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All About Bitcoin – Part 6

Potential Bitcoin Disasters, Problems, And Challenges

Bitcoin has produced huge positive returns for early adopters - bitcoin millionaires - and huge loses for those that bought the $260+ hype bubble in April of 2013. Even the most staunch supporters know bitcoin has already had multiple stoppages at the site handling 80% of exchanges (MtGox.com), along with hacks of bitcoin wallets, price crashes from major sellers entering the market, and now government notice of bitcoin's success. The future will bring more challenges, as this section explains.

Failure Analysis Of The Bitcoin System

Bitcoin relies on a network. The network relies on computers. Internet, telecom, satellite and other communication systems must be free and functional for the computers to form the network. Computers and the network rely on electricity.

Any one of these legs of the bitcoin system can take it down.

Ultimately, bitcoin relies strictly on the belief that they are rare and worth holding, spending, and transacting with. Unlike gold and silver, there is no use for a bitcoin and never will be, other than the role as a token residing within a computer network.

Even though there are services now working on creating physical forms of bitcoins, there is no practical method of confirming the legitimacy of that bitcoin address and spending power without computing power. Eventually, without electricity and computing power, bitcoin would cease to exist.

This is a critical issue with bitcoin that will initially prevent wide spread adoption for critical wealth storage.

Some of the physical forms of bitcoin now afloat are:

The distributed nature of the bitcoin network and mining is both a great strength and somewhat of a weakness. The network verifies all the transactions. It also solves any disputed transactions. With a huge and growing number of nodes, there is no single server to hack for the miners, spenders, merchants, or governing body. Without a central storehouse of key data such as a CitiBank, Bank of America, or any number of other major banks, the system is much more robust than almost any other currency system.

Bitcoin has also passed the acceptance test because it has a four-year history. Though major retailers have not adopted bitcoins, smaller ones have accepted it. Wordpress, Reddit and many smaller businesses are bitcoin friendly. There are at least 1,000 stores using BitPay for merchant services already.

Now that bitcoin has recovered from its previous slump and sits comfortably at $625 today on June 4, 2014, it confers stability to bitcoin. Time is bitcoin's friend. There will be fewer options for destroying bitcoin. Large retailers will no longer be able to ignore it as it continues building credibility and reaches a more predictable exchange value.

Bitcoin is not out of the woods at all. There are dark forces after bitcoin's hide, and they have already struck. They have a few key targets we will explore next.

Main Targets For Hacks And Attacks

MtGox.com covered about 80% of the transactions where people bought and sold bitcoin. It looked a lot like a stock market with price charts, buy/sell orders, and small fees for the transactions. MtGox.com shut down during the April 2013 crash. They claimed that too many people were signing up for accounts – about 60,000 per day – but that does not seem to be a valid excuse for a shut down that lasted from $260+ down to around $100 in BTC exchange value on April 11, 2013.

Bitfloor.com shut down immediately and for good when the crash happened. The exchange function where we trade out of bitcoins and into dollars, euros, yen, or any other currency or payment system exposes the exchange to significant currency risk. They can lose our bitcoins and/or our national currency in a blink. This will continue to be an inherent risk in the near future.

A brief history of some of the main shut downs:

MtGox and other bitcoin exchanges shut down for block chain issues; there are splits in the block chain because of differing claims to be the valid chain. Another similar problem shut down the exchange on June 23, 2012.

The big shut down though, occurred on April 3, 2013 and April 11, 2013. There was no technical difficulty. Instead, MtGox decided to cool the market instead of allowing it to trade free. Bitcoin has had several code problems in which there were unverifiable bitcoins within the network.

The first and worst incident occurred shortly after bitcoin came into existence. In August 2010 over 184 million BTC were generated in a transaction and sent to a few addresses in the network. They were soon spotted as false bitcoins (BTC), the flaw in the code that created the false BTC was corrected, and within hours the network was back up.

On March 13, 2013 there was a split in the block chain as a result of a large number of blocks created that did not match with previous ones because of a difference in software and the size of the blocks created. This resulted in two sets of block chains depending on the version of the software 0.7 or 0.8 being run. The developers working with Bitcoin.org resolved this split by agreeing to use the 0.7 version and all the transactions checked against that block chain. Even after a 23% drop in bitcoin value due to this split, bitcoin bounced back.

The lesson though, is that bitcoin can have problems with the core code. We all know our computers are not fool proof. Such is the issue with bitcoin.

