Mark Thomas Williams, better known as Professor Bitcorn and for claiming that bitcoin would crash to $10 by mid 2014, last month appeared at the World Bank Conference in Washington, D.C where he outlined his top ten risks associated with Bitcoin. The PDF is available here or read the 10 threats below.
1. Bitcoin Is Not Legal Tender
- It is a voluntary currency and its use as a transactional currency is limited to those willing to accept it.
- If businesses or individuals suddenly decide no longer to accept it, bitcoin will become worthless.
2. Extreme Price Risk
- Since inception, bitcoin’s historical price volatility has been over 130 percent.
- Annual year-to-year price volatility (2010 – 2014) remains well over 100 percent.
- During 2014, annual price volatility (117%) has increased since 2013 (103%).
- Daily price movement can reach 10 percent.
- Extreme price instability undermines its usefulness as a safe and reliable transactional currency.
- Bitcoin exhibits price risk 7 times greater than gold (18%), 8 times greater than the S&P 500 (15.5%) and 18 times greater than the U.S. Dollar (7%)
- If the U.S. dollar had similar triple‐digit price risk how many consumers use it?
3. Extreme Price Risk Can Quickly Erase Company Profit Margins
- Merchant net profit margins are industry specific but general range from 10 to 20 percent.
- Given bitcoin daily price movements can be as high as 10 percent, business owners accepting bitcoin could see profit margins reduced or completely erased in a matter of days.
- This tripe-digit annual price risk makes bitcoin more suitable for Wall Street type trading companies possessing sophisticated management systems, controls and tools than for merchants.
4. Bitcoin Is A Hyper Asset Bubble In The Process Of Deflating
- At the start of January 2013, bitcoin traded at $13, peaking in November 2013 at $1,000.
- Over 90 percent of bitcoin are also hoarded setting a temporary price floor.
- Since this 2013 market peak, bitcoin has dropped by over 70 percent in value.
- In October bitcoin traded as low as $280.
5. Growing Concentration And Bankruptcy Risk To Financial Middleman
- In an effort to avoid bitcoin's extreme price risk, merchants are increasingly using the risk-mitigation services of firms such as Coinbase and BitPay.
- These firms do no eliminate system-wide bitcoin price risk but simply warehouse the risk on their books.
- Relaying on these two thinly capitalised financial middleman to mitigate risk, creates a dangerous level of industry concentration risk should one or both of these firms fail.
6. Bitcoin Exchange Bankruptcy Risk
- The industry remains unregulated with little oversight which has opened the door for unscrupulous operators to take advantage of bitcoin buyers and sellers, increasing fraud and bankruptcy risk.
- In November 2013, bitcoin exchange, GBL based in Hong Kong, closed its doors, costing investors over $4 million.
- In December 2013, the European Banking Authority also warned of the dangers of other exchanges failing and lack of investor protection.
- In February 2014, Mt. Gox, the Japanese based exchange filled bankruptcy costing consumers up to $400 million.
- Since 2009, t he majority of bitcoin exchanges that have opened for business have also failed.
7. Bitcoin Use Can Trigger Significant Tax Risk
- Unlike "legal tender", bitcoin has been designated by the IRS, for tax purposes, as property.
- This designation is significant. Unlike "legal tender", consumers that use bitcoin can be subject to additional taxes.
- This tax ruling provides a further incentive to hoard bitcoin and not utilise it for transactional purposes also reducing market liquidity.
8. Transactional Fraud Risk – Double Spending
- Under Bitcoin protocol all new transactions are validated through the blockchain, a public ledger that is independently verified every 10 minutes.
- This 10 minute windows posses potential risk should two businesses be paid with the same bitcoin.
- If double spending occurred during this time gap, the last merchant to report the transaction would have little recourse to collect on payment.
9. Significant Consumer Protection Risk
- Although numerous governmental agencies have issued stern consumer warnings (e.g., CFBP, FINRA) there are no laws in place for protecting consumers against theft, fraud or human error.
- Bitcoin is an anonymous, digital currency that eliminates banks as financial middleman and in doing so eliminates the legal protections offered by such structures.
- Unlike chargeback protection offered through credit cards, once bitcoin transfers are made they are irrevocable leaving consumers with no recourse for dispute resolution.
- Bitcoin features also make it an ideal target for cyber criminals. If an e-wallet is hacked and coins stolen or transferred by mistake, they are lost forever.
- It is estimated that about 10 percent or 1.3 million bitcoins totalling over $500 million have been lost and are permanently out of circulation.
10. Sovereign Attack Risk
- If adopted in its current raw form, bitcoin has the potential to undermine the longstanding bond between sovereign and its currency.
- Sovereign power and the responsibility is intertwined with currency creation, control and regulation. Governments exercise a monopoly power on currency creation with the understanding that doing so will provide its citizens with a greater level of economic stability.
- Citizens are given the ability to use "legal tender" to satisfy public and private debts including paying taxes.
- Under the Bitcoin model, those who create the algorithm, protocol, manage the transactional ledger and mine virtual currencies would become the new central bankers, controlling a monetary basis, an immense power and responsibility.
- Bitcoin has a fixed growth rate and built-in scarcity capped at 21 million e-coins by 2140. This naive approach assumes that a currency supply formula derived today can automatically meet th ebbs and flows of economic cycles over 130 years without monetary interventions or input of human judgement.
- Such an approach is also dangerously deflationary.
- If bitcoin were allowed to co-exist as "legal tender" it could also create a situation where under Gresham's Law "Bad money drives out good". In such a scenario, bad currency (bitcoin) would be used and good currency (US Dollar) would be hoarded, creating greater economic instability.
Professor Mark Thomas Williams concludes that:
1. While bitcoin is an example of new technology that has clear promise, it also poses a multitude of risks to consumers, companies and sovereigns.
2. Bitcoin and its delivery system can not be separated. The strength or weakness of the system is linked to bitcoin the currency (engine) and Bitcoin the delivery platform (rails). No matter how sturdy the rails, if the engine is not sound due to extreme market volatility, or artificial scarcity, the system can not function at reliable and safe levels.
3. Bitcoin is not an experiment conducted in a controlled environment. Currency creation and management is the lifeblood of the global economy. The payment system is the financial plumbing.
4. Pumping a pseudo currency into the veins of the economy and adopting a new payment system without regorous testing would be risky and highly imprudent.
5. To counteract the panoply of risk associated with virtual currencies such as bitcoin, there needs to be greater regulation, international oversight, sovereign control and stronger consumer protection rules put firmly in place.
6. Bitcoin as a payment platform could be beneficial as long as there is regulation, central banker oversight and ownership is made transparent.