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Bitcoin's Fatal Flaw

Bitcoin's Fatal Flaw

Bitcoin has had some extremely wide swings in the course of one single day. In fact, on one recent day, Bitcoin went from about $500 to $900 in a matter of hours. Certainly no long-lasting currency can expect to have such wild and senseless gyrations in such a short amount of time. This leads me to believe that too often pure speculation is driving the Bitcoin.

By Theodore F. di Stefano E-Commerce Times ECT News Network
12/05/13 5:00 AM PT

Bitcoin has had quite a ride this year. In late November, the virtual currency was valued at around US$675. When you compare that to its price of about a year ago, you'll find that the currency has risen about 50 times its year-ago value. Does this make sense? I don't think so.

Though I now think that the time for virtual currencies has come, I do not think that Bitcoin would be an ideal alternative at this time. It's just too volatile. I'm also not a believer in investing and speculating in Bitcoin -- or any currency, for that matter -- unless your name is George Soros, the billionaire investor who made countless millions speculating in currencies.

Yet today, Bitcoins can legitimately be used as a means to purchase goods and services on certain Internet sites, as well as to purchase retail goods and services where the proprietor will accept them. In fact, today there are certain restaurants worldwide that will accept payment in Bitcoin.

Generally Accepted Currency

Investopedia defines a currency as follows: "A generally accepted form of money, including coins and paper notes, which is issued by a government and circulated within an economy. Used as a medium of exchange for goods and services, currency is the basis for trade."

I suppose that one could say that the key part to this definition is the phrase "generally accepted." As of this writing, there are still many people who have never heard of Bitcoin. Therefore, it is certainly not generally accepted.

Another key element of a viable currency is trust. The U.S. dollar has been around for a long time and certainly has broad-based international acceptance. There is a high degree of trust in the dollar and in our country. Still, anyone can, of course, speculate in dollars -- or in any other currency.

However, the dollar is so generally accepted that many goods are currently internationally priced using the dollar as a monetary unit of measurement. One example of this is a barrel of oil; it is still dollar-denominated, and we often hear news reports give oil prices based upon the dollar and not on any other foreign currency. I don't ever see Bitcoin reaching this status.

Trust and continuity have a great deal to do with the fact that the dollar is a generally accepted monetary unit. It's still regarded as a "safe haven" for wealthy people and, actually, for countries. Just think, we now owe both China and Japan about one trillion dollars each, due to their purchase of U.S. debt. To say that these countries have faith in the longevity and trustworthiness of our country would be an understatement.

A Lack of Trust

There are several glaring flaws to Bitcoin, but the main one is lack of trust due to lack of governmental oversight and regulation.

Another flaw is its volatility. Bitcoin has had some extremely wide swings in the course of one single day. In fact, on one recent day, Bitcoin went from about $500 to $900 in a matter of hours. Certainly no long-lasting currency can expect to have such wild and senseless gyrations in such a short amount of time. This leads me to believe that too often pure speculation is driving the Bitcoin.

Bitcoin has become somewhat like the game "musical chairs," where there's one fewer chair than players at the start. Inevitably, when the game is over, someone is left standing without a chair. That's what speculation can do to an investor, and that's part of what I believe is driving the wild gyrations in Bitcoin speculation. It's no game for the faint of heart.

A trusted currency simply doesn't have such wild gyrations in its value, especially within the course of a few hours. This begs the inevitable conclusion that trust is one thing that Bitcoin doesn't have going for it.

There is another thing that Bitcoin doesn't have going for it, and that is a central bank. We have the Federal Reserve System, which is our monetary watchdog -- our central bank. It is tasked with the responsibility to insure the seamlessness and sound functioning of our monetary system. A well-functioning central bank adds to the trust in a monetary system. Bitcoin doesn't have that.

The fact that Bitcoin is a stateless currency doesn't do much for it either. Major currencies such as those of the United States, China, Japan and Germany have economically respectable countries and large industrial powers behind them. You might not like the politics of a particular country, but you know that it will do all that's possible to back its currency.

The reality that Bitcoin is an encryption-based currency also strikes at the trust factor. Many people don't know what an encryption-based currency is. Far fewer know the cryptic formulae that are the underpinnings of Bitcoin. Someone highly schooled in the world of computers who also knows something about Bitcoin's encryption-based currency might say that it is soundly encrypted in order to protect anyone holding Bitcoin, but the reality still remains that worldwide there are too few people today who know about the encryption regimen of the Bitcoin.

Wave of the Future

So who should be buying Bitcoin if it carries so many caveats with it -- and are there other alternative virtual currencies to consider?

Based upon what I know about Bitcoin as of this writing, I would leave the "investment" in Bitcoin to the speculators. Bitcoin is yet to be proven to be a viable, long-term currency. That said, I do feel that virtual currency is the wave of the future. Using paper currency and coinage to purchase goods and services is patently outdated.

I realize that we have debit cards and credit cards, as well as other forms non-cash transfer, but there is still a need for instant currency -- specifically, a cash-like currency sans the paper or the coinage. I also feel that the U.S. should start thinking of a way by which it can eventually phase out its present-day paper and coin currency.

Hopefully, Bitcoin will serve as a wake-up call that technology won't be denied and that a virtual currency, backed by a country and a central bank, will be the norm in the not-to-distant future.


Theodore F. di Stefano is a founder and managing partner at Capital Source Partners, which provides a wide range of investment banking services to the small and medium-sized business. He is also a frequent speaker to business groups on financial and corporate governance matters. He can be contacted at Ted@capitalsourcepartners.com. Follow Theodore F. di Stefano on Twitter.


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