Bitcoin, trust, fraud and psychology affects cryptocurrencies challenged to be real economic investments. This unproven currency invention remains free of any central authority, backing or regulation, while presenting investors with numerous challenges.

Managing Investment Market Risks course, lesson 7  introduces and explains Bitcoin and cryptocurrency for investor. Links at the end guide you to related lessons if you want to learn more.

What’s in this lesson for me?

The lesson presents investors with Bitcoin, cryptocurrency and blockchain issues that help or hurt their wealth. The lesson defines, explains and identifies the advantages and disadvantages of this currency invention to help you understand cryptocurrency possibilities and risks.

Understanding Bitcoin and cryptocurrency

Bitcoin and cryptocurrencies are speculation that need mass acceptance to achieve real success. Without broad public and government acceptance this fascinating and innovative idea will be a coulda-shoulda-woulda been great. Until general acceptance happens, serious limitations and risks need any investor or speculator to pay attention. Investors must be aware of the facts, the claimed benefits and the risks of Bitcoin and other cryptocurrencies.

What is Bitcoin?

Bitcoin and other cryptocurrencies are digital currencies. Digital currencies are electronic. online assets or records that use decentralized, peer-to-peer systems to trade or transfer ownership. Bitcoin is the first digital currency invention created in 2009. Many imitators followed. I expect there will soon be more than 2,000 cryptocurrencies. When money comes to mind we think of legal tender or fiat currency, the money issued by government. We believe the currency is backed by the government that issued the currency. For example, U.S. dollars are backed by the U.S. Government and the European Union nations back the euro. A second type of currency are commodity backed such as gold or silver coins. And now with the invention of cryptocurrency, a third type of currency has come on the scene. Bitcoin and the many other cryptocurrencies certainly generate controversy and get attention.

Blockchains track transactions

Essential parts of the cryptocurrency invention are related creations, digital wallets and blockchain. Of course digital currency gets stored in digital wallets! Like cryptocurrency itself, digital wallets are online electronic creations like computer file directories to store the digital currency file. When told the...“blockchain is a distributed, decentralized, public ledger",  it was as clear as mud! Clearing the mud took some digging to understand blockchain is a database used to store digital information. The blockchain tracks and records all trades, exchanges or transaction for a specific bitcoin. Transfers occur between digital wallets. For a transaction to happen, data or the digital information about the transaction gets grouped into a block of data. An exchange between wallets requires blocks of data representing each side to link or chain together with sophisticated math.

Always new blocks but same old blockchain

Those new blocks get added to the existing block chain tracking the specific Bitcoin being used. The blockchain grows endlessly following the Bitcoin from transaction to transaction. That means the record of the seller and buyer are in the blockchain forever. That is innovative. In a normal accounting or bookkeeping, the typical ledger or record notes both the seller and buyer tracking both sides of the transaction. Then the record moves on to the next transaction but drops the previous seller from any record in the future. Just the current seller and buyer are noted. All previous sellers and buyers are dropped as the record moves on. The seller record follows the seller; the buyer record follow the buyer. The seller and buyers can each have a record or accounting that includes their transactions but no record gets attached to or tracks the individual currency asset. In the case of blockchain the blockchain tracks the cryptocurrency asset every time it gets sent between any two digital wallets. That produces a permanent record that can not be changed. No seller or buyer identification gets dropped and all transactions are uniquely marked and tracked.

Communal or shared ledger maintenance

Traditional records are centralized. For example your bank keeps the records of all transactions in all customer accounts. In the case of blockchain records, the ledger is kept and updated by the cryptocurrency community. For example, the Bitcoin network tracks and records all Bitcoin transactions everywhere. That network is a unique feature of the cryptocurrency blockchain. Multiple computers in the network are all tracking the transactions of each and every Bitcoin. That is provides a form of fraud protection. A fraud has the impossible job of fooling all the computers in the network. The blockchain began on a handful of computers controlled by trusted associates having a copy of the blockchain. To accept a transaction, computers on that network had to agree on the details for a transaction to be accepted. A qualification process was established to grow the network which grew from those first few computers grew into a huge network. That network of numerous records now spreads across the world in an unhackable secure matrix. That shared ledger means cryptocurrency operates without a central authority, master computer or institution in charge. Should any computer in the network fail, go offline, be hacked or stolen, all others go on without it, without losing data and without downtime.

