Monday, September 21, 2015

The Problem with Bitcoins and Other Virtual "Money"

Recently I heard that someone who knows somebody I know bought a form of "crypto-currency" that is similar to Bitcoin, and was recommending that others buy also buy it.

When I first heard of Bitcoins I thought they were silly and an extremely dangerous thing to invest in.

Bitcoin is something that doesn't exist; it's virtual. It's a lot like Federal Reserve Notes, but when you posses them you don't even get a piece paper.

It's hard to comprehend, but imagine that I had a website where you could play checkers. I could then make a virtual currency on the website where people pay 20 "checker-dollars" for a game and receive 40 "checker-dollars" if they win. I could then charge people to buy "checker-dollars" because even though no real money is created, I did create a nice gaming website for people to play.

With the Bitcoin (and other virtual "currencies") people pay money to buy Bitcoins but they only get a number on their screen; they don't get to play a game or anything else of true value.

So why aren't Bitcoins free? Because whoever made them only made a certain number of them and for whatever reason a lot of people bought them. This increases the price of it because of supply and demand. Prices continue to change based on the ratio of people buying or selling them, just like any other product.

It is possible to make money by trading them, but only if other people will buy them. People trade something that doesn't even exist because it can fluctuate so much (because its "value" is only determined by how many people are buying into it) and they hope to make money, or they are ignorant and simply think, "It works so it must be real." The problem with this seemingly pragmatic thinking is that it will only work for a time. Eventually you have to sell the Bitcoins, and eventually people will no longer want to buy them.

I personally think the whole idea is rather insane. People have made millions of dollars and others have lost millions of dollars...over nothing. Something cannot stay away from its real value forever. Bitcoin and other virtual "currencies" will come crashing as soon as people start becoming logical.

Of course, on the other hand, powerful people might try to make all currency virtual, but even if they would, you shouldn't encourage it.

But, you may argue, Federal Reserve Notes are not backed by anything either. True indeed. And eventually the USD will crash (unless it gets backed by something). But for the moment it's what the government uses and people respect it and so you probably don't have much choice but to use it. With Bitcoins and other virtual "currencies" you have a choice. Use it! Don't spend your dollars on something that doesn't exist.

Although it sounds good to use something that is not operated by a central bank, why use something nonexistent?

Another reason you might want to use Bitcoins is because you think that people will have confidence in them and Bitcoins will not lose value. I disagree, but for the sake of argument let me ask a question: why couldn't someone else who has the technology simply create another form of virtual "money" tomorrow? What makes Bitcoins so special?

What should be used as money? Gold and silver (or other precious metals) or something similar. There is a limited amount of gold and silver; no one can create them (and thereby reduce the value of other people's money (A.K.A. stealing)), and they will always be around.

For more details and a much better explanation of why Bitcoins and other virtual "currencies" are a poor investment, I highly recommend Dr. Gary North's article, Bitcoins: The Second Biggest Ponzi Scheme in History.

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