Thursday, January 11, 2018
The decision to purchase units of Bitcoin is, first and foremost, a matter of political philosophy.
By Brian Tall
For the purpose of this commentary, we assume readers have a basic understanding of what Bitcoin is (but it will not be necessary to understand blockchain technology, encryption protocols, mining, and other technical nuances of how it works). For those in need of a basic primer before proceeding, read this overview.
The meteoric price appreciation of the cryptocurrency Bitcoin has sparked around-the-clock media coverage as curious (confused?) observers rush to learn the ins and outs of digital currencies. In turn, clients are looking to us for our opinion on Bitcoin and have begun asking whether we ought to consider allocating a portion of our portfolios to the digital currency.
In deciding whether an allocation to Bitcoin (or any other cryptocurrency) is right for you, it is essential to first understand the motivations of the many individuals and groups who have been attempting to create a viable digital currency for the better part of 35 years.
The Origins of Cryptocurrency
Now, much of the commentary surrounding Bitcoin might lead you to believe this “movement” is all about technological advancement and innovation (i.e. blockchain technology). But, for innovations to replace firmly entrenched ways of doing things, they generally need to solve some sort of problem or inefficiency.
With endless ways for consumers to efficiently transact in today’s marketplace—cash, credit, debit, PayPal, Venmo, iPay, electronic check deposit, etc.—it has not been clear to us what problems Bitcoin solves for the average consumer. At first blush, Bitcoin simply appeared to be a solution in search of a problem (i.e. “This new blockchain technology is cool! Let’s find ways to use it!“).
For innovations to replace firmly entrenched ways of doing things, they generally need to solve some sort of problem or inefficiency.
What we have come to realize, however, is that Bitcoin is more about ideology than technological advancement. That is, the original motivation of the individuals working to develop a viable digital currency was not about improving transactional efficiency in the global financial system—they were after something different entirely.
The basic idea of cryptocurrency can be traced to a 1983 white paper, “Blind Signatures for Untraceable Payments,” by David Chaum. In the first three paragraphs of his paper, Chaum identifies a timeless dilemma we face as a society:
“Automation of the way we pay for goods and services is already underway, as can be seen by the variety and growth of electronic banking services available to consumers. The ultimate structure of the new electronic payments system may have a substantial impact on personal privacy as well as on the nature and extent of criminal use of payments. Ideally, a new payments system should address both these seemingly conflicting sets of concerns.
“On the one hand, knowledge by a third party of the payee, amount, and time of payment for every transaction made by an individual can reveal a great deal about the individual’s whereabouts, associations, and lifestyle. For example, consider payments for such things as transportation, hotels, restaurants, movies, theater, lectures, food, pharmaceuticals, alcohol, books, periodicals, dues, religious and political contributions.
“On the other hand, an anonymous payments system like bank notes and coins suffers from lack of controls and security. For example, consider problems such as lack of proof of payment, theft of payments, media, and black payments for bribes, tax evasion, and black markets.”
Privacy, Security, and the Future of Capitalism
Americans have long been divided in their views about the trade-off between personal privacy and security needs. Some believe we should accept less privacy to achieve stronger security against emerging threats and illicit activities, including terrorism, cyberattacks, extortion, drug and human trafficking, etc. Indeed, this applies to communications, financial transactions, and all other internet-powered activities. But, there are also individuals and groups who believe we should protect personal privacy in all cases and at any cost—this is what Bitcoin is about.
Now, the purpose of this commentary is not to argue a side in the fiery privacy vs. security debate. Rather, we recognize that the widespread adoption of one or more cryptocurrencies could have far-reaching implications for society, and our aim is to help our readers make an informed investment decision that aligns with their personal values. With that goal in mind, we believe it is important for anyone considering an investment in Bitcoin to first understand the motivations and ideological beliefs of the prominent figures in the cryptocurrency movement.
While the creator(s) of Bitcoin have remained anonymous (operating under the pseudonym Satoshi Nakamoto), they are known to have been associated with the cyber-activist group, “Cypherpunks.” The initial intent of the group—founded by Eric Hughes, Timothy C. May, and John Gilmore in 1992—was to hold small gatherings for informal discussions relating to cryptography. But, over time, the size of the group swelled to several hundred individuals that included many prominent figures in the computer industry.
With such a large following, the founding members authored papers that discuss their ideology, along with the over-arching agenda of the group. In a paper titled “A Cypherpunk’s Manifesto,” one of the three founding members, Eric Hughes, describes the group’s core purpose:
“We cannot expect governments, corporations, and other large, faceless organizations to grant us privacy out of their beneficence …
“… We must defend our own privacy if we expect to have any. We must come together and create systems which allow anonymous transactions to take place.
… We the Cypherpunks are dedicated to building anonymous systems. We are defending our privacy with cryptography, with anonymous mail forwarding systems, with digital signatures, and with electronic money.
“… Cypherpunks deplore regulations on cryptography, for encryption is fundamentally a private act…even laws against cryptography reach only so far as a nation’s border and the arm of its violence. Cryptography will ineluctably spread over the whole globe, and with it the anonymous transactions systems that it makes possible.
“For privacy to be widespread it must be part of the social contract. People must come and together deploy these systems for the common good. Privacy only extends so far as the cooperation of one’s fellows in society.”
