Should I invest in Bitcoin? An investor's story

This article is about an investor who owns Bitcoin and shares his insights on Bitcoin investment.

In 2015, we saw venture capitalists pour more capital into Bitcoin than ever before, though much of that investment has been around the underlying technology behind Bitcoin, called the blockchain. Meanwhile, the price of the coin has been stuck between $200 and $300 for much of the year (after hitting a high point in late 2013), but in the past few months, Bitcoin has not only risen but has broken through the $400 mark and has remained stable over the past few weeks.

In the first part of this series, I explored 10 reasons why Bitcoin is an investment option, such as the growing trading volume, the fact that Bitcoin is undervalued compared to other investments, and therefore, in my opinion, an investment in Bitcoin will bring a good return (I expect the market outlook to change over time).

However, for this still early digital currency, any number of events could cause the value of Bitcoin to drop, if not plummet, to zero. Wences Casares, founder and CEO of XAPO, said in a recent interview via REALVISION video network: "I think there is a 20% chance that the value of Bitcoin will drop to zero, and a 50% or slightly higher chance that it will become mainstream in the digital world, in which case there will be as many users as WhatsApp. To do this, each Bitcoin needs to be worth $1 million, 2,000 times its current value. There is about a 30% chance that Bitcoin will successfully enter a profitable niche market without disappearing. But it is not widely used, so the price will not drop to 0, but it will not reach $1 million either."

However, given what Vince Casares said could happen to cause the value of Bitcoin to drop, you should be prepared to lose your investment. In this article, I will explore 10 risks that threaten the future value of Bitcoin.

1. The upper limit of the number of Bitcoins can be changed

One of the main factors affecting speculative investment in Bitcoin is that the number of Bitcoins is capped at 21 million, a situation further exacerbated by the fact that every four years, the number of Bitcoins is halved, reducing this number from 20 to 12.5 (one block reward is released approximately every ten minutes).

There have been several discussions in the Bitcoin community forums about removing the cap, with Jon Matonis, former executive director of the Bitcoin Foundation, saying he believes it’s an inevitable problem. Ryan Selkis, director of the Digital Currency Growth and Investment Group, said last summer that periodic halvings of block rewards are a viable option. In a series of tweets and media reports, Selkis said the community might agree on a 1% to 2% inflation rate for the base currency. Removing the cap would solve two problems: First, Bitcoin’s wealth has been concentrated in the hands of a few people so far. Removing the cap would help reduce their share. The other potential problem is that there will come a time when paying miners (the individuals and businesses that run the computers that maintain the system) isn’t enough to cover their costs, which include block rewards and transaction fees. When block rewards decrease, if transaction fees don’t increase, the security of the entire system is at risk because miners will have trouble making enough profit, leading to centralization issues and making the network more vulnerable to attack.

However, Selkis advocates removing the cap and setting inflation between 1% and 2%, which he believes could attract more people. But it is unclear whether removing the cap would reduce the value of Bitcoin by then.

2. Possible cyber attacks

One of Bitcoin’s core features is that it is a decentralized system. Its security comes from the fact that it is maintained by different entities from all over the world. If it became more centralized, it would create opportunities for an attacker (or a group of attackers) to subvert the system.

A 51% attack comes from a miner or a group of miners acting in concert (51 attackers for every 1% of the network power) harvesting and controlling more than half of the Bitcoin network's computing power, enabling them to "double spend" or disrupt transactions, which would undermine people's confidence in Bitcoin. On the one hand, the risk here seems greater than it seems, because in theory, malicious miners do not even need to actually control 51% of the network's computing power. On the other hand, the types of damage that the attacker can do are limited. For example, the attacker cannot reverse other people's transactions or change the amount of currency generated per block or create new currency.

But in any case, it is scary that a miner can control such a large proportion of the network, and it will affect the value of the currency. For example, the Ghash.io mining pool has been close to 51% of the network computing power many times, but it has promised that it will never use 51% of the computing power to attack the network. However, relying solely on the promises of miners is not a reliable solution.

Chris Burniske of ARK Investment Management, the manager of the first public fund to invest in Bitcoin, says the chances of a 51% attack being successful and profitable are low. As of August 2015, he estimated that an attacker would not only have to invest $400 million in infrastructure to carry out such an attack, but would also have to sustain the attack for several weeks to be profitable. Even if the attacker was able to do so, they would not be able to profit if the value of Bitcoin collapsed.

However, Dave Hudson, vice president of software architecture at blockchain technology company Peernova, also pointed out on the Hashingit.com blog that even if the attack is revealed and the value of bitcoin drops, if they can take a very good price differential against bitcoin, then they will still be able to profit from it.”

