearly available to bitcoin 'investors'. No doubt. So is possibility of fractional ownership for those buying elephants as pets or condos in Bahamas. Hell, you can even have a fractional ownership of a few acres on the Moon. End of story.

Highly secure networks are not a feature of cryptocurrencies, as we all know. Frequency of hacks and other cyber events involving cryptos exchanges this year exceeds the same for large corporate IT infrastructures, according to our research data. Put differently, cryptos appear to be more frequently targeted by cyber crime and/or are more vulnerable to attacks and theft than larger publicly listed corporations. Now, notice that, for now, vulnerability is in wallets and exchanges, not in blockchain itself. 'For now' is the key bit. We do know that cybercriminals are incentivised by abnormally high returns to crime (see https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3033950) and we know that cybercrime is evolving rapidly to acquire ever-expanding capabilities, tools and strategies. It is simply inconceivable that blockchain will remain 'unhackable' into the near future. More importantly, current evidence of the lack of efficient corruption of the blockchain itself rests on the assumption that it is technology that is a barrier to entry for the cyber criminals. This is an untested proposition. In reality, most likely, the reason for lack of efficient penetrations into blockchain system itself is the existence of the low-hanging fruit in the form of exchanges and wallets, as opposed to the impenetrability/security of the blockchain itself.

Blockchain 'changing incentives structure' is the daftest argument in favour of anything, including the blockchain. There is no 'incentives structure' difference between holding/investing in a BTC and holding/investing in any other speculative asset. None. Full stop. Bitcoiners and blockchainers did not change human nature. They did not rewrite our positive and negative incentives systems. To claim otherwise is to impose such a vast range of assumptions on our behavioural incentives and constraints as to make basic economics 101 sound like a reality-hugging discipline of empirical rigour.

'Code wins against theory' is another 'incentives change' mumbo-jumbo. Code, in the case of Bitcoin and cryptos, is theory. Not because it is physically disembodied from the currency. But because it is the basis for the key assumption (axiomatic theory, idiots?) of 'trust'. Bitcoiners are quick to point that there is no 'mistrusted' Central Banker behind the BTC, because there is a 'trusted mathematical algo' behind it. I rest my point, folks. Because you know 'trusted' and 'mistrusted' terms are (1) the defining terms of the bitcoiners' logic, and (2) these terms have nothing to do with logic or mathematics: they are purely subjective. 'Code is theory', morons, because it only matters as long as we believe it matters.

Do bitcoin or cryptos remove 'systems inefficiencies'? Doh! See transactions costs above, lack of exchange medium function, above, lack of storage and exchange security, above. The promise of the blockchain is to reduce systems inefficiencies when it comes to registering and storing information. This has nothing, repeat, nothing to do with BTC or cryptocurrencies. Besides that, there is a host of major problems with market efficiency of bitcoin (see https://www.forbes.com/sites/francescoppola/2017/07/26/the-fundamental-conflict-at-the-heart-of-bitcoin/2/#527d30435aac and https://arxiv.org/abs/1704.01414).  In basic terms, today, Visa and Mastercard are vastly more efficient (in cost, time and security of transactions sense) than BTC is. Worse, as bitcoin rage evolves, efficiencies of the crypto to act as an information clearing platform are further reduced by system congestion. If anything, the boom we are witnessing is 'creating inefficiencies' rather than reducing them.

Finally, there is the last argument that 'enough talented people believe' in cryptocurrencies to warrant their rise to power. Oh, dear. Enough talented people believed in the property bubble, in the dot.com bubble, in every bubble, to drive the respective assets to mad levels of valuations and the eventual crashes. Enough talented people believed that the Sun revolves around the Earth at some point in time too. Talented people beliefs are not exactly a decent test for resilience or sustainability or success of anything. Let alone, cryptos. Why 'let alone'? Because in cryptos case, 'enough talented people' pool of believers is a highly skewed pool of 'talent' defined by affinity for one type of technology. In a way, 'enough talented people' here is equivalent to the Church of Scientology. They define their own breed of 'talented people' by identifying them as believers in the Church. It is a circular argument, folks.