Other blockchains for other uses

The blockchain idea has be adopted for many different uses and had many more features added. Governments, banks and other companies continue the use and development of the blockchain for unlimited types of data and transaction records with no cryptocurrency connection.  Banks are tracking payments, governments are tracking properties and voting records and companies are experimenting with other asset and deal tracking.

Investing or speculating

Bitcoin is an asset just like lottery tickets or dollar bills. But Bitcoin is no investment. Bitcoin and all other cryptocurrencies are speculations. They have no stored value. In contrast gold at least has a stored value.

However, like gold, cryptocurrency has no ability to earn. An investment must pay but cryptocurrency pays nothing. The entire value is the owner betting that a greater fool can be found to pay more.

As such, the possibility exists that this could all end well but the odds are long and the case full of holes. Still, should it all work out, Bitcoin could be a spectacular speculation winner. For those who buy low and sell high it is.

To be clear, investments must pay now and forever. Bitcoin pays nothing. In that way it is like gold. Interesting but pays nothing so like gold is no investment. However, in contrast to gold, the stored value of Bitcoin is also nothing.

Advantages

Cryptocurrencies offer advantages.

Lower or void fees and exchange costs

On the plus side cryptocurrency can provides secure and effective low fee payments and transfers of value. Crypto transactions have no fees or exchange costs avoiding intermediary, government or exchange costs.

Numerous cryptocurrencies

You can use and trade bitcoins or any of more than over 1,600 cyber currencies! All you need is to get someone to agree they have value!

Private Key

Only the owner controls their own private key. This is also a risk because if you lose it, it is gone with no recovery.

Difficult to counterfeit

The decentralized virtual currency uses cryptography as the prime security feature and a distributed network to avoid counterfeits.

Mobile friendly

Cryptocurrency can be used for transactions over mobile networks with no banking system needed to work.

Simple transfers

Unlike other asset or currency transfer systems, all owned, controlled and administered by third parties, crypto systems work around private technology keys owned by the holder. This is a strength or advantage and also a risk.

Risk, you can lose the key and there is no recovery! Should you use a web based digital wallet to hold your cryptocurrency, owners can also have that lost. Many examples of both cases have occurred.

Confiscation protection

Crypto removes the ability of government to confiscate or inflate away value. Cryptocurrency disciples trot out the examples of central bank of Cyprus sought access to the uninsured deposits in their banks. The situation was complex and complicated but the point relevant to crypto fans was there was an government willing to reach into private bank accounts in effect seizing or confiscating private property of citizens.

Venezuela is a different case but another example of the government screwing up the asset values of people's assets. In this case imbecilic government economic and financial incompetence destroyed the prosperity of a high living standard country with years of political and social foolishness.

Immediate settlement

When you can find someone to deal with cryptocurrency the transaction can produce immediate settlement. At lease in theory...that's the rub...there are many wrinkles in how transactions actually work.

Identity theft protection

The crypto system pushes data rather than letting the payee pull your data and identity as credit cards do.

Access to everyone

Open to all, including anyone without a bank account. In Kenya the M-PESA phone based mobile money transfer and microfinance service work without any need for a bank.

Decentralization

Blockchain technology managed by the crypto network with no central authority. Peer to peer network has no need for a centralized system.

Universal service

At lease in theory, crypto works anywhere without need for an exchange rate between currencies.

Cryptocurrency challenges & disadvantages

Fraud and criminal issues

Fraud protection claims are suspect. Cryptocurrencies routinely get used by fraudsters to scam people, companies and governments. While counterfeiting has not been accomplished, that is minor comfort for this fraudster enabling invention. It enables black market dealing.

One way transaction

Senders can't arbitrarily reverse a transaction like an arbitrary credit card charge back. This feature attracts scammers and fraudsters making rip offs easier for the scammers.