If other assets besides Bitcoin are put on the Bitcoin blockchain, and the value of those assets exceeds the cost of attacking, it may make the attacker more willing to launch an attack. (Some companies have considered putting assets on the Bitcoin blockchain, such as using 1 million Bitcoins to represent $1 million worth of Apple stock, through a method called "colored coins", but many companies seem to be abandoning this approach).

3. Transaction volume moves from the Bitcoin blockchain to sidechains or private chains

One of the reasons some investors are bullish on Bitcoin right now is the rising volume of transactions. However, some developments will move at least some of the volume on the Bitcoin blockchain to so-called sidechains, where transactions (Bitcoin or other assets) are maintained not by anonymous miners but by a group of entities that agree to run it, and then batched into a single transaction that is periodically verified on the main Bitcoin blockchain. So instead of processing every transaction on the Bitcoin blockchain, they will be compressed and the actual number of transactions will be reduced.

Burniske believes that moving transactions to sidechains "will slow down the price increase." If you don't have a private chain, then your bitcoin may not get the price it deserves. But he said, "I still think that this demand (to batch verify transactions) will get higher and higher, and there will always be a day when the price will rise."

4. The Bitcoin network has not successfully transitioned from relying on block rewards to relying on transaction fees

Currently, the vast majority of miners’ income comes from block rewards, with 99.7% of miners’ income coming from block rewards in 2014 and only 0.3% coming from transaction fees. It seems that transaction fees will have to increase by several times to replace block rewards, and Burniske believes that the current block rewards cause miners to over-invest in infrastructure, especially when it comes to Bitcoin’s current market value. In “Bitcoin: Securing the Network”, Burniske predicts that mining will eventually become less capital intensive and miners will eventually become less profitable. One risk is that as block rewards decrease, the number of miners may decline, causing centralization and making it more vulnerable to 51% attacks, but he believes that 1.2% transaction fees (without block rewards) will adequately reward enough miners to avoid 51% network attacks and maintain and keep the network secure.

5. China’s firewall or other network issues cause the Bitcoin network to split

“China has a very strong firewall that blocks internet traffic,” Hudson said. “If the firewall causes Chinese miners to be disconnected from the global Bitcoin network for a few days, during which time Chinese miners continue to mine, the rest of the network will be mining a completely different set of transactions. That looks like a pretty irreconcilable divergence, with no way for them to regain one win while the other is completely lost.”

Generally speaking, the system only works as long as the vast majority of online mining hardware and a large percentage of miners follow the same rules. So basic network connectivity issues and "disagreements" when different miners are running different versions of the software can also cause the currency's value to drop.

6. Lack of a central authority to block the progress of the protocol.

“Decentralization is both a good thing and a major hindrance to Bitcoin as a technology,” Hudson said. “The fact that it’s decentralized not only makes Bitcoin work well, but it also means that when problems occur, it’s very hard to agree on a solution.”

Jonathan Levine, co-founder of bitcoin compliance firm Chainalysis, said it takes a long time to get all the miners to upgrade their software. You need to release software upgrades around the world, reach consensus, and ensure that changes to the bitcoin protocol are made through a rigorous management process. A lot of people use the bitcoin network, so you need to make sure these changes are valuable to everyone. In 2015, the challenges facing the process of scaling bitcoin were clear. When the issue was muddied and divided by social groups, how to increase the size of the blockchain to accommodate more transactions? Currently, each block of transactions, which is processed every ten minutes, can contain up to 1MB of data, allowing it to process seven transactions a second (by comparison, Visa's network processes 6,500 transactions per second). Blocks need to be capped at some kind of limit, otherwise the network will be filled with junk transactions. But in the bitcoin community, there are disagreements among various miners, core developers, full node operators (the people who transmit transactions to the next block), bitcoin companies and other businesses. Is there another way to increase the number of transactions processed on the network? Or, if the block capacity is increased, how to increase it, and how much capacity is appropriate.

So far, “some progress has been made,” he said. If the community not only resolves the block capacity debate but also comes up with a solution to future problems, it would bode well for continued growth in the value of Bitcoin. However, it’s not clear if there are bigger issues that need to be addressed.

"Open source is very easy to copy in existing design models," Hudson said. "Everyone can see what they should look like. When changes are made, many participants have a vested interest and tend to delay, and there doesn't seem to be a good way for almost all participants to handle it."

For example, he said, a good engineering practice is to build simulations that allow developers to change various parameters and see how it affects the network.

