Video - Why Bitcoin Matters - Mauldin Economics

Bitcoin is a digital currency for the internet age. It was developed by an unknown programmer named Satoshi Nakamoto. Bitcoin is now the number one venture capital since the last quarter of 2014.


We live in an increasingly computerized online world where everything from self-driving cars to drone delivered pizzas are stretching our belief of what's possible. Recently the digital currency Bitcoin has been stretching our understanding of what money can be.

Bitcoin is a great breakthrough because it gives rise to the dream of a single fabric of exchange.

Early adopters say it will revolutionize global payment systems and the financial industry.

Bitcoin has the ability to become a perfect form of money. It will completely decimate the business models of Western Union and the MoneyGram.

But is a currency not backed by any central bank or government sustainable?

I think there's a huge blockade to Bitcoin becoming even remotely mainstream.

There are a lot of unanswered questions about the Bitcoin experiment, but the technology behind it is here to stay and the potential is huge.

Look at it, learn it, understand it and keep your eyes open for new ideas because they're everywhere right now. I mean, they're really flowing fast.

So what makes Bitcoin such a breakthrough, how risky is it and can this radical new form of exchange be the future of money?

It was in early January 2009 that an anonymous programmer created the first Bitcoin. They call themselves Satoshi Nakamoto. But today we still don't know who is actually behind it. Bitcoin is an entirely new form of currency. Totally decentralized. It's not backed by any central bank or central government. Existing only on computers, it's a digital currency for the internet age. At first Bitcoin was obscure, trading for pennies and accepted only in remote corners of the Internet. But by 2013, the currency exploded on to the mainstream.

Bitcoins are booming.

The value of each Bitcoin hit a new high.

The price of Bitcoin continues to skyrocket now topping $1200 for the cyber currency.

But then things started to go wrong even faster than they had going right.

China today barred banks and other financial institutions from handling Bitcoin.

Russia came out and said it's basically illegal to use Bitcoin.

Mt. Gox unexpectedly shut down today owing hundreds of millions of pounds.

The price of Bitcoin dropped in half and many wrote it off as a failed experiment but Bitcoin hasn't gone away. Despite the hurdles, the currency is slowly gaining widespread acceptance. The price is starting to stabilize and a lot of investors are interested in Bitcoin and the technology behind it.

It was the number one venture capital industry target last quarter. $97 million in the last period. It's an insanely hot industry right now.

By the end of next year, there will be about a total of a billion dollars or more of new venture capital in Bitcoin companies and that means lots of possibilities.

The early adopters are going to have a period of unfettered access and a lot of fortunes are going to be made in that period.

What a lot of people feel appreciate is that Bitcoin in places like Silicon Valley is a religion and the key decision makers, the managers, the founders of some of the most well-known tech companies own Bitcoin. They love Bitcoin and they're all trying to figure out what is the best way to incorporate Bitcoin into their business.

The types of businesses that that can launch from Bitcoin, this huge disruptive potential across all transaction based type industries. It could change remittances. It can change money transfer. It can change trust. It can change lending. It can change the financial system as we know it.

I don't think Bitcoin is going away. I think that technology is going to find its way into the fundamental fabric of the way all trading systems work with the commodities, Forex, stocks, bonds, trading of deeds, passing of documents and information. The concepts behind Bitcoin are fundamentally game changing.

So what is Bitcoin and what makes it so special? Satoshi has managed to create digital scarcity. You can't duplicate Bitcoins and only 21 million will ever be produced. Bitcoins can't be copied because the Bitcoin network is essentially a public ledger. All transactions are verifiable on something called the blockchain. Anyone can link a computer to the Bitcoin network to help verify transactions and to make sure there is no double spending. The process uses huge amounts of computing power to solve complex math problems and to confirm transactions. People who do this are called miners. That's because by running this confirmation process the miners also create new Bitcoin. They keep the new Bitcoin as their reward.

The idea behind it is that the best system is one in which the hive, the aggregate opinions and knowledge of everyone involved in a network, is the best arbiter and verifier of everything that's going on in that network.

It's an open source project so every line of code can be reviewed and audited, and it really is probably one of the most reviewed sources of code that's actually ever been released.

Bitcoin is based on new discovery that it's possible to create a completely distributed autonomous peer-to-peer financial infrastructure on the internet itself.

The idea behind Bitcoin is brilliant. Because for the first time we have a math based currency. You have both a currency and a payment system that runs on not just faith or trust in a system but a mechanical predictable expansion in the growth of money supply.