Prominent Attacks, Scammers, And Bottlenecks

The cryptographic code for bitcoin is virtually impossible to crack. That brings all the focus for hackers to use more basic brute force methods of shutting down exchanges and getting bitcoins.

A DDoS is a Distributed-Denial-of-Service attack that sends huge numbers of bot data visitors that overload servers. When an exchange gets hit, inevitably the value of bitcoins tumbles. This alone would provide enough profit to motivate hackers to crash exchanges for cleaning up the now devalued BTC's. When the exchange gets back up and running, the value of BTC's climb and the hackers have their pay day- possibly. It is also possible that the hackers simply want to crash the service. InstaWallet was crashed by a similar attack and never recovered.

Other possible attacks:

Government regulations attempt to restrict access to exchanges, label it an investment, or that it is trying to be a currency that threatens the government monopoly. All these fall under Financial Crimes Enforcement Network ( FinCEN).

This black-boot agency putting a damper on our monetary freedom is saying users of bitcoins do not fall under FinCEN rules, but any exchange or wallet services do! They are known as MSB's or money services businesses. This means that any service that transfers, exchanges, stores, or interacts with bitcoins on a per fee basis, could eventually be the target of the U.S. treasury, FBI, IRS, and any other agency that chooses to participate.

This represents the greatest threat against bitcoin. Our mystery developers behind bitcoin saw this attack coming. Their answer was to distribute the ability to exchange bitcoin. They built in a “black market.” What they really built in – was freedom for free people to transact without anyone else knowing about it, taxing it, or being able to stop it.

There is no way short of taking down the Internet and/or power grid for the government to fully stop bitcoin. That won't necessarily stop them from trying, however.

Profiting With Bitcoins

Successfully trading in any market requires serious study, a keen ability for pattern recognition, and deep knowledge of historical trends and evaluation systems. This section covers the basics of trading only.

Surprisingly, applying basic trading principles often produces the largest profits. More sophisticated trading techniques, sometimes called scalping systems, require more effort and yield small profits, if any at all.

We will proceed from the simple mechanics of buying and selling bitcoins, to decision criteria for when to buy or sell (the essence of trading), all the way through bitcoin trading robots or trading services.

Trading Bitcoins

We can buy or sell bitcoins with anyone who is willing to transact with us. For instance, we could buy bitcoins locally with LocalBitCoins.com.

Notice a few interesting and critical developments in this market:

  1. Online prices are more consistent, as we would expect.
  2. Local prices are both over and under the online price.
  3. There is as much as a 24% difference between the lowest and highest prices approximately. Ignore the wild $956.20/BTC. Everyone else will.

This is key information for day trading scenarios. We could conceivably buy bitcoins for $122.96 in lots up to $1000. Then we could sell them all day long for $140.81.

Our profit works out to about 8 x $17 = $136 (We will neglect gas costs, and buying fractional amounts of bitcoins).

We could also simply buy bitcoins online and then sell them locally for a small mark-up. This seems to be the simple trading system of choice for the $153 and $147 sellers.

All we need to do is follow the easy steps described in my earlier article. Briefly, we buy bitcoins using our Dwolla, Coinbase, Blockchain, or other wallet with a custom produced address from a bitcoin exchange. We can choose Bitcoin-24, Bitcoin7, or others.

Then we sign-up for LocalBitCoins. Post our price on their “Sell Bitcoins” section, and we are in the bitcoin trading business. While this “arbitrage” method of trading can deliver a reasonable profit, there are bigger profits available for more aggressive profit seekers.

Our best opportunity for trading with bitcoins involves online only trading. We will buy BTC with our national currency through a trading exchange, and then sell BTC for either our own national currency, or another national currency.

Switching currencies may not be allowed on certain exchanges or in certain countries. Switching currencies between the buy side and sell side of our trade can also add significant complication to our trade. A better move is to stick with one national currency unless we are experienced with FOREX trading already.

Now, for the nuts and bolts of selling bitcoins, much is the same in terms of fields, with a key difference. When we sell bitcoins, the exchange takes a slice of the transaction in the form of a reduced selling price. Other exchanges operate differently.

The difference between the BTC Buy price and the BTC Sell price is called the “spread.” It is also sometimes known as the Bid/Ask spread. Bid for what buyers are willing to pay, and Ask for what sellers are willing to sell at.

