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Bitcoin is a Bubble and I will tell you why

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Humans are considered rational beings. Every once in a while greed and exuberance trumps rationale we end up with a Bubble. Bitcoin is a bubble and it will fall precipitously. Here’s why…

Some Economics

Value of any product is arrived at through a process that matches demand and supply. If there is a lot of demand for a product and few people offering it, the price go up. There is a greater perceived value for it since the supply is limited — Everyone who wants it, cannot have it. The vice versa is also true. But as with most things in life there are certain exceptions to this rule.

High-end luxury products have an aspirational value and hence the higher the price the higher the demand tends to be. These are called Veblen goods. There are also Giffin goods where this effect is seen with inferior goods.

Either way, in all of these cases price is a consequence of consumption.

There is another case where prices can be made to rise artificially, through hoarding and creating artificial scarcity. The hoarder buys large quantity of a good and waits for the price to rise high enough before beginning to sell it slowly to the actual consumer at an elevated price.

Markets play an essential role is matching demand and supply, which results in price discovery. Markets are the price discovery platform that most of us depend on. We have markets for everything, stocks, currency, commodity, bonds, etc. Most of these trades take place through instruments that are representative of the same. Stock is a company is represented by shares — Stock here represents the assets of a company and the ownership is attributed through shares. There are similar trading instruments for everything that is traded.

The place where this trade is managed, which I referred to an a market earlier, is known as an Exchange. An exchange is where trades are executed and the instruments change hands between the buyer and the seller. The job of an exchange is to provide a framework, to regulate and enable the trade to take place.

Blockchain

Let us say you have a Rs. 10/- currency note. You take this note and buy tea from a tea stall. He in turn takes the note and pays for the fuel bill. He in turns takes the note and pays the school fees for his child. The note has been used for several transactions but we do not know where it originated from and how many hands it changed. If this note were an online token we could track it all the way through.

If there are a set number of tokens in circulation and each of the token can be tracked, there is no way that any fake token can be introduced without changing the total number of token in the system. Furthermore if an anomaly is found, it can be quickly tracked back to its origin.

A Blockchain is a chain of records which are called Blocks. Each block represents one transaction and hence the entire history of an single instrument can be tracked from beginning to the end. A blockchain is what makes it possible for us to track every token. Research on blockchain began in 1991 but the distributed blockchain, which is the basis of all modern blockchain was invented in 2008. The distributed blockchain kept the block of records on every computer that is a part of the system. This redundancy is the secret sauce that make blockchain a phenomenal technology.

This makes it near impossible to fake any transaction because that fake transaction. It is not enough to enter a fake transaction in your own block, the same transaction needs to exist in every copy that is part of the system. Each copy is protected by public key encryption on each user’s system (If you wish to know how encryption works). If any anomaly is found, it can be quickly localized and eliminated.

Bitcoin

Bitcoin is one of the implementations of blockchain as a currency. Bitcoin tokens can be mined by solving mathematical problems, but the total supply of bitcoin available is limited by the algorithm. The more bitcoins get mined, the harder it becomes to mine further. The mathematical problems are solved using the computer but the problems take longer and longer to solve as times goes on.

Now, once you have these Bitcoins, you need a way to transact, for which bitcoin wallets exist, where these coins get stored. The wallet is your copy of the blockchain.

Some people thought, “Hey! Why not trade bitcoin?” and they created Bitcoin exchanged. Just like a stock exchange, Bitcoin is bought and sold on Bitcoin exchanges. There are several across the world and they execute bitcoin sale and purchase.

Individuals and companies have been mining bitcoins since it was introduced. Today this mining has assumed industrial scale with more and more people getting interested and mining becoming harder and harder. There are entire server farms that are being committed to mining bitcoins and in all likelihood these are being hoarded for a future date when it would likely be sold.