Most currencies disappear over history because they're eliminated by overpopulation, right, overprinting. Well, this we've already said is only going to have a limited supply. So I think the disruptive potential is really, really big.

Bitcoin potentially has the ability to become a perfect form of money because it is both finite in supply, the increase is fairly predictable of the money supply and more importantly it has fantastic utility. You can use Bitcoin now to buy a cup of coffee, you can buy a car, you can buy a house, buy a yacht.

Bitcoin is neither money nor a payment processing technology. Let's be clear. Bitcoin is about moving around pieces of information and ensuring that information is trustworthy and can't be replicated. It's effectively a signing mechanism. It's the ability to attach to the physical exchange of something, a virtual exchange that matches that.

Whether or not it's considered money Bitcoin has value because of the transaction verification it offers. Owning Bitcoin gives access to the public ledger that is the blockchain. And because miners are rewarded for maintaining the blockchain with new Bitcoin, transaction costs are very low. This opens up many new possibilities.

You know, if a hedge fund wants to participate in this thing right now they can go buy a Bitcoin. They're not necessarily interested in that though what they're really interested in is the thing that develops a 10x, 20x, 100x return for them. And that's going to be an investing in these companies that are developing new products and services around not only Bitcoin but all of the tangential applications that will flow from it.

The remittent space alone is a $500 billion a year business which on average remittance companies charge about 10%. So you're talking about $50 billion that might through Bitcoin end up in the pockets of the sender or the receiver versus some type of middleman. If Bitcoin is successful as I think it can be I think every online merchant will accept Bitcoin just like credit cards. I believe it will completely decimate the business models of Western Union and MoneyGram. They will likely become the codex of this decade.

The cost behind something like Western Union isn't profit margin. The cost is compliance with regulation, handling of cash, dealing with things like robberies and any cost advantage that Bitcoin has today in the scenarios is a 100% attributable to the fact that it doesn't comply with any of the regulations that the rest of the financial industry complies with.

We don't yet know exactly how much money people will be able to save because of Bitcoin, but with a total market cap of Bitcoin sitting around $6 billion the Bitcoin currency is still too small to challenge the financial industries.

What is lacking right now is liquidity. There is very little ability for a major investment to come in in scale. The creation of a derivative market in the alternative currency world is going to prove to be extremely important. That will help reduce volatility and it will help create liquidity in the market. It's absolutely necessary.

The Wall Street money has to come in because the size of the Bitcoin monitory base and more importantly the daily trading volume is not high enough yet to support very, very large merchants accepting it. It's not large enough to support taking on the $500 billion a year remittance business. But once that money comes in and once you see that trading volume I believe that will be the catalyst for people on a global scale to know what is Bitcoin and own Bitcoins, use Bitcoin. The only way we're going to get there though is all of the companies that the VC's are funding they're going to have to come out with the products that are going to make it easier to buy Bitcoin, to hold Bitcoin, to use Bitcoin.

By its very nature Bitcoin is a very complex system. Very transactionally simplistic but very complicated for the end user to use. And I think for most people this concept of holding on the virtual currencies, exchanging them for real currencies it's something most people are going to adopt. One of the problems with Bitcoin is that it takes us backwards in the transaction chain. Suddenly you're dealing with something that's much more cash like. If Target had been hacked and instead of using credit cards what was stolen from them were actually Bitcoins that they had been storing Bitcoin addresses in their systems and those systems were compromised, Target won't just have a PR nightmare on their hands they would be out of business.

Now there are a lot of people, a lot of early adopters that lost a lot of money with the collapse of Mt. Gox. But one of the things that we saw again is it wasn't any fundamental hole or problem with Bitcoin itself. It was the fact that the Bitcoin wallets weren't protected. Mt. Gox didn't take security seriously.

Bitcoin security is based on a consensus model where the system listens to the majority of the computing power. That opens up the risk that someone could manipulate the currency if they managed to control more than half the system's capacity.

I believe that the math underpinning Bitcoin is sound, but there's a lot of players that build the infrastructure and that sort of run this web that yeah, sure if they teamed up, if they built a consortium where they had enough computing power, majority computing power to take this in a different direction or do something different they could.

I think Bitcoin's more fundamental problems don't come from the risk of someone controlling the network. They come from the risk of what we don't know. How much happens behind the scenes on all the different wallet implementations? Donald Rumsfeld has said famously to paraphrase, it's not the known unknowns that kill you it's the unknown unknowns.