For this case the BUY/SELL is about $0.40 USD. Not a large spread, amounting to less than 0.5% of the trade.

The good news here is that trading bitcoins is not administratively expensive. The In/Out costs or round trip are less than 1% of the trade, and often free. Some stock, options, and commodities traders can see In/Out costs between bid/ask, commissions, and exchange fees of closer to 3% or higher.

Trading on other bitcoin exchanges operates in a similar fashion.

This is all manual entry trading, not automated or computerized trading. Manual trading can deliver fantastic returns so long as we time our trades and our directions correctly. That is the focus of the next section – answering the question of up or down and when.

General Trading Principles For Bitcoin

Trading technicians focus on three general trends:

  • First, and most importantly, is the macro or long-term trend. This is also referred to as a secular trend.
  • Second, is the medium or primary term trend.
  • Third, is the micro, secondary, or short-term trend.

These terms refer to different time periods for different markets, but roughly speaking they break down as follows:

Macro/Secular is for greater than 5 years and usually less than 25 years. Gold and silver were in a secular or macro bull market from 1970's into 1980.

Primary/Medium term trends run for a year or more, but not generally longer than 4 years. The U.S. general stock market as shown by the S&P500 has been in a secondary bull market for several years.

Micro/Secondary trends run less than a year and often refer to moves lasting a few weeks or months.

The recent dip in the U.S. stock market is probably a micro bear or down trending market. When it reverses and goes higher, it will confirm that this was a secondary down trend and not a switch to a secular bear market.

All of this seems simple until we have to make the up or down decision. We need only get one decision correct for making a great trade. So, what is the secular or macro trend for bitcoins relative to our national currency?

The other trends – primary and secondary – are both harder to call and often provide a more limited profit. We will cover how to determine those trends briefly, but first we should look to understand the millionaire maker, aka the macro or secular trend.

The short answer is: Up. Bitcoin is designed to rise in value on average, every year.

Bitcoin has several forces going for it and increasing the exchange value over the long term:

1. Almost all national currencies are vastly out-“printing” bitcoins. There are about 12 million BTC's as of this writing, while the Federal Reserve creates over $85 billion in USD's for buying government securities every month.

Simply taking an approximate value for the total U.S. currency in near circulation divided by BTC gives a staggering number of the potential value for $/BTC.

M2 is a mid range predictor of the currency available for transactions in the U.S. M3 is the broadest but discontinued form, while M1 is more descriptive of cash on hand. M2 sits at about $10.5 Trillion per Federal Reserve reports.

If only 10% of M2 funds went into BTC, that would be about $1 Trillion.

This looks like:

$1,000,000,000,000/ 12,000,000 = $83,333/BTC

Yes, it is extremely unlikely that 10% of M2 will find it's way into BTC. More likely, and currently happening, is that the number of BTC world-wide participants entering the market grows monthly. So, all we really need is 1% of the world-wide M2 value including the active traders in Japan, China, Russia, Europe, and Africa. Bitcoin will soar in value over time, unless either an exchange default, or a government decisively takes it down.

2. Bitcoin is worldwide. Almost 70% of searches for the word “bitcoin” come from outside the U.S.

Asia drives a lot of the bitcoin trade; Asia is growing much faster than the U.S. Anything tied to Asian growth, will outperform national centric growth patterns.

3. Increasing taxation and confiscation across the world will drive citizens toward anonymous currencies that have no centralized controlling institution. Many investors in Europe, the U.S, and Asia watched in horror as Cyprus banks and the government stole up to 60% of some bank accounts.

Bitcoin wallets avoid this confiscation threat altogether. There is no bank that can close our bitcoin accounts or wallets. We can choose to keep our bitcoins on our computers or USB drives or even memorize them. Bitcoins were designed for just this situation: the need for a private, decentralized, potentially anonymous (hence nontaxable) unit of account, safe from confiscation.

4. More and more stores are accepting bitcoins. Numbers are hard to come by on the acceptance rate (over 1000 stores), but already there is a core of stores that translate the virtual value of BTC's into hard goods. With that translation, BTC's gain credibility and utility. When BTC's stabilize more over the $100 point, it will be easier for stores to transition into accepting them.

Wild swings in BTC exchange rates made pricing goods difficult for merchants. Also, with a limited stock of BTC's circulating, there is not enough demand as the user base is limited. When bitcents are traded and even microbits and lower denominations are more common, then the distribution of BTC's can spread.

