A few thoughts - Sunday, January 11, 2015

[Steve Sokolowski]

Edited at 2:45pm

News just broke that Bitpay fired 9 employees: http://qntra.net/2015/01/bitpay-lays-of ... ees-today/. If true, then things are worse than I thought and these layoffs are the second piece of news just this week of big, well-run companies starting to run into real problems.

My opinion is that this news is going to trigger another panic. It looks like there was already a huge sell a little while ago. Whenever there are huge market moves, ask yourself what those people know that you don't.

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A few thoughts for today:

I thought that I should return, at least for today, with a few observations. Most of my time is now spent on development for this mining pool, and a failed engine in my car has eaten up a huge amount of time trying to learn what the most economical way to get back on the road is.

Andreas Antonopolous shadowbanned

As a quick aside for those who aren't aware Andreas Antonopolous was shadowbanned from reddit this morning. The arbitrary nature of shadowbans is why I no longer post to reddit, and the fact that Antonopolous can be shadowbanned shows how large a problem overzealous administrators are on reddit.


Reminder of the one way that bitcoin can fail

I read the news and bitcointalk.org and reddit and am surprised at how many people talk about the "antifragility" of bitcoin. They correctly point out that Bitstamp's failure didn't cause the underlying network to fail, and that transactions are continuing as usual. The error comes when most of these people extend their observations deduce that, because bitcoin can't be shut down, it will therefore continue to improve and prosper.

Such people are missing that the network continuing on was never a question. The odds that some sort of security flaw would be discovered and that the flaw would be unfixable have always been close to zero. Nobody doubts that the bitcoin network will continue on as long as people choose to use it.

As I stated last March, the only way that bitcoin can fail is if, for whatever reason, people decide not to use it. The technology is a breakthrough, the network is resilient, and it works. However, there have been many technologies that people decide not to use, even though they are clearly superior to the existing alternatives. I already used the example of 3D televisions, phones, and video games. In the case of games, 3D allows the player to significantly improve his performance by being a more accurate shot. Another example of a technology that is clearly superior but which is not widely used is Google Glass. I spent $500/yr for glasses, so $1000 for Google Glasses and the enormous benefits they provide over phones is miniscule. Yet, even though the technology is superior, some people avoid Google Glasses. Since no studies have been performed on the subject, I can't speculate why, but anecdotal evidence (for what it's worth) suggests that "societal reasons" rather than technological ones are to blame.

The loss of these technologies, if they do disappear, will be a shame, because they represent a step backwards and remove choices for consumers. Even if many people don't find a use for Google Glass, there are many people for whom Google Glass would be a godsend. I, for example, have difficulty recognizing people's faces. No matter how many tricks I've tried to remember people's names, they always fail. Perhaps I will finally find some memory trick some day that makes it easy to remember who people are, but in the meantime, Google Glass can perform facial recognition with high accuracy. Yet, Google may decide that they aren't selling enough Glasses to continue to produce them. That means that people who really need the technology end up with a lower quality of life.


Is there any indication that usage is declining?

Since I believe that the only way that bitcoins can fail is if they aren't used, the next question to ask is whether there is indication that usage is declining. Beginning on January 1, I'm now beginning to believe that the answer is "yes."

Many people are misled by two issues that make headlines. First, big companies announce that they are going to accept bitcoins as payment, leading many to believe that there is yet another symbol of bitcoin's continued ascent. Second, the "number of transactions per day" chart keeps rising, leading venture capitalists to proclaim that usage is at an "all time high." Yet, despite how many merchants are accepting bitcoins, the actual number of users spending them at the initial merchants to adopt (like Overstock) is declining. Additionally, 5% of the entire network's transactions last week consisted of a single spammer sending money to many addresses advertising some service.

And even though some companies are accepting bitcoins, the really interesting applications are not appearing. Instead of releasing a functioning barebones network and slowly improving it, promising projects like storj and OpenBazaar are in perpetual "beta" (or worse) mode. The developers of these projects don't understand that it would be better to get something out there that works, and then add more operating systems, GUIs, and non-core features. While they work on getting something perfect, they fail to realize that what they do have likely presents an superior alternative to the existing systems already.


The industry is in danger of collapsing

Vault of Satoshi, a Canadian exchange that closed its doors earlier this week, could signal the start of a disturbing chain reaction in the coming months. While businesses closing are nothing new, what is noteworthy is that Vault of Satoshi was a trusted exchange that had superior functionality to most of its competitors. Apparently, the exchange began working on a completely different business in movie streaming, and eventually a decision was made to abandon the bitcoin industry and to move into entertainment because it was more profitable.

Some compare the current slump to 2011, when bitcoins fell to $2 and then recovered. In 2011, there were few, if any, serious businessmen in the bitcoin industry. Since there was a smaller pool of people, the quality of those people was lower. With a larger number of people working on something, there is a greater variance in their skill levels; think of Penn State and Lehigh [CENSORED]'s football teams; you have a greater chance of finding talent when there are more students to choose from. The bitcoin industry employs thousands of developers - some who are unproductive, and some who produce high quality work. When a business starts to decline, the lower-performing employees aren't going to disappear; they can't find a job anywhere else, so they stay put. What happens is that the best employees are the first out the door, because other industries are willing to pay a lot for them.

