Demystifying the Blockchain and Crypto Currencies for your FIRE
Written by Kyle Mayers
June 04, 2018 |
Can investing in Blockchain and Crypto Currencies help you retire sooner?
People pursuing a Financial Independence Retire Early (FIRE) strategy are always on the lookout for new and enticing ways in which to advance their retirement date. The rationale is pretty simple: it is tough to save enough for retirement, and to do it before you are 65 is even more difficult. With Blockchain and Crytpo Currencies serving as the latest invention in the world of financial engineering, you need to be aware of their opportunities and risks before you invest your hard-saved money.
Arm Yourself With Knowledge
As with any new financial concept aimed at parting you from your money, your best defense against getting burned is knowledge. Fortunately, since Bitcoin first emerged, there has been a wealth of content written on the subject of Bitcoin as well as its underlying technology, Blockchain.
The blockchain is intended to serve as an immutable (i.e. cannot be edited or changed) ledger recording every Bitcoin transaction that has ever occurred. Anonymity is enabled by identifying transaction participants only by their wallet identifier, not any details that relate back to them as individuals. Transactions are approved only after the network of Bitcoin computers has completed an ever increasingly difficult proof-of-work which means that hijacking the system is next to impossible, even with large server farms. The distributed nature of the Bitcoin network means that not only must one computer agree that the proof-of-work is sufficient, but all participating machine must as well. Once that agreement is replicated throughout the network as an entry onto the blockchain, it can never be undone or modified.
Before there was a Bitcoin, there was cryptography. Understanding its heritage and how it was used by enthusiasts to facilitate privacy in an online world is essential reading to fully understand the plumbing that drives both Blockchain and all Crypto Currencies.
In the landmark book, Crypto: How the Code Rebels Beat the Government Saving Privacy in the Digital Age by Stephen Levy, readers are walked through an excellent background on the chronology of cryptography. Many of the names of people who would later be familiar to the world of Bitcoin are introduced in this book: Adam Back, Nick Szabo, and Wei Dai. Even the early notion of electronic cash is discussed and the challenge of using crypto technologies in a world constrained by export restrictions on cryptographic algorithms.
An excellent account of the history of Bitcoin and its use in anonymous transactions was penned by Nick Bilton in his classic American Kingpin: The Epic Hunt for the Criminal Mastermind Behind the Silk Road. The Silk Road was a dark web marketplace that was used for the purchase of illegal goods. It was later seized by the US Government, but not before the maintainer of the site, Ross Ulbricht, had managed to elude authorities for over 2 years. During that time, Ulbricht managed to earn a fortune on commissions of each sale.
Part of what makes this story so compelling is the implicit proof it offers of the anonymity of the Bitcoin and Blockchain platform. Were it possible to simply crack the encryption used in Bitcoin, authorities would have done just that. But intelligence forces that included the Internal Revenue Service, the Drug Enforcement Agency, the Federal Bureau of Investigation and the U.S. Marshals Service instead were forced to resort to good old sleuthing to track Ulbricht down. I won't say any more, because I found this story so compelling, and further detail might spoil it for you, should you decide to read this book.
Identifying Opportunities For Bitcoin in your FIRE
By some estimates, a single bitcoin will someday be worth $100,000.00 US. The original platform was built with a hard cap on the number of Bitcoins that could ever be mined using computer processing within the Bitcoin network. That cap was set at 21,000,000 Bitcoins. Given the relative scarcity of Bitcoins, it is possible their value could hit that mark.
Greater acceptance of Bitcoin will increase demand. The creator of Bitcoin realized that once all of the Bitcoins were mined, network participants would have no incentive to continue to use Bitcoins. To provide an incentive for continued use, the winning computer to identify the valid proof-of-work when transferring Bitcoins from one user to another would be awarded a percentage of the transaction amount. Assuming the percentage awarded is 10%, if I attempt to transfer 10 Bitcoins to you, once the network has processed the transfer, I will have 10 Bitcoins withdrawn from my wallet, you will have 9 added to yours, and the remaining 1 Bitcoin will be awarded to the computer that successfully delivered the proof-of-work. Increased demand will equal higher prices in a limited market, which is a feature of Bitcoin.
Blockchain has buzz, there is no question. Industries as diverse as supply chain management to insurance are constantly showcasing blockchain presentations in their respective industry conferences. Companies supplying blockchain technologies, such as Blockstream led by Dr. Adam Back will at least have the ear of incumbent industry players, so their success has more to do with execution, than proof of a business case. Blockchain - from a business case perspective - seems to be widely accepted at this point.
Risks of Blockchain and Crypto Currencies in Your FIRE
Investing Bitcoin is fundamentally speculative. You own no more of a base asset in Bitcoin than you do cards in a hand of poker. The closest thing you have to an underlying asset is the electricity consumed by the computer that successfully completed the proof-of-work. Granted, fiat currency is also backed by no underlying asset, but at least there is the commitment by the issuing government to honor the amount.
Bitcoin is volatile. In the span of a single day, Bitcoin can increase or decrease in value by significant jumps, sometimes as much as 100%.
The legality of Crypto Currencies may be challenged. Your current investment will not likely result in criminal implications, but your investment's future value could diminish. The encryption used within Bitcoin was at one time subjected to export restrictions, so it is not beyond reason that authorities could yet place restrictions on the use of Bitcoin.
Experts believe Bitcoin and Crypto Currencies in general are in the midst of an enormous speculative bubble. Bitcoin went live in 2009, but did not really gain widespread appeal until its value crossed $1,000 US in 2017. Since that point, it has enjoyed a 20 times gain, which is extremely unusual performance.
The remarkable gains in Bitcoin have been accompanied by investment brokers seeking to capitalize on the appeal of Bitcoin. Funds such as the Fidelity Innovators Suite market these speculative investments as American as apple pie, accompanying their TV commercials with Fly me to the Moon by Frank Sinatra.
The problem here is that by presenting such investments as normal and downplaying the associated risks, these types of brokers are withholding critical information from the clients they allegedly serve. As an investor, you need to be advised by someone who will be completely transparent about the associated risks of an investment opportunity. Not someone who will pipe in pleasing music to help prey on your naivety.
If Bitcoin does continue to rise in value perpetually, it will buck the trend of past bubbles exhibiting similar performance such as the Tulip Mania of 1619 or the US Housing Market in the early 2000's. And as we've learned from Mutual Fund managers, past performance is not indicative of future results. Nothing is guaranteed in the world of crypto, not future performance, and not even your existing investment. Stored funds are not insured, so if the market you use to manage your Bitcoin investments goes under, such as the debacle of Mt. Gox, you will have no recourse.
Summary
Investing in Blockchain and Crypto Currencies in your FIRE plan is entirely question of your risk appetite. There is no evidence at this point you will reduce the duration of your retirement if you begin investing in Bitcoin. Sure, it has enjoyed a fantastic run since 2017, but that is no indicator that run will continue. In fact, if Bitcoin follows the pattern of past bubbles, now would be a terrible time to invest. If you do choose to put your hard saved money in Blockchain or Crypto Currencies, arm your self with knowledge. Being aware of the details of these technologies is the only way to know if they are a good fit for you.
Do you hold cryptocurrencies in your FIRE savings? Are there any other blockchain risks or opportunities for FIRE retirement?