Wider distribution will mean more customers with BTC's to spend, leading to stores meeting the demand.

Already nightclubs such as EVR in New York City accept bitcoins with a phone app. Trend setting merchants such as this will bring bitcoin all the popularity needed to close the gap with traditional, centralized currencies.

5. No significant competitor can challenge bitcoins entrenched user base, which has been developed over 4 years. Already the bitcoin competitors are gathering funding and moving in to take over. They will have trouble succeeding because their benefits are marginal, and they will have to build a new user base. We will discuss the future of bitcoin and possible competitors in a later section.

All the above factors will send the general trend for bitcoins relative to national currencies steeply upwards. This trend will continue for many years, possibly as far as 20 years, until there are conflicts within the currency system.

We can then buy the long-term trend and sit tight while our wealth increases, when comparing BTC to our national currencies.

For primary and secondary trends, the simplest trading methodology is also one of the most effective.

What we are looking for are extreme moves where the short-term trend moves significantly beyond the longer-term trend. This tells us that a bubble or reversal may be at hand.

At the Financial Survival Center there are sometimes warnings saying to sell out of BTC immediately. When the price leaps outside of the upper bounds of Bollinger bands, and the short term EMA moves much higher than the long term EMA, then jump off the BTC ride into a national currency.

Conversely, when the BTC value dives deep into the Bollinger bands, and the short term EMA crosses below the long term EMA line, there is a good opportunity to buy shortly. Then we can ride the short term EMA back up as it re-crosses above the long term EMA.

The main reason we can make these trades confidently is that there is a fixed amount of BTC's in the system. That gives it a strong upward trend bias. We also know that when there is too high of a price spike, the down move will be swift and relatively short-lived. All of this knowledge stems from our most important call – in which bitcoin is in a secular bull market against all national currencies.

This is all manual trading. More automated trading uses key techniques such as:

- Stop Loss orders (for selling based on a triggered loss level) - Stop Age (time based selling) - Target Price (buying or selling based on reaching a price) - Buy Order Protection (forces over priced orders to below current market rate)

The stop loss and target price tools are the most critical. With a high beta market, the stop loss should be set as high as 20% or even 25%. Lower beta markets can use a 10% stop loss, or what is known as a tight stop loss. This translates to buying in at $100 and setting a stop loss at about $80.

While there could be much more written for covering other trading techniques, this basic knowledge will suffice. We can spot the too highs and too lows for selling and for buying. That is all we need to do for making a handy profit with bitcoins.

For those interested in learning more about trading any currency or market, the challenge is there are too many books or courses available. Financial Survival Center has a free newsletter for trading, general investing, alternate income, and alternate currency investing.

Bitcoin Application Development

The trend for bitcoin trading leads toward trading robots. While we might consider this a threat, it can be the saving force for bitcoin. Bitcoin suffers from high volatility or Beta as explained earlier.

Trading robots can reduce this volatility. Trading robots, or software, that tie into trading exchanges via Application Development (Programming) Interfaces, will make frequent small trades when there is movement in the market either up or down.

These frequent trades for small gains (and losses), are called scalping trades. They steady the market considerably because price movements immediately result in buys or sells against the move.

There have been a few free trading bots written in PHP, but they were pulled off sites quickly. Personal experience has shown that these free bots were almost always home to trojans. A robot that is consistently clean and profitable is worth a fortune. The essence of what makes the robot work is being able to spot the price trends instantly, execute instantly, and avoid significant losses.

There are downsides for trading software robots. They can crash a market when they gain too large a market share. This is partly what happened in the famous Oct 1987 Black Monday crash. Mutual funds triggered excessive selling with computerized trading platforms.

Future Of Bitcoin And Alternative Currencies

Opportunities And Dangers Ahead

The majority of bitcoin users are coming on board from outside the U.S.

Opportunities being seized and presented to the market place include:

1. Physical forms for bitcoins with Bitbills and others.

2. A myriad of applications for Android, iPhone, iPad, Windows, and the tech favorite, Linux. aCurrency, an Andorid app for currency conversion now links to bitcoins. Bitcoin Wallet for Android and many others allow bitcoins to be used almost like a credit or debit card, from our phone. Either we scan in our bitcoin address and wallet information from a generated QR code, beam it, email it, or go through a web interface (plus other types of withdrawals not yet fully functional).

3. Merchant services from BitPay, OkPay, Dwolla, etc. are making it easier for merchants to accept and cash out their BTC's.

