Bitcoin and Crypto Currencies. Explained
Would you use Bitcoin to send money or as an investment?
Respond here. You will be able to see the results before and after you read this article.
Bitcoin. The original idea
“Bitcoin allows any two people, anywhere in the world with an internet connection, to make a transfer of value in a few minutes without any middleman. You could send $1 million to somebody and have the exchange settled in 10 minutes or less. No banks, no foreign exchange.”
When I read that in The Wall Street Journal, I embraced the idea. I believe there should be no restrictions on the movement of capital. Or People. In the European Union, we have implemented that, and it works fine. Let’s stick to the movement of capital. I first bought Bitcoin 5 years ago, before traveling to Tokyo on Square. I was unable to spend it. More on that later.
The Crypto part
Coinbase does a good job of explaining this. Crypto means “secret” in Greek.
The sender “encrypts” the message, which obscures its content to a third party, and the receiver “decrypts” the message, making it legible again.
Cryptography is the practice of sending secure, encrypted messages between two or more parties.
In companies, we encrypt messages about compensation, M&As, and other sensitive matters. WhatsApp is encrypted. Nothing special about the crypto word.
What is Bitcoin?
A simple definition could be “computer code, that some people regard as money, an asset”.
What is money? I am not going to go through academic definitions. Years ago, I learned that on the Micronesia island of Yap, in the past they used stones as money. I was intrigued by it, so I flew from Geneva to Tokio to Yap (I am curious, I’ve been to 193 countries).
While years ago it would have been hard to explain that people were valuing a stone at $10,000, now it’s not. People are buying NFT (Non-fungible-tokens) at higher prices. To educate consumers on NFTs, students at NYU and I created our own NFT.
How about lines of computer code called Bitcoin? How much is it worth? The price started at a few cents, and it reached $67,000 at one point. Since then, it has lost more than half its value. More on that later.
Making (mining) Bitcoin
To make Bitcoin, a computer must solve a randomly generated mathematical puzzle by trial and error. Simply put, mining is a lottery.
Anybody can download and run these software programs. The more miners that are racing against each other, the higher the degree of randomness or difficulty to get the reward.
Every 10 minutes, one miner gets a reward of 6.25 bitcoins. The rate was 50 bitcoins in 2009, but it gets reduced by half every 4 years. The last Bitcoin will be mined in 2140.
Mining it’s too complex and expensive for most people. Miners use specialized computers with chips designed just for that purpose.
Miners operate in countries with a low cost for utilities.
Listed companies mining Bitcoin lose money.
Bitcoin. The mining noise
It would drive you nuts. “It’s like a giant dentist drill that won’t stop” the Wall Street Journal pointed out. Companies mining go to rural areas, where less sophisticated residents live and get zoning approvals that cities then regret.
The environmental cost
Bitcoin is extremely inefficient. It uses more energy than a mid-size European country like the Netherlands.
Bitcoin Wallets
A Crypto wallet is similar to a bank account. It enables you to hold and transfer Bitcoin to others.
Transfers to/from others can be free, depending on the country and platform. It’s like transferring money to someone with an account in the same bank.
Transfers to other wallets can be costly and take time, at least 10 minutes.
A solution called The Lighting Network makes it easier, by having transactions in the same wallet settled internally. This is comparable to having all Visa card transactions from consumers (buying) and merchants (selling) who have an account at Capital One settled within the bank, instead of going through Visa.
Read more about Crypto wallets
Terminology. Bitcoin, Blocks, and Blockchains
Bitcoin: computer code that some people regard as money.
The process to create and audit the code is cumbersome and difficult. To buy, sell or transfer Bitcoin easily, one needs an intermediary or wallet.
Block: transactions are batched into “blocks,” which are then connected in chronological order in a long, unbroken “chain.” This is why the software became called “blockchain.”
Blockchain: a database containing several blocks or transactions. The information is publicly available and replicated on thousands of computers — or “nodes” — around the world witch simultaneously verify the information.
The Wall Street Journal and The Economist have done an excellent job at explaining these terms. I recommend these articles and videos:
Bitcoin Primer: What You Need to Know About the New Virtual Currency
What Is Cryptocurrency, and How Does It Work?
Crypto: will the bitcoin dream succeed?
Creating a Blockchain
26 students at NYU taking my Finance class created a Blockchain replicating the Bitcoin process.
They anonymously wrote over 200 questions (blocks) about the material learned in class, on a public ledger, anonymously reviewed by other students (miners).
Their blockchain contains over 2,111 records. See their Blockchain, a public ledger, here.
Their bitcoin reward was extra-credit. Their work will be used for Pro-Bono classes I teach. Read more about the class here.
Bitcoin to transfer money
Let’s compare using Bitcoin to send money internationally from 2 perspectives: that of Maria, an immigrant worker sending $300, and John, an investor sending $1 million.
Sending $300 with Bitcoin. Cost $30
The total cost for Maria to transfer $300 with Bitcoin is $30 or 10%.
Maria has to pay 2.3% to buy Bitcoin, and her mom another 3% to sell Bitcoin or 5% to use an ATM.
Additionally, there is a spread of at least 1%-10% in the buy-sell price.
Sending $300 with a Visa card. Cost $0
Fee to use: $0
Foreign exchange fees: $0
Refund ATMs fees: in-full
*This is for Visa cards issued by Schwab, Chase Sapphire and others. ATM refunds are anywhere in the world (photo). Visa and MC use wholesale foreign exchange fees, the best for consumers.
Sending $300 with MoneyGram or Western Union. Cost $0-$11
Fees vary depending on whether the amount is sent to a bank account. The $0 with MoneyGram is to send from a US bank account to a bank account in El Salvador.
Summary. Cost to send $300
To transfer $300, Bitcoin is very expensive
Paying with a Bitcoin Visa
Coinbase issues a Visa debit card. I used it to buy a $3 train ticket. The total charges for a $3 transaction were over $ 2, including Coinbase fees and the hidden spread. With a Capital One Visa card, I pay no fees, get 2% cashback, and free insurance. The Coinbase visa is good, but not the best option.
Sending $ 1 Million with Bitcoin. Cost $10K.
The total cost to transfer $1,000,000 with Bitcoin is over $10,000.
Paypal, Coinbase, and others have small limits, increasing the transactional cost. The cost of the spread needs to be added as well. Technically, if you would have minted your own Bitcoin and had the expertise to send it to someone with the same infrastructure, you would only pay the transaction fee. In my opinion, when looking at the pricing for these products, we need to consider what is available to most consumers.
Cost to wire $ 1 million: $0-$50
John has an account at Fidelity investments, Schwab, TD Ameritrade and Chase Private.
Clients with $1 million in assets don’t pay to send wires. They are free. Customers with just $1 pay $50 for international transfers. Wires are credited the same day, at good banks.
Cost to send $1,000,000. Summary
To transfer $1 Million, Bitcoin is more expensive.
Bitcoin as an investment
Bitcoin Price drops
Bitcoin is extremely volatile. Over the past 10 years, it dropped by more than 50% eight times. June 2011 -99%, August 2012 -56%, April 2013 -83%, December 2013 -50%, December 2017–2018: -84%, March 2020: -50%, May 2021: -53%, May 2022: -53%.
Could this happen to Bitcoin?
More efficient cryptos are a challenge. Internet Explorer, Yahoo, PalmPilot, and Compaq had a leading market share. They are now bankrupt, have disappeared, or lost over +90% of their value and were replaced by a competitor.
Bitcoin vs other investments
Apple and Amazon, grew more than Bitcoin. Bitcoin has increased by +100 times. Facebook +500 times, Apple +350,000 times, Amazon +18,000 times, and Berkshire Hathaway +300 times.
The process to make or mint Bitcoin is a lottery. As of May 2022, its valuation also seems to be randomly driven. Under such scenario, over the last 12 months, compared to 4 stocks with a market cap greater than $5 Billion, this is the performance as of March 5th, 2022. Bitcoin -21%, LIBERTY GLOBAL PLC +83%, FRONTIER COMM +80%, CHESAPEAKE ENERGY +64%, CRESCENT POINT ENERGY +52%.
Stocks shown are 4 out 1,324 with a market cap >$5 Billion. They were selected for academic purposes only. Last 12 months’ performance is as of March 5th, 2022.
Someone hacked your account
In the largest hacks, $250 million to over $500 million was stolen.
If your account is hacked, you are out of luck.
Stock investors are protected by the SIPC. Bank depositors by the FDIC. There is no protection for crypto-currencies.
Bitcoin is traceable
Criminal activity is continuously tracked down and perpetrators arrested, as shown in these cases reported by the WSJ, which also highlights that it’s a myth that Bitcoin is untraceable.
El Salvador. The first country to make Bitcoin legal tender
I went to El Salvador and met with bankers and consumers. Read about it here.
Would you use Bitcoin to send money or as an investment?
Responses before and after
After listening to this presentation, a significant number of respondents change their minds both about using Bitcoin to send cash or as an investment.
This article appears also in Chapter 7 of my book “How to Make Money” available on Amazon. Proceeds go to donate copies to foster financial education.