Bitcoin Debacle

There are a couple of lessons to be learned from the current Bitcoin debacle at Mt. Gox, the Bitcoin currency exchange that just folded in Tokyo. According to online Time magazine:

Right now, the price of a single Bitcoin on the biggest exchange in the world is $0, from an all-time high of $1,200. Or it would be, if anyone could even access it. Mt. Gox, a Tokyo-based digital currency exchange that started as a Magic: The Gathering card game community, has frozen all transactions. It increasingly looks like anyone who was holding Bitcoin at Mt. Gox is out of luck.

First of all, if it looks like a Ponzi schemewalks like a Ponzi scheme and talks like a Ponzi scheme it most likely is a Ponzi scheme. The world of Bitcoins is unregulated. You hear about how someone bought a Bitcoin for a dollar and the next thing he knew it was worth a thousand dollars. Well, who would be so foolish as to take their money out of the world of Bitcoins when the price is still going up? Maybe a smart investor would. Even if someone did convert their Bitcoins into Yen, Euros or dollars at the Mt. Gox exchange, there were lots of folks buying in to the Ponzi scheme and still driving the price up. Beware of unregulated markets and stories that are just too good to be true!

The second lesson to be learned from the Bitcoin debacle at Mt Gox is that everyone these days is at risk of being hacked. When your coins are in the world of computer bits and bytes your money is vulnerable. It turns out that someone stole a lot of Bitcoins from Mt.Gox and the theft went unnoticed for years. According to Time:

The exchange’s rapid death spiral is a result of the apparent theft of 744,000 Bitcoins (six percent of all available Bitcoins) due to a security breach, a crime that went unnoticed for several years…

So, it is not just Target Corporation who is hurting because of hackers. But, here is the deal. Maybe you paid $100 for some Bitcoins a few years ago. And maybe you thought that they were worth a hundred times that much. You would have expected to have cashed in your Bitcoins for $10,000. If this was the total extent of your investments you are in a sorry state. If, on the other hand, you took our advice about investing and paid off your credit cards first, bought a home second, and put aside six months’ worth of income in a bank account, you are not in such bad shape. If you further diversified your investments into stocks, real estate and even invested offshore you are doing just fine, thank you.

Belief versus Intrinsic Value

Smart long term investors understand the concept of intrinsic value which is the value today of an investment based on its forward looking income stream. This concept has made many people rich when they have analyzed the likes of Microsoft, Google or Apple. Ignoring this concept can lead to huge losses. The problem with new financial products like digital currencies is that they have no track record on which to make a sound judgment. When naïve investors buy into the hype they lose their money such as now with the Bitcoin debacle with Mt. Gox.

As new financial products, digital currencies are an inherent gamble. There are vulnerabilities in the form of hacker attacks, untrustworthy entrepreneurs, and the possibility of the government regulating them out of existence…

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