Bitcoinia

At first I thought Bitcoin was silly - geek libertarian naïveté of using technology to escape the forces of evil called “financial system” and “government control”. And don’t get me wrong - a platform sporting killer apps like “Drug Dealing for Dummies”, “MoneyLaundry 2.0” and the unexpected Chinese runaway success of “From China with Cash” (which has gone largely unnoticed in the US), expecting governments to keep their hands off? Good luck with that.

I was surprised seeing an authority like Chris Dixon leading $25M investment in Coinbase. Earlier investments in the space had been somewhat on the other end of the gravitas scale. Was I missing something?

 I took the time to dig a bit deeper into the technology and protocol, and actually agree that this is significant and disruptive innovation. It has the potential to make money transfers and micropayments way more secure and efficient than what is available in US today. But then, US is also hopelessly lagging the rest of the world in this, as in other infrastructure investments.

Both Europe and China already have national payment gateways, through collaboration between financial institutions and the governments. They are non-profit. Government provide regulatory, banks provide oversight. The result is super efficient debit plastic, with fixed transaction fee of a few cents. It also allows such “radical” ideas as direct wire transfer between accounts in different banks, without having to write a check. To European and Asian readers: yes, you read that right.

While visiting the Nordics I have not needed cash for years. Plastic is accepted everywhere, at no significant cost for anyone. In the occasion when you need to pay a friend or split a bill, a mobile banking transfer is now as easy as sending a text. China is quickly moving in the same direction through UnionPay, which might transform the global credit card business.

But Bitcoin could surely solve real use cases, also outside US. Social, digital micro-incentives in advertising and gaming is a good example. I am sure there are many more.

Still, Bitcoin in its current form as a currency is doomed. Why? Because a currency needs stability, and stability is provided by a central bank.

To enthusiasts, the idea of having a currency with no central bank seems to be a good thing. The argument is along the lines that it will become more stable as central banks cannot inflate the value by printing more money to fund government deficit.

So here’s my prediction of how Bitcoin will play out in the current form. I believe the currency will survive this first hype curve, supported by enthusiasts in tech community. What will ultimately kill it as a currency is when increased transaction volume makes it a meaningful asset class for hedge funds. With no backing or oversight, it will be paradise for market making traders. They make money whenever there is volatility and sufficient volume of amateur traders to crush. The resulting permanent volatility will effectively make Bitcoin unusable as a currency.

Bitcoin could work great though if it were just a digital payment protocol. If it was pegged to the dollar, or rather a basket of dollar, euro, yuan and yen, it could be a serious disruption and help make financial transactions frictionless. Digital exchanges like Coinbase could become the new de-facto digital payment gateway. Could this be the scenario the smart money is investing in?