7. Other competing protocols may surpass it

The emergence of Bitcoin and other digital currencies will shape the future of digital assets. But the question is whether all virtual currencies and similar protocols will be traded or just a significant part of these transactions. After all, there are more than 700 other digital currencies.

As I wrote in Part 1 of this series, Stephen, CEO of Bitcoin payment processor BitPay, said, “If this digital currency is more secure and liquid than Bitcoin, then we might be able to switch away from Bitcoin and toward this only alternative currency.” Since the value of a currency and a network lies in having more people using it, if people begin to perceive another network as superior to Bitcoin, that could undermine the value of Bitcoin.

Some of the competitors that pose a threat to Bitcoin include Ethereum, which has similar technical capabilities to Bitcoin and a token called "Ether". Ripple, another competitor that focuses on international payments of currencies, XRP. New protocols being developed by the technology and financial industries, such as the "Open Ledger Project" launched by the Linux Foundation, whose participants include giants such as IBM, Cisco, Intel, JPMorgan Chase, Wells Fargo, Accenture, etc.

8. World events trigger sanctions on Bitcoin

“There are a lot of national policy debates around encryption, surveillance capabilities, counterterrorism measures, and so on,” Levin said, citing the Paris attacks and whether Daesh used bitcoin. “If governments feel that these issues are not under control and are causing very serious social problems, such as terrorism, then this will be a big problem. I think governments feel that bitcoin itself is too small to be a threat to any country, and it provides a lot of interesting innovation in the financial services space and provides a lot of inspiration for new types of financial arrangements, so bitcoin will continue to be used.

However, a recent RAND Corporation report on “Virtual Currency: National Security Implications” said extremist groups are likely to begin issuing and using their own virtual currencies, rather than using existing digital currencies such as Bitcoin, which could make them more vulnerable to cyberattacks by sophisticated adversaries.

9. Certain government regulations put the entire network at risk

"Governments have the means to make it incredibly difficult for people who hold bitcoin, and I wouldn't say the crisis is here," Levin said. "I think the regulators are very strong on this reform, and I feel like there will be a day when the government will say to bitcoin holders, 'The party is over.'"

Hudson also believes that this could affect the Bitcoin network. "More than 50% of mining takes place in China, and if the Chinese government decides that they want to regulate Bitcoin in a certain way, this would obviously lead to systemic risk. Being in a place where there is government regulation would affect the nature and function of the network."

10. Bitcoin’s value is unstable

Bitcoin has proven to be an volatile investment over the years, with its ups and downs. However, for Western investors, Bitcoin is even more volatile because investors from different cultural backgrounds may use different methods to invest, making it even more unpredictable. In particular, the Chinese investment method is more similar to Western gambling. Bobby Lee, CEO of Bitcoin China, said this method has affected the price fluctuations. "Some Chinese investors are very opportunistic. If they think the price will go up, they will pick up every penny on the ground to invest."

Barry Silbert, founder and CEO of Digital Currency Group, which has invested in 55 cryptocurrency companies, noted that the bitcoin exchange market is fragmented into 12. "If you want to buy or sell $5 million to $10 million of bitcoin, that will cause the price to go up or down by 10 percent. If all exchanges were connected, or there was one exchange and one big order book, you could buy and sell $5 million or $10 million and it wouldn't have much of an impact on the price. Of course, all the exchanges tend to move in tandem. If someone sold $5 million of bitcoin on an exchange in China ... you'd see all the exchanges move down together." In addition, he said volatility would remain high due to the lack of a mature derivatives market.

Xapo founder, Casares, said in a RealVision video interview that he believes that if people put "money they can't lose" into the Bitcoin trading market, then the price will go down. If at some point, people start to feel that this is a no-brainer - it's going to go up 1% every week no matter what. People start to mortgage their homes to buy Bitcoin, or put their children's college funds or their retirement funds, money that is "money they can't lose", and when the price goes down, people have to sell because they can't afford to lose more... so you can imagine the panic when it goes to zero.

The reason, he said, is that Bitcoin has no fixed value: "Its value is determined by the market collectively." He said that this value will not return to zero, it will eventually end at $15, but it will not gain public trust after that. "That's what I care about most. I'm glad that Bitcoin is still very volatile. Volatility is my friend. The moment I saw volatility slow down, I started to worry because I could imagine that unidentified funds were flowing into the Bitcoin market, which was dangerous."

Original article: http://www.forbes.com/sites/laurashin/2015/12/28/should-you-invest-in-bitcoin-10-arguments-against-as-of-december-2015/
By Laura Shin
Translator: slieta5
Reward address: 1CrCnYDtpYB7vYxXCpDw6joMvKE64XVxUQ
Editor: printemps
Source (translation): Babbitt Information