Awareness

Awareness is limited as new ideas like digital currency take time to become known as well and more time to be used and a real part of economic life.

Education

Few people have a working knowledge of cryptocurrency. Although millions have heard of bitcoins and cryptocurrency very few know much about it. Knowledge is limited to fairly small numbers of people. Fewer people still own it and very few of them actually use cryptocurrency for legitimate legal transactions.

Acceptance

Cryptocurrencies share the challenge of limited acceptance as few businesses accept crypto payments.

Adoption

The process of actually getting started with cryptocurrency is not quick or easy. This limits the adoption of cryptocurrency.

Risk

Cryptocurrency carries a huge loss risk because the lack of any security safety net or protection for password errors, technical errors (hardware fails) or fiduciary fraud. Many millions have been vaporized by this fault.

Fraud

Fiduciary fraud is real and regular bad news with many crypto digital exchanges going out of business. Many means in the range of 45% of the exchanges have failed! Of the failures, two out of three offered no reimbursement to their victims. Most exchanges barely last more than a year! This is a risky business and certainly a risky place to play with money!

Volatility

Cryptocurrencies wildly cycle through a huge range of prices which draws droves of traders, speculators and high frequency traders to add turmoil and more trading volatility. The constant and severe price fluctuations challenge users and merchants to make a deal fair to both sides.

Crypto scams and fraud

Cryptocurrency scam and fraud schemes are real issues so far without resolution.

Regulation

Regulators grumble that cryptocurrencies are the mother of money laundering schemes. Regulations have the potential to severely impact cryptocurrency values.

Scaling

Cryptocurrency touts ignore the design limits of the system. As now designed the system severely limits transaction speeds and numbers. For small numbers of players and transactions that has little concern. However, the crypto system design can not come close to supporting the pace and volume of conventional transactions.

Storage

There is another serious design problem built into the cryptocurrency system. Storage on thumb drives and such can get lost or stolen vaporizing assets. The system offers no security in case of loss.

Applications

There is a lack of practical applications for Bitcoins or other cryptocurrencies. Actually making use of cryptocurrencies challenges owners because uses are so very limited, except for illegal transactions. Few practical legal applications exist. Cryptocurrency touts should consider developing applications for cryptocurrency to the following:

• Establish a way to disrupt fiat currency.
• Make it usefully do what fiat currency can do.
• Make it work in any electronic payment system.
• Legal low-cost international money transfers.
• Establish cryptocurrency associated electronic contracts.
• Make it used or accepted for Kickstarter campaigns.
• Establish legal low-cost micropayment transfers.

Bitcoin digital currency challenge

Cryptocurrency touts say Bitcoin exchanges point the way to the future of money. If so, money is in for a rough ride! The future is filled with fraud and loss if Bitcoin exchanges are the future. I don’t think it will be so.

Bitcoins are the imaginative invention of a pseudonymous developer and offered as a digital or cryptocurrency for an alternative electronic cash system. It is money created by computer strokes without any government oversight, control or influence. When buyers and sellers agree, bitcoins can be used for electronic transactions.

Brain cycles and advanced cyber knowledge created and distribute bitcoins. In my opinion, at this time, only the gullible or crooks have any need for them. If you need further information, the Wikipedia entry gives a reasonable, extensive and balanced review.

Bitcoins are legally defined as currency

In multiple jurisdictions, courts have made legal declarations that bitcoins are currency. Advocates are ecstatic in a “see I told you so” sense that bitcoins have been legally defined as currency.

However, that ignores how courts got to that legal point. In every case that I looked at, the court were dealing with criminal activities. Authorities were dealing with various forms of fraud that involved payments made in Bitcoins.

The legal issues were criminals trying to dodge responsibility for stealing or defrauding victims by arguing Bitcoin was not currency. If that was  accepted as a legal ruling, bitcoin payments would not be legal transfers of value. If the courts accepted that legal con job, all criminal activity involving bitcoins would get a free pass! Criminals would never be convicted of thief, fraud, money laundering or any illegal transaction by demanding or making payments in bitcoins!