Value of any product finally lies in its consumption

The value of anything is down to consumers finally adopting the product and using it. This is where demand invariably arrives out of. Whether it is businesses or individuals, utilisation is the key. Keeping something does not create value unless it is an antique. Bitcoin is definitely not an antique.

Source: https://blockchain.info/charts/n-transactions

The graph aboves shows the confirmed Bitcoin transactions per day. At its lowermost it is about 130,000 and at its peak its at about 365,000. It averages out at about 275,000 per day.

Let me just add some perspective. Visa processes about 24,000 transactions per second. So in about 12 seconds Visa does the entire days worth of transactions on Bitcoin!

Although this is not a straight comparison since Visa is a method of exchanging money while Bitcoin itself is a store of value. The market capitalisation of Visa as a company stands at USD 230 Billion while that of Bitcoin stands at USD about 70 Billion dollars. A third of the value of Visa??

Comparing it with gold, which is a store of value unlike Visa which is a transaction mechanism akin to Blockchain; Comex which is a commodity exchange based out Chicago (one of many across the world) does about 289,000 gold contracts per day. The number across the world would probably be in the millions, not to mention the transactions that take place through stores, banks and other means.

There are about 16,500,000 Bitcoins available today. Out of this only about 640,000 is exchanged everyday.

Hoarders will dump

I think the value ascribed to bitcoin given its abysmally small circulation is purely due to the hoarding that many are engaging in. Most of the people just buy bitcoin for the purposes of speculation.

People buy bitcoin and then they keep it.Since nobody is selling (Would you, if you know what you have is doubling in value every 6 months?) — Prices rise.People hear prices are rising — They clamor to buyDemand rises — Price risesSome of the early hoarders keep releasing small amounts of it

The above graph illustrates how this works. For price to rise, the demand has to be high; this demand should be powered by consumption and not hoarding.

My take on this is that the price rise of Bitcoin is fake. It is powered by speculators who are willing to pay more and more in the hope that prices would keep rising. The limit on the supply is additionally helpful in driving the prices up and keeping them there.

Looking into the past

There are plenty of cautionary tales of bubbles but for me the one that most closely matches this is — The Tulip Mania.

Tulips by themselves had no great value.

Tulip was a unique flower and was used for royal gifting. The prices of tulips shot up suddenly on speculative purchase of tulip futures. There were, many who made money during the upsurge. After a couple of years of frenzied buying, the demand for buying newer and newer contracts seemed absent. There was no inherent value in it. Panic set in and ultimately it suddenly collapsed in Feb 1637. Within 3 months all of the value was wiped out, because there was none to begin with!

The same is true of Bitcoin today. Its not like Bitcoin is the preferred currency for transaction or that people are switching to transacting through bitcoin at unforeseen pace. A crazy number of speculators are buying into it for the sake of speculation. There is no inherent value and one day in the not so distant future people will realise it.

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About the Author

This article was written by Vivek Srinivasan.

Experience

5 Important Reasons Not to Raise Capital for Your Startup

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I recently had dinner with co-founders of a startup who’d just raised quite a bit of money for their company, a deal which incidentally I’d passed on. The meal was fantastic: fresh salmon from the bay, washed down with a particularly good New Zealand pinot noir, while watching the sun go down over the water. Really you’d expect my mood to have been chipper… but it wasn’t.

The evening was spent with the founders congratulating themselves for raising money. I’m not being a killjoy but it felt like the end of the line, not the beginning. It felt like all the preparation had been done, all the work completed, all the sweat, tears and marriage breakups had already been had, and now finally they’d succeeded. Except of course that wasn’t the case. This was the beginning not the end.

All they’d done was raise some money. Money which, though it may be needed to fulfill their goals, stands as a liability. Now, I’m all for celebrating success but this attitude really worries me and here’s why.

VC culture has come to equate raising capital with success, where each successive round of financing successfully completed is denoted as success,but you know what, VC culture is wrong.

Success is success and raising money is raising money. Let’s not confuse the two.