So, no, none of the above arguments are either necessary or sufficient to establish the future of cryptocurrencies or the BTC. Try again. Try harder.

10/12/17: Folks, there isn't a Russkie in the Alabama waste collection ditches

No, it is not Russia Today, nor Sputnik, nor some other 'foreign agent' reporting this, but the U.S. own Newsweek. The mass media, mainstream news publication headlined its recent report with this: ALABAMA HAS THE WORST POVERTY IN THE DEVELOPED WORLD, U.N. OFFICIAL SAYS (http://www.newsweek.com/alabama-un-poverty-environmental-racism-743601).

You know things are pretty much going South when the UN sends in a "Special Rapporteur on extreme poverty and human rights" to look into the, that is right, poverty and human rights record of the world's leading democracy, the Number One, the shining light on the ever-dark horizon, that marks the way for the destitute and the oppressed... ah, you know the leitmotif.

It would be a bit of a 'right, UN, say no more' if it weren't for the hard cold facts mentioned in the Newsweek article, the open sewers, the 2017 hookworm outbreak, the "nearly 41 million people in the U.S. live in poverty. That's second-highest rate of poverty among rich countries" reported by another, non-RT/non-Sputnik agency, the U.S. Government's own Census Bureau. Were it not for the fact that the UN investigator is a U.S. law professor (well, he might be a foreign agent too, who knows).

It would be, may be, discountable, were it not for a 2016 Allianz Global Wealth Report (yes, the non-commie insurance company) that shows the U.S. Gini coefficient (a measure of inequality: the higher the Gini coefficient, the greater is inequality) at 0.81 - the highest in the world and also provides this snapshot of the wealth held by the fabled and famed U.S. engine for social advancement - the middle class:

The above, of course, shows that the U.S. middle class has lowest share of national wealth in the world. Source: https://www.allianz.com/v_1474281539000/media/economic_research/publications/specials/en/AGWR2016e.pdf.

Here is the problem, folks. If the U.S. mass media ever gets its act together, and instead of chasing the ghosts of the Russian bogeys starts paying real attention to what is going on in American homes and backyards, things might get seriously testing. But, for now, the good thing is, there's always a Russian enemy hiding somewhere in the bushes. Although, most likely not in the same bushes that sit atop the Alabama waste collection ditches. 

10/12/17: Rationally-Irrational AI, yet?..

In a recent post (http://trueeconomics.blogspot.com/2017/10/221017-robot-builders-future-its-all.html) I mused about the deep-reaching implications of the Google's AlphaZero or AlphaGo in its earliest incarnation capabilities to develop independent (of humans) systems of logic. And now we have another breakthrough in the Google's AI saga.

According to the report in the Guardian (https://www.theguardian.com/technology/2017/dec/07/alphazero-google-deepmind-ai-beats-champion-program-teaching-itself-to-play-four-hours),:

"AlphaZero, the game-playing AI created by Google sibling DeepMind, has beaten the world’s best chess-playing computer program, having taught itself how to play in under four hours. The repurposed AI, which has repeatedly beaten the world’s best Go players as AlphaGo, has been generalised so that it can now learn other games. It took just four hours to learn the rules to chess before beating the world champion chess program, Stockfish 8, in a 100-game match up."

Another quote worth considering:

"After winning 25 games of chess versus Stockfish 8 starting as white, with first-mover advantage, a further three starting with black and drawing a further 72 games, AlphaZero also learned shogi in two hours before beating the leading program Elmo in a 100-game matchup. AlphaZero won 90 games, lost eight and drew 2."

Technically, this is impressive. But the real question worth asking at this stage is whether the AI logic is capable of intuitive sensing, as opposed to relying on self-generated libraries of moves permutations. The latter is a form of linear thinking, as opposed to highly non-linear 'intuitive' logic which would be consistent with discrete 'jumping' from one logical moves tree to another based not on history of past moves, but on strategy that these moves reveal to the opponent. I don't think we have an answer to that, yet.

In my view, that is important, because as I argued some years ago in a research paper,  such 'leaps of faith' in logical systems are indicative of the basic traits of humanity, as being distinct from other forms of conscious life. In other words, can machines be rationally irrational, like humans?..