Judges' currency rulings show wisdom

Thank goodness multiple courts were quick enough to see a resolution to the legal issue, bitcoin, a currency or not? They simply ruled that bitcoin was currency. As such using it in a crime could transfer value and be theft or fraud or another crime.

The clever and imaginative ‘not a currency’ defense suggested was thrown out. Legal systems can make some nutty findings but in these cases it seems legal sense and common sense were in sync. They got this one right.

The future

On the rest of planet Earth, government backed national currencies serve populations that trust the value of currency. We trust that value is there when we receive or make payment. Currency is only good to us if we can spend it as we wish, where we wish.

Zimbabwean notes that I hold as souvenirs have face values in the billions. But they are worthless. They have no ability to transfer any value whatsoever. The smallest denomination of Canadian Tire money can buy more than a billion Zimbabwean dollars. And that promotional coupon is only good in massive amounts at one store. For non-Canadians, Canadian Tire money are promotional coupons used by a major retail chain in Canada.

The key to the value of any currency is the psychology and trust of all involved in the transactions throughout the economy. Your payment to me is only acceptable when I believe value has transferred. Likewise when we offer currency for bread or a taxi ride the other party has to accept and actually receive value.

The chance that bitcoins will ever be more than an amusing curiosity and financial sideshow are about the same as the chance that gold will ever again be made the base value of American dollars. Anyone thinking that does not understand how credit works or the money supply gets created.

Trust is the base of any currency value

When we collectively lose trust the system, any currency system, instantly stops. That is exactly what was underway in the 2008 credit crisis and crash. Other then speculations, Bitcoins will never have any significant economic role beyond a barter level or for black market transactions until the many issues covered in this lesson get addressed.

Do not forget that the potential spenders are pushing cryptocurrency. Buyers are not lined up few businesses or service providers are yet keen to accept cryptocurrency. It may come but there is no need to be early to the cryptocurrency party.

Why this lesson matters

The many issues that challenge Bitcoin and cryptocurrencies will keep it hobbled in the speculative camp for some time. Still, that will not be forever. As investors we need to be aware of the related issues and prepared to give it another look when things change. Until then, only extreme risk money should be considered for any cryptocurrency speculation.

Key take aways from lesson 7, Bitcoin fraud trust and psychology, includes:

Bitcoin, trust, fraud and psychology affects cryptocurrencies challenged to be real economic investments. This unproven currency invention remains free of any central authority, backing or regulation while presenting investors with numerous challenges.

• Bitcoin and cryptocurrencies are digital currencies.
• All cryptocurrencies are speculations.
• Digital wallets store and blockchains track cryptocurrencies.
• Advantages of cryptocurrencies
  • lower or void fees
  • numerous cryptocurrencies
  • private keys protect and risk owners
  • counterfeit difficulty
  • mobile friendly
  • simple transfers
  • confiscation protection
  • immediate settlement
  • identity protection
  • access
  • decentralized
  • universal
• Disadvantages and challenges
  • fraud and criminal issues
  • one way transactions protect crooks
  • awareness lacking
  • education needed
  • acceptance needed
  • adoption limited
  • risk of no security safety net or protection
  • fraudulent loss is real and regular
  • volatility issues
  • crypto scams and frauds
  • regulations pending
  • scaling challenges the system
  • storage flaws
  • lacking applications
  • currency challenge
  • trust for cryptocurrency has not been established

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Managing Investment Market Risks, lesson links:

Introduction to Managing Investing Market Risks Lesson 1

Dangerous dividend warning signs Lesson 2

Investor retirement saving dangers Lesson 3

Exotic ETFs blow-up portfolios Lesson 4

Stock scam awareness defense Lesson 5

4 Stock scam tips Lesson 6

Bitcoin fraud trust and psychology Lesson 7

Investors hold patient cash Lesson 8

3 Risk or opportunity signals Lesson 9

Option risks, dangers and opportunities Lesson 10

Cautious look at options Lesson 11

Selling low melts wealth Lesson 12

Next lesson 8: Investors hold patient cash

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