4. There are also a host of competitors on the horizon. Ripple is the biggest and best financed so far.

Produced by a company called OpenCoin Inc., Ripple is based on similar concepts to bitcoin. Ripple is open source and distributed around a network exactly like bitcoin. One of the key differences is that there are already about 100 billion ripples in existence, but they are fed into the system on a controlled basis.

It also uses something called social capital for backing financial capital. Plus, it has trust features for selecting networks to use for payments or transfers. What has the bitcoin world suspicious though, is that OpenCoin Inc. is backed by large Wall Street venture capital firms. Luckily, Ripple is no longer associated with OpenCoin Inc.

Ripple has “Betamax” stamped all over it. Bitcoin is working, out of the gate sooner, belongs completely to a voluntary community, and is not affiliated with Wall Street interests.

5.Other digital-only competitors include Litecoin, Lucre, OpenMoney, OpenCoin, Voucher-Safe and many more.

Entrenched competitors that are not seeing the growth, but do have tangible assets - gold and silver - backing them include:

These gold or silver backed currencies are not widely used, traded, or accepted. They do have the advantage of being backed and convertible into physical precious metals. Without wide market acceptance, however, their future is limited.

6. Most critically, there are efforts for backing bitcoins with gold or silver. This is a critical step that will cement BTC's as a functional form of money. There are reasons for not taking this step, as it decentralizes the network if there must be storage for the gold. However, a de facto backing by gold would mean that the value of a BTC is respected enough that it can be tendered for gold.

Agents For And Against Bitcoins: Alternative Currencies

Governments, banks, the Federal Reserve (and all central banks), Visa, MasterCard, American Express, taxing agencies, some tech companies such as Apple, Microsoft, Google, Amazon, and the United Nations are all staunchly opposed to bitcoin.

In time, bitcoin can put many a bank under. No more credit card fees, bank accounts fees, or controlled interest rate schemes can flourish when we can provide our own banking services through choice.

On the plus side, the Internet software groups support bitcoin strongly. The younger generation has adopted it as their own. Asia is betting on bitcoin to preserve their hopes for increasing wealth while their central banks create massive inflation. Those wishing to keep funds from being confiscated will use bitcoin (as the Cyprus event demonstrated).

Forces allied with bitcoin are more widespread, determined, active, and clever than those opposed to bitcoin. Bitcoin seems to be emerging victorious.

Predicting Prices For Bitcoins

Already, we’ve calculated a possible worth for $/BTC north of $80,000.00 based on the U.S. M2 value.

Including all the worlds’ currencies in that calculation will send that number up four-fold or more.

More important than the currency value of a BTC, is what the realizable value of one will be. We could, and probably will, have a currency regime change between now and 2139 when the last bitcoins are mined. The question is what will we be able to buy with a bitcoin, or a dollar for that matter?

The U.S. dollar will buy less of the critical goods over time, as has been the case ever since 1929.

The value of a dollar has declined roughly 97% over that period. Bitcoins will move higher and lower, but will not experience a waterfall decline – unless attacked and stopped by governments or banks. Bitcoins will continue their market penetration, pushing aside inflated national currencies.

Expansion Markets For Bitcoins

There are many opportunities for bitcoin entrepreneurs.

1. Bitcoin consulting for getting online and offline merchants integrated with bitcoin appliances, pricing, out-conversion, marketing, and trading.

2. Developing and selling bitcoin trading robots. This is a huge potential opportunity for those with the software skills for tackling the coding along with the trading chops for making the robot a profit winner.

3. Bitcoin financial transfer agents for converting from debit cards, credit cards, loans, gold, silver, local currencies, creating transfers, etc. The old guard institutions consider bitcoin the enemy. This leaves an open window for those willing to get over the MSB hurdles.

4. Bitcoin network monitoring codes for alerting bitcoin users of unusual activity across the network.

This would be similar to the stock market where futures indicate the direction of the market before it opens. With this service, bitcoin users could be alerted to when there is a market-rocking event and make decisions accordingly.

5. Bitcoin advertising network. One of the biggest issues for bitcoin is that businesses cannot easily use it for buying business services. An advertising network suited for bitcoin clients will absorb the bitcoin flow from online merchants. Google refuses to convert to bitcoin, so another avenue is needed.

Bitcoin seems to be here to stay.

To a future of bitcoins…and freedom.


Categories: Bitcoin | Cryptocurrency


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