Raising money amounts to taking someone’s hard-earned capital. Capital which has been acquired by sweat, savings, maybe even theft but it’s someone else’s nevertheless. That, folks, is a liability no matter which way you spin it!

Realise that even if the capital never came with strings such as board seats, preferred equity, liquidation preferences or any host of other typical “strings”, realise that capital ALWAYS comes with strings which I’ll get to shortly.

So in the event that you’re an entrepreneur, emboldened by the fact that most anyone in Silicon Valley today sporting a hoodie, some pimples, and professing to work out of his grandmother’s garage, can get funded and at eye-watering valuations, let me give you 5 reasons why raising money may be a bad idea for your business:

1. Lack of Focus

Multi tasking is rarely a great strategy for any business. If you doubt me, try rubbing your belly and patting your head.

37signals built one of the most successful businesses in their niche by remaining extremely focused on just one product. My point is that it’s next to impossible to be running around raising capital, while remaining focused on building your fledgling business.

Unless you’re sitting in Silicon Valley which stands as a distinct anomaly to the rest of the world, let me assure that raising money will likely take you far longer than you ever thought, will come with more distractions than you’ve even thought, and the progress in your business will suffer.

2. ROI Can Be Poor

Time has a cost. The time spent raising money can often be time poorly spent.

I little while ago I was pitched by a company which had developed a minimum viable product, cheap to produce, easily shipped and which when sold, netted a $10,000 profit. The founders were, however, trying to raise $250,000 and had been on a road show for 3 months already!

Consider that by focusing on building, marketing and selling that very product they needed only 25 products sold to reach their $250,000 they had spent the last 3 months raising. The sheer insanity of what they were doing forever precluded any investment.

3. It Can Be Expensive

Further to the above, as an entrepreneur you might consider paying brokers to raise you capital. While this is an option realise that in any financing round up to Series A, it’s not uncommon to have to pay up to 15% of capital raised, and sometimes even include some warrants, preferred stock or options.

In short, it’s expensive money. Really expensive.

4. Capital Comes with Strings

You should expect that incoming investors may want board seats and input in your company. Do you want that? Does the capital you’re looking for come with the kind of strings you are comfortable with?

You can take money from all sorts of sources.

  • Family and friends will invest because they like you, or maybe they hate you and want you to go away. Or they feel guilty and can’t bare the thought of the next thanksgiving dinner where they’re the only family member who haven’t backed your idea and aunt Marge will make a stink about it. These are psychological strings. Are you OK with them?
  • Angels will invest if they believe you’ve got a good chance at success and often, if they feel they can, add some personal expertise. These guys are not stupid though, and will likely structure deal terms including ratchets, liquidation preferences and so forth. Strings may be that the input by the angel(s) is not something you want. These guys can be of immense value but make sure interests and personalities are aligned otherwise you risk a lot of strife.
  • And venture capital comes with a set of different strings. This particular avenue of financing deserves an article in itself and I’ll write about it next week.

5. Too Much Capital Can Actually Be a Bad Thing

I’ve seen good ideas go to the wind when founders raise too much money. Money can certainly make people do daft things and I’ve learned that as well.

The fancy office space suddenly becomes “necessary”. Scrappy goes out the window in favour of “professional”.

You want to know what is really professional? A company that manages its cash flows, is scrappy as hell, is intensely, manically focused on building awesome value, and realises that when markets turn, as they always do, it’s the strong that survive and thrive. And the strong are always scrappy.

Make sure the money is aligned with your outcomes. Understand who you’re dealing with and what the motivations are. Most of all, don’t just follow the herd because the herd is rarely right.

If, after reading this, you’re not scared away and believe that your company has world changing potential, is less than $10M pre-money valuation and “needs to exist” then feel free to contact me. I’ll be happy to look at your pitch. I’ll almost certainly say no and be kind about it but maybe, just maybe that doesn’t take place.