As far as Hughes’ manifesto is concerned, there is nothing controversial to speak of. He states that the aim of the group is to create systems and protocols that ensure privacy for those who want it—no surprise there from a group of cryptographers. But, in a paper titled “Cyphernomicon: Cypherpunks FAQ and More,” Timothy C. May describes a more extreme ideology:
“To be blunt about it, I’ve come to despise the modern version of democracy we have. Every issue is framed in terms of popular sentiment, in terms of how the public would vote. Mob rule at its worst.
“… But maybe we can stop this nonsense. I support strong crypto (and its eventual form, crypto anarchy) because it undermines this form of democracy.
” …Crypto anarchy effectively allows people to pick and choose which laws they support, at least in cyberspatial contexts. It empowers people to break the local bonds of their majoritarian normative systems and decide for themselves which laws are moral and which are bullshit.
“… Bear in mind that most of the “Cypherpunks agenda,” to the extent we can identify it, is likely to provoke ordinary citizens into outrage. Talk of anonymous mail, digital money, money laundering, information markets, data havens, undermining authority, transnationalism, and all the rest is not exactly mainstream.
“… I accept that many people will find the implications of crypto anarchy to be more than they can accept.”
First and foremost, cryptocurrencies are about creating anonymous transactions systems, not more efficient transactions systems. To that end, cryptocurrencies are more about ideology than technological advancement. Specifically, advocates of cryptocurrency are those who aspire to protect personal privacy in all cases and at any cost.
As noted, it is not our aim to argue a side. But, we do believe it is important for you, the investor, to consider your own beliefs before taking a position in cryptocurrencies. In other words, to what extent do you believe law enforcement agencies should be able to access private information for the sake of ensuring national security interests and enforcing laws? For example, is it worth sacrificing some level of personal privacy to prevent terrorist attacks, sanction enemy states, combat human trafficking, etc.? Unless you believe personal privacy should be protected in all cases and at any cost, cryptocurrency might not be right for you.
Cryptocurrencies are more about ideology than technological advancement. To that end, consider your own beliefs before taking a position in Bitcoin.
Looking beyond the privacy vs. security debate to the longer-term implications of “cryptomania,” we must also point out that many of the prominent figures in the cryptocurrency movement consider themselves to be “anarcho-capitalists.” By way of background, anarcho-capitalism is a political philosophy that advocates for the elimination of the state in favor of a society based purely on voluntary action (i.e. all services would be operated by privately funded companies without compulsory taxation).
A more difficult quandary to consider is the extent to which cryptocurrencies—if widely adopted—could one day undermine democratic institutions (according to the anarcho-capitalist doctrine). In a world where people abandon traditional fiat currencies in favor of stateless cryptocurrencies, what happens to entitlement and welfare programs, national defense, etc.? Unless you hold strong libertarian views (i.e. you desire a self-regulated and voluntary state), cryptocurrency might not be right for you.
In our view, the decision to purchase units of Bitcoin is, first and foremost, a matter of political philosophy (i.e. How far do you think government should be able to go in protecting national security interests? More generally, what do you think the role of government should be? Do you want to invest in something that could someday undermine democratic institutions?). Said differently, we view cryptocurrencies as an activist movement that falls outside the scope of our discretionary investment recommendations.
So, You Have Decided to Invest in Bitcoin
Moving past the philosophical questions, for those interested in allocating a portion of their assets to Bitcoin, there are important considerations:
- Bitcoin is perhaps the most volatile “asset” in the history of financial markets. It is not uncommon to see the price of Bitcoin plunge by double-digit percentage points in the span of a couple hours (for no apparent reason). In the course of researching and writing this paper, the price of Bitcoin declined from ~$19,000 to ~$11,000, and subsequently jumped back up to ~14,000.
- Bitcoin is not a “productive” asset with a positive expected rate of return like traditional stocks and bonds, so we really don’t know what to expect of it. The price of Bitcoin is sure to rise if it becomes widely adopted (given its limited supply), but that remains a highly speculative proposition.
- As of year-end 2017, there were 1,381 different cryptocurrencies available for trading over the internet (owing to the fact that anyone can create a new cryptocurrency at any time). While Bitcoin is the largest cryptocurrency by market capitalization today (thanks to its first-to-market advantage), there is no telling which one will ultimately reign supreme (if they are still around in a few years). If you expect that cryptocurrencies will become more widely-adopted (and your prediction is proven correct), you could still lose your investment if you do not buy the right cryptocurrency.
- Regulators in countries across Asia (Thailand, China, Russia, Vietnam, Taiwan) have already moved to ban Bitcoin, while others have expressed concerns (Singapore, South Korea). Regulators in the United States and Europe have been slower to address the rising popularity of cryptocurrencies, but will eventually have to. It remains unclear whether a decentralized, stateless cryptocurrency can actually be regulated, but any mention of the word “regulation” is sure to cause heightened volatility.
- This is not a “how to” guide on Bitcoin, but we highly recommend reading one or taking an online course before purchasing units for yourself. Importantly, there are several detailed steps one must take to safeguard Bitcoin units from hackers, computer glitches (e.g. damaged hard drive), or general carelessness (e.g. lost password). If these steps are not followed, you risk having your Bitcoin units stolen or lost with no recourse.
The views shared in this commentary are those we hold today, but should be considered “tentative.” While attempts to create digital currencies are not a new phenomenon, they have only recently garnered mainstream attention. As such, we expect to learn more over time.
Brian Tall serves as the chief investment officer at Brighton Jones.
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