It takes years to become knowledgeable about software code. What happened when Vault of Satoshi failed is that several developers who had become experts in bitcoins threw away years of experience to work on movies. Even if we assume that the exact same number of jobs will continue to exist in the bitcoin industry because another exchange comes around to replace them, that knowledge is lost; it isn't coming back. The owners of the new exchange will need to look in other industries to find developers, and those new developers will make security mistakes and be unproductive at first. The new exchange will be of lower quality, at least at first, simply because even the smartest people can't become experts in a day.

It's difficult for people to understand that it won't take much to set off an exodus from the bitcoin industry. If transaction volume contracts in half, the industry isn't going to simply be half as large. It will have half as many companies, and the companies that remain will be the least competent. Good employees don't hang around in declining businesses; they move on to better things because they can. If we start to see closures and failures, they will be of the best businesses, and the remaining people will be incompetent or at best average.


Why "this time is different" than 2011

If the doomsday scenario described above comes to pass, then the people who leave aren't going to come back. It's easy to see why if you look at this site's mining pool. If it ever becomes necessary to shut down, then Chris will need to find a job to support himself. To find a job, he would need to move to Houston, where the oil industry is. Suppose that the business is terminated and he moves to Houston and gets a job. Then, suppose that there is another bitcoin bubble or another bitcoin business opportunity arises.

At that point, Chris (or some other stereotypical person who left the industry) has already spent thousands of dollars to move across the country. He has a steady income at a company where he can move up the ladder. His resume would be undesirable if he left that job after just a few months, and moving again would be time-consuming and expensive. He already worked 80 hours per week for years on his failed business, so he is burnt out and unlikely or unable to do it again. His knowledge of bitcoins has waned due to disuse as his brain is being filled with knowledge about his new job. He would know that bitcoins are likely to crash again and possibly put himself in a similar situation after the next bubble. And he lost tens of thousands of dollars in the failed business, so he doesn't have the capital to try again even if he wanted to do so. The odds of someone in that position returning to the bitcoin industry would be very low.

If businesses start to fail, unlike in 2011, the exceptional programmers who entered bitcoins are unlikely to come back. One lesson readily apparent from "Shark Tank" is that the venture capitalists on that show have never invested in a business that was put on hold for a few years, or which peaked and declined. The VCs have plenty of other options and would be unlikely to return to an industry that has already lost them so much money before.


Conclusion: price is important

The conclusion to draw from all of this is that price is, indeed, important. Price is the most important factor in determining the success or failure of the bitcoin protocol. People who claim that bitcoin adoption is going to happen eventually because there are lots of people at work on the technology fail to see that corporate profits are heavily influenced by bitcoin price. Merchants are drawn to bitcoins when prices are rising. Exchanges turn more volume and make more money. Mining pools become more profitable. Consumers are able to afford more when their coins are worth more. There is a cycle that builds upon itself.

Even if you are inclined to argue that "price is irrelevant," it's difficult to argue that a falling price is of benefit to anyone except short-sellers. If a rising price benefits a lot of people, and a falling price benefits only short-sellers, then how can price be irrelevant?


An aside: a second missed bubble?

I like to look at the cycle of bubbles to determine market movement, even though bubbles are not the popular thing nowadays. Everyone knew that late July was the timeframe when the previous bubble was expected, and when there were no signs of it happening, I said in early July that it was time to get out before the fall that eventually happened. Another eight month cycle is about to come up in early February, and I don't see why the same won't be true this time around. If there is no movement upwards within two weeks to signal the start of a bubble, then my opinion would again turn bearish and we should expect another cycle of decline.

I likened these cycles to the cycles of human development, where each period has an overarching question that needs to be resolved affirmatively or negatively. The April 2013 bubble was about bitcoin simply being a working technology (it was). The late 2013 bubble was about bitcoin being accepted by governments (it was). The past two cycles have been about whether the wider public will use bitcoin, and the answer for the first cycle was a resounding no. I'd guess that the question has not changed, and the answer is still no, so we'll go through another cycle with the same question. If that happens, then the next cycle may be do-or-die. I predict that, if there is not a bubble in February, we will see a contraction of venture capital money this quarter compared to Q4 2014.

If you agree with the idea that the technology models the human lifecycle development model, then you should also expect that the ETFs that are claimed to be the savior of bitcoin will make no difference in the next cycle, because institutional investment is not the limiting factor. The limitation is whether people will use bitcoins, and I would not buy into an ETF until there is a clear answer to that question.


Buy or work?

The people who make the most money are those who are willing to buy when everything looks like it is going to fail. I'm certainly not selling.

Interestingly, the risk I see for the entire industry is that buying bitcoins requires so much less risk than working in bitcoins. To buy, you just click a button. If bitcoins fail, you just continue working to earn back what you lost. If you have job in bitcoins, failure is a much more costly problem. The unequal distribution of risk between buying bitcoins and actually creating ways to use them is a worrisome sign for me of the technology going forward.