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About the Author

This article was written by Chris of of capitalistexploits.at.

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Entrepreneurship

Will Financial Liberalisation Trigger a Crisis in China?

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The People’s Republic of China (PRC) has been liberalizing its financial system for nearly 4 decades. While it now has a comprehensive financial system with a large number of financial institutions and large financial assets, its financial policies are still highly repressive. These repressive financial policies are now a major hindrance to the PRC’s economic growth.

The PRC is at the beginning of a new wave of financial liberalization that is necessary for supporting the country’s strong economic growth. The country’s leaders have already unveiled a comprehensive program of financial reform, which includes 11 specific reform measures in three broad areas: creating a level-playing field (such as allowing private banks and developing inclusive finance), freeing the market mechanism (such as reforming interest rate and exchange rate regimes and achieving capital account convertibility), and improving regulation.

But could financial liberalization lead to a major financial crisis in the PRC? What would be the consequences for financial stability as the PRC moves to further liberalize its financial system? If the PRC repeats the painful experiences of Mexico, Indonesia, and Thailand, then it might not be able to achieve its original goal of overcoming the middle-income trap.

International experiences of financial liberalization, especially those of middle-income economies, should offer important lessons for the PRC. In our new research, based on cross-country data analysis, we find that financial liberalization, in general, reduces, not increases, financial instability. This powerful conclusion is valid whether financial instability is measured by crisis occurrence or by fragility indicators, such as impaired loans and net charge-offs. The only exception is that financial liberalization does not appear to significantly lower the probability of systemic banking crises, although it does lower the risk indicators for banks. These results have higher statistical significance and are greater in magnitude for the middle-income group than for the entire sample.

The insignificant impact on banking crises, however, should be interpreted with caution. One of the possible explanations is that under the repressed financial regime, the government supports banks with an implicit or explicit blanket guarantee. This reduces the probability of an explicit banking crisis, although the banking risks may be even greater because of the moral hazard problem. In fact, government protection of banks could also increase the probability of a sovereign debt crisis or even a currency crisis before financial liberalization.

If financial liberalization significantly reduces the likelihood of financial crises, especially in middle-income economies, then why did some middle-income economies experience financial crises following liberalization? We further investigate whether the pace of liberalization, the supervisory structure, and the institutional environment matter for outcomes of financial liberalization.

We obtain three main findings. First, an excessively rapid pace of financial liberalization may increase financial risks. The net impact on financial instability depends on the relative importance of the “liberalization effect” and the “pace effect.” In essence, what the “pace effect” captures could simply be the prerequisite conditions and reform sequencing that are well discussed in the literature. Second, the quality of institutions, such as investor protection and law and order, also matter. International experiences indicate that investor protection can significantly reduce the probability of financial crises. Third, the central bank’s participation in financial regulation is helpful for reducing financial risks during financial liberalization. This is probably because central banks always play central roles in financial liberalization, especially in the liberalization of interest rates, exchange rates, and the capital account. If a central bank is responsible for financial regulation, its liberalization policies might be more cautious and prudent.

Our research findings offer important policy implications for the PRC. (1) Further financial liberalization is necessary not only for sustaining strong economic growth but also for containing or reducing financial risks. (2) Gradual reform may still work better than the “big bang” approach, and sequencing is very important for avoiding the painful financial volatilities that many other middle-income countries have seen. (3) The government should also focus more on improving the quality of other institutions, especially market discipline, to contain financial risks. (4) It is better for the central bank to participate in financial regulation. The new regulatory system should focus exclusively on financial stability and shift from regulating institutions toward regulating functions. It should also become relatively independent to increase accountability.

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About the Author 

This submitted article was written by  and  of Asia Pathways, the blog of The Asian Development Bank Institute was established in 1997 in Tokyo, Japan, to help build capacity, skills, and knowledge related to poverty reduction and other areas that support long-term growth and competitiveness in developing economies in the Asia-Pacific region.

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