There is no indication that anyone is trying to overwhelm the system but government can threaten Bitcoin in a much more conventional way, regulation.

Right now, the regulation of virtual currency industry is still akin to a virtual wild west.

The IRS has already declared that Bitcoin will be taxed as property while New York State is looking at licensing for the industry. All around the world governments are trying to figure out if Bitcoin is a threat and what they should do about it.

It really comes back to the age old question of can regulation keep up with the pace of innovation. In a world where innovation is starting to grow and really accelerate at an exponential pace, this is the big question and the question that I have is whether or not this whole range of transformative technologies will be allowed to take off, will be allowed to accelerate productivity growth in our economy at a time when we desperately need it.

If you had asked me two years ago what I thought the biggest risk to Bitcoin was I would have said government regulation. But what I didn't appreciate at the time is there is still such an anti-bank sentiment that exists with policymakers and legislators and regulators that when I'm in D.C. behind closed doors and I can't tell you how many times a decisionmaker said you're telling me if Bitcoin is successful Western Union will have to reduce their fees by 80%, great.

Ultimately, there will be a meeting of the minds I think. I think the regulators will recognize that this is impossible to stop and they will do their best to encapsulate it within their existing system. And I think the Bitcoin community or the digital currency community itself will recognize -- they're already doing it to some extent, will recognize that some level of regulation will be necessary for the rest of this stuff to happen.

Sitting here in America, we might have an interest in something like Bitcoin existing that allows people within emerging markets to sort of convert the Renminbi, the rupee, the Rand into something like Bitcoin, get it across the border. Bitcoin becomes a channel through which those savings can freely flow past capital controls. That's a big risk for emerging markets. I think that's why the Chinese tried to tighten down on it so much in the past year. I think that's why you'll see more prosecutions, more regulations, more attempts to stop something like Bitcoin in the emerging world because it sort of opens up the emerging markets flank for controlling their capital flows.

So where do we go from here? What does the future hold for Bitcoin? Will there be enough investment, enough widespread adoption?

I think most of us are struggling with, okay, well, how do I play it? Because it still has the perception of being for individuals, small dollars, really not scalable. I don't want to sit at home and mine Bitcoins and have five or six of them. But that's clearly not the case, right. I mean, this thing is growing exponentially. The investors, the institutional investors, the banks, the broker dealers all starting to learn about Bitcoin for the first time getting up to speed and quite frankly getting excited about it. And I think over the next three to six months we'll start to see some real money moving into the space which will likely have a pretty positive impact on the price.

It will speed up and be easier and be safer and be cheaper than any of these systems right now. And that's what we will find ultimately brings the consumer over when those benefits are adequately communicated over to them. Right now, it's all the early movers and shakers, the guys that are leaning forward and quick adopters of new technology. It will move fast. It will move extremely fast. Merchants are -- big merchants are looking at adopting Bitcoin right now. There's nothing to stop rich people from being dumb about an idea especially when an idea is ideological in nature. Fundamentally, what really limits its adoption are combination of and how poorly it has responded to some of its security problems as well as its own complexity. You add that to the trust factor and I think there's a huge blockade to Bitcoin becoming even remotely mainstream.

Whether or not it becomes the underpinning to a new financial system really depends on what happens with our own financial system today. From that perspective, central banks are their own greatest threat. Should there be an unwind or a forceful deleveraging past what we've already seen. A resolution to what Ben Bernanke calls the worst financial crisis in history like we saw in '08. Bitcoin could be there to fill the gap or something like it. That's why it matters.

Bitcoin is going to evolve and it's going -- as it involves it will absorb more and more of the world's commerce and it'll almost be imperceptible as it happens. At some point, it will become clear that this is the payment system for the world economy and probably the standard of value for all monetary exchanges.

So the question of the day is whether Bitcoin will evolve into a currency that we all use. The important word in that question is evolve. Because as an economist I see that Bitcoin 1.0 has some inherent problems in it. It's massively deflationary. It's going to be difficult to put it into a place where we can use trillions of dollars of transactions and there's some security issues. But those can be dealt with because the transaction technology is the powerful piece of the puzzle. Bitcoin 2.0 and as it evolves into 3.0 is going to revolutionize. It will transform how we do transactions and how the world does commerce. Stay tuned as we pay attention to the evolution of Bitcoin.

Written by Melvin Draupnir on January 7, 2015.