8/12/17: Coinbase to Bitcoin Flippers: You Might Flop

If you need to have a call to 'book profit', you are probably not a serious investor nor a seasoned trader. Then again, if you are 'into Bitcoin' you are probably neither anyway. Still, here is your call to "Go cash now!" https://blog.coinbase.com/please-invest-responsibly-an-important-message-from-the-coinbase-team-bf7f13a4b0b1?gi=f51a107183c9.

In simple terms, Coinbase is warning its customers that "access to Coinbase services may become degraded or unavailable during times of significant volatility or volume. This could result in the inability to buy or sell for periods of time." In other words, if there is a liquidity squeeze, there will be a liquidity squeeze.

Run.

So a couple of additions to this post, on foot of new stuff arriving.

One: Bloomberg-Businessweek report (https://www.bloomberg.com/news/articles/2017-12-08/the-bitcoin-whales-1-000-people-who-own-40-percent-of-the-market) that some 40% of the entire Bitcoin supply is held by roughly 1,000 'whales'. Good luck seeing through the concentration risk on top of the collusion risk when they get together trading.

Two: Someone suggested to me that ICOs holding Bitcoin as capital reserves post-raising are part problem in the current markets because by withdrawing coins from trading, they are reducing liquidity. Which is not exactly what is happening.

Suppose an ICO buys or raises Bitcoins and holds these as a reserve. The supply of Bitcoin to the market is reduced, while demand for Bitcoins rises. This feeds into rising bid-ask spreads as more buyers are now chasing fewer coins with an intention to buy. Liquidity improves for the sellers of the coins and deteriorates for the buyers. Now, suppose there is a sizeable correction to the downside in Bitcoin price. ICOs are now having a choice - quickly sell Bitcoin to lock in some capital they raised or ride the rollercoaster in hope things will revert back to the rising price trend. Some will choose the first option, others might try to sit out. Those ICOs that opt to sell will be selling into a falling market, increasing supply of coins just as demand turns the other way. Liquidity for sellers will deteriorate. Prices will continue to fall. This cascade will prompt more ICOs to liquidate Bitcoins they hold, driving liquidity down even more. Along the falling prices trend, all sellers will pay higher trading costs, sustaining even more losses. Worse, as exchanges struggle to cover trades, liquidity will rapidly evaporate for sellers.

It is anybody's guess if liquidity crunch turns into a crisis. My bet - it will, because in quite simple terms, Bitcoin is already relatively illiquid: it takes hours to sell and spreads on trading are wide or more accurately, wild. Security of trading is questionable, as we have recently seen with https://www.fastcompany.com/40505199/bitcoin-heist-adds-77-million-to-hacked-hauls-of-15-billion, and the market is full of speculation that some of these 'heists' are insider jobs with some exchanges acting as pumps to suck coins out of clients' wallets. The rumours might be total conspiracy theory, but conspiracy theories turn out to be material in market panics.

8/12/17: Happiness: Bounded and Unbounded

Why I love Twitter? Because you can have, within minutes of each other, in your tweeter stream this...

and this

That's right, folks. It's the Happiness Day: bounded at 0.2% annual rate of growth for the workers, and unbounded at USD11 trillion for the Governments. All good, right?

But of course all is good. We call the former - the 'great news' for the families, and the latter, 'savage austerity'.  Which is, apparently, good for the bonds markets... no kidding. At least there isn't a bubble in wages, even though there is a bubble in bonds.

8/12/17: China v U.S.: Forbes

Forbes on the U.S.-China Trade disputes and more, with a quote from myself: https://www.forbes.com/sites/kenrapoza/2017/12/06/what-american-corporations-really-think-about-china/#50d58a117868.

Full backgrounder in here: http://trueeconomics.blogspot.com/2017/12/51217-us-china-trade-confrontations.html.

5/12/17: U.S.-China Trade Confrontations: Redrawing the Post-Bretton Woods Order

I have recently posted some select slides relating to the background to the U.S.-China latest standoff in the WTO. Here is the full set of slides detailing U.S.-China battle for hegemonic dominance in post-Bretton Woods institutions: