Bitcoin Paranoia. Blockchain Baloney.

“Bad dreamer, what’s your name?

Looks like we’re ridin’ on the same train.

Looks as though there’ll be more pain.

There’s gonna be a Showdown.”

— Electric Light Orchestra

This article addresses misperceptions growing around the newly celebrated fad in financial circles, blockchain. Bitcoin/blockchain is a technology with the potential to revolutionize transactions, and perhaps even accounting. I will begin by putting front and center before you the most important thing to remember in understanding Bitcoin/blockchain.

There is only one blockchain, and Bitcoin is used in every single transaction on the only blockchain.

When you read almost any other discussion of Bitcoin or blockchain written for laymen, you will think that Bitcoin and blockchain are separable. They are not.

To explain: Blockchain and Bitcoin are components of a single transaction technology. Investopedia provides a surprisingly accurate definition of the pair:

“A blockchain is a public ledger of all Bitcoin transactions that have ever been executed. It is constantly growing as ‘completed’ blocks are added to it with a new set of recordings. The blocks are added to the blockchain in a linear, chronological order.” (Author’s note: Even here there is spin. The misleading first word, “A” should be “The.” Reading the definition carefully makes that clear, since only one blockchain-like thing uses Bitcoin.)

This article disputes much of what you have read or will read about blockchain. Disputing is needed. The big players, for example, have a hidden agenda that taints what their apologists say about the Bitcoin/blockchain technology, unintentionally in some cases, I believe.

The smaller advocates of Bitcoin/blockchain have other hidden agendas that color their writing too. One agenda is to distance oneself from Bitcoin’s undeserved bad reputation. Another is to minimize reader awareness of the difficulties associated with getting Bitcoin/blockchain off the ground. This article will address these agendas, hoping to help to provide a sort of Rosetta Stone intended to partially clear the Bitcoin/blockchain fog.

The technology of Bitcoin/blockchain has other implementations, most of them doomed to failure. It is possible to use the methods of the Bitcoin/blockchain technology to imitate its properties in part. Since Bitcoin/blockchain is open source, there is no issue of patent infringement. But that is most likely because Bitcoin/blockchain has nothing to fear from competitors.

These imitative implementations are what all the reports of blockchain that omit mention of Bitcoin are talking about. If these other applications of the technology were called MacBlockchains or iBlockchains, or eBlockchains, I would have no problem with them. But no. To remedy this oversight, I am going to pick a generic name for them, O’Blockchains, which I will use when I describe the genre going forward. (Irish ancestry, obviously.)

O’Blockchains, like the original, are all single, continuously updated public or private ledgers, with regularly added spreadsheets, called blocks, verified by multiple independent electronic auditors, called miners, who, as a group, approve each new block by consensus. Verification adds a block to the O’Blockchain, a single chain of blocks. Only one, Bitcoin/blockchain, uses Bitcoin.

In every public version of the O’Blockchain, the miners are compensated for their verification efforts by receipt of a cryptocurrency, like Bitcoin. Thankfully, these alternate cryptocurrencies have been separately named. No. 2 to Bitcoin in terms of use is called Ethereum. Ethereum claims to be “smarter” than Bitcoin. This is, if accurate, a logical and laudable improvement, and strengthens the parallel I have drawn elsewhere between Bitcoin/blockchain and IEX, the putative securities exchange that also threatens some of the bigs, and also threatens to make financial transactions more profitable for the rest of us. IEX is also introducing smart transactions.

Why Does Bitcoin have a bad rap? There are three reasons Bitcoin has a bad rap.

  1. Bitcoin/blockchain is mysterious. It doesn’t help that the bible of Bitcoin, (which like everything else about bitcoin is easily accessible on the internet – just google ” bitcoin pdf“.) was written by a gentleman, Satoshi Nakamoto, who is apparently fictitious. The miners who verify blocks on the blockchain are also no one you’ve ever heard of, and apparently happily relatively unknown. And they are mostly located in Iceland — somewhere you’ve never been — because it has the globe’s cheapest and most abundant energy.
  2. One result of the Bitcoin/blockchain innovation is that Bitcoin, like any other means of payment, is also a store of value. Any role for the Bitcoin/blockchain technology as a transaction and record-keeping method is going to be hindered badly by the popularity of this alternative use. Bitcoin speculation that the world will tire of fiat money and rush to the Bitcoin alternative is hopelessly naïve. The governments that issue fiat currencies will not be amused by the presence of a currency alternative that has a supply in an amount that is not directly determined by government policy-makers. The way forward with government is cooperation.
  3. Governments are also concerned by the ability to make payments on Bitcoin/blockchain in violation of federal money-laundering law. I await the government initiative to identify a method by which this could be avoided within the Bitcoin/blockchain system. I’m sure it will be forthcoming soon. That way we will know US government regulators have an open mind about Bitcoin/blockchain, as the UK regulators, who seem blissfully unconcerned, do.

Will the O’Blockchains amount to anything? Probably not. The essential feature of Bitcoin/blockchain which makes it likely to be the one and only successful implementation of the technology is its near-biological tendency to propagate itself.

Its self-propagating feature is this: The system works by compensating a user of massive computer power to “prove” each new block added to the blockchain. This compensation, importantly, outstrips the value of a hacker attack of Bitcoin/blockchain by the same computer. The blockchain grows this way and new blocks get bigger as demand for Bitcoin/blockchain grows. Both forms of growth increase the demand for the independent miner’s computer power.

Like any system, the potential likely exists to attack Bitcoin/blockchain and hack it. However, the fundamental resource applied by hackers, computer power, would have to be present, the experts report, with force greater than 300,000+ copies of the largest supercomputer in existence operating simultaneously. There are not close to 300,000 of these supercomputers now. But if they existed, these computers would successfully function if they had the uninterrupted full power of the sun’s energy for 10 minutes. I think I’ll worry about global warming or something instead.

Any smaller O’Blockchain must build from zero transactions. It therefore starts small and vulnerable to attack. But don’t rule out alternatives such as Ethereum that actually improve on the underlying technology, if the competing system accepts the fundamental significance of open source to Bitcoin/blockchain’s success so it can grow like Topsy. Like the internet, there will be proprietary closed blockchain systems analogous to intranets. They will be small change, technologically. But there will be only one global game-changer. And that will most likely be Bitcoin/blockchain.

Everything that either explicitly denies or opposes Bitcoin’s utility without proposing an alternative is a non-starter. And that includes almost everything I have seen proposed by major corporations so far. I discuss the single exception to date here.

Why the Rap Against Bitcoin for Facilitating Illegal Transactions is Rank Hypocrisy. Yes, illegal transfers are done using Bitcoin. But criminals have an overwhelming favorite when they smuggle, trade and evade taxes. Good old paper US dollars.

Click to enlargeThe $200 Million Haul from one of “El Chapo” Guzman’s Arrests.

I first learned the most important use of US paper dollars listening to economist Milton Friedman tick off the relevant statistics at a lunch hosted by the San Francisco Fed. The theme of the Friedman discussion was that the primary use of all paper currencies is payment for illegal activities. But the star is US paper. One interesting evidence of this is that the largest denomination by bills in circulation for most currencies is what Friedman called “a day’s wages,” in the case of the US dollar, the $100 bill. Try paying for something at a retail store with a $100 bill. They won’t accept them.

The following statistics are borrowed from a paper written by Campbell Harvey, “Bitcoin Myths and Facts”. You can find it here. The $100 bill constitutes 73% of the outstanding value of US paper currency. Ever received one of those from an ATM? The average Bitcoin wallet contains $4000. My wallet has never contained that much.

If our government were really concerned about media of exchange used for illegal payments, they would be looking for a trustworthy digital version of cash. The possibility has been explored by the private sector without success.

The way forward in Bitcoin/blockchain for investors: The most important key to understanding future commercial success is clear. Bitcoin is open source. It depends in no way on trust, which is to say the fundamental service a bank has provided historically — a third party that provides trust — will be getting in the way. Bitcoin/blockchain will be commercially disastrous for commercial banks.

Here are the “tells” to identify baloney when assessing the value of any of the thousands of commercial projects announced by the banks like JP Morgan Chase (NYSE:JPM) and Goldman Sachs (NYSE:GS); the startups that the bigs have invested billions supporting; the non-bank investor-funded startups; the projects announced by the big IT firms such as IBM (NYSE:IBM) , Microsoft (NASDAQ:MSFT) and Google (NASDAQ:GOOGL); and the internal projects announced by exchanges such as NASDAQ (NASDAQ:NDAQ) and the Australian Stock Exchange.

If they avoid the use of the name Bitcoin (or worse, dump on it), the project is a no-go. If the use of blockchain is internal, never reaching an open source transaction engine, forget it.

The winners will be gateways — Apps to get to the open source host, or perform functions the open source technology enables. And like their cousins on the internet, they will mostly be free.

So while investors, in particular, and ordinary users of financial services, in general, are going to benefit enormously from Bitcoin/blockchain, relying on a supportive UK regulatory establishment, for retail investors it’s a different story. The retail investor profit opportunities from this technology will very likely follow the path of the internet users, like Amazon (NASDAQ:AMZN) and Facebook (NASDAQ:FB). In other words, the creators get rich before the rest of us get in.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.