What Are Digital Currencies – And What Do They Mean For Gold? Guild Investment Management

What Are Digital Currencies — And What Do They Mean For Gold?

What Are Digital Currencies — And What Do They Mean For Gold?

All the competitors have their proponents. While some are clearly more serious contenders than others, at the end of the day, disagreement is heated even among technical experts and non-experts who pursue windfalls in digital currencies. While the excitement lasts, there will be enough stories of overnight digital currency millionaires to keep the process going, but eventually the music will stop. (Of course, speculation can be joy — as long as you recognize it for what it is.)

Digital Currencies Are Here To Stay

While picking winners and losers in the rapidly growing field of digital currencies is very sophisticated, digital currencies as a entire are doing something for which there is request. While they share some characteristics with other assets, they combine those with unique characteristics of their own, and therefore they will appeal to users and speculators who want those characteristics. That means that they will proceed to exist (even if some governments determine they shouldn’t), so at some point after the dust lodges, intelligent speculators, and even investors, will need to determine whether digital currency is an asset class in which they want to hold some of their wealth.

Bitcoin was the model for challenging digital currencies for good reason. It came up with elegant solutions to fundamental problems of exchange, which we’ll describe below. Other digital currencies, while differing in technical details, share bitcoin’s solutions in broad strokes. Understanding the technical details is not as significant as understanding the basic nature of what digital currencies are attempting to achieve, and how they achieve it. With that clear view, speculators and investors can make the essential decision of whether participation in this fresh asset class aligns with their private goals and risk appetite — or whether they should overlook it entirely.

The very first thing to realize about bitcoin is that the entire system is rooted in a desire to eliminate financial intermediaries, and permit people transacting business to make their exchange directly with one another. Bitcoin is anarchist money. It isn’t created by a central authority, it isn’t backed by a central authority, and transactions are not confirmed by a central authority. Indeed, the bitcoin system sets out to liquidate the need for any “central authority” — whether that’s a government, a bank, or any “trusted intermediary.”

Some readers may instantly think, “There’s an asset like that already — it’s gold.” In the contemporary economy, gold is the asset whose ownership is at bottom a vote of “no confidence” in central authorities and the stability that they create — or at least a hedge against their failure.

What bitcoin sought to do (and what its anonymous inventor largely succeeded in doing) was to create an asset that would, like gold, be independent of governments and banking systems — but that existed only digitally, and thus had a host of other characteristics that are desirable in a digitally connected world.

Gold has mass. It takes up space. It’s difficult to divide so that it can be used in exchange. It requires physical-world vigilance and security to prevent theft. It has to be carried and physically exchanged in order to conduct transactions, which could be inconvenient and dangerous. Using third parties to perform any of these functions exposes the possessor of gold to the risk of theft and fraud.

Bitcoin, on the other arm, takes up no space, and can be exchanged instantly over any distance. While it can be stolen, that theft can only occur on the edges of the bitcoin system, where it interacts with the established financial world. As it is constructed, within itself, the bitcoin system is impervious to theft and fraud (with one significant caveat, which we’ll mention below). A bitcoin wallet — indeed nothing more than a set of cryptographic keys providing you the power to allocate bitcoins from your address to some other address — in cold storage, unconnected to the internet, is entirely secure.

In brief, bitcoin set out to be digital gold for the digital age. Will it succeed?

The Top twenty Digital Currencies By Market Capitalization

The mechanics of digital currencies are sophisticated in their actual implementation, but the broad structure is not difficult to understand.

In order to eliminate the need for financial intermediaries, any digital currency system has to solve two problems: the problem of identity and the problem of ownership.

The current global financial system also solves these problems. Central authorities — banks, governments, and courts — keep exhaustive accounts of financial assets and of the ownership of those assets, tying those accounts to identity records maintained by other authorities. When you withdraw money from your bank, the bank has a system to confirm your identity — relying on many other expansive and intrusive identity-confirmation systems within government. Then the bank has to verify your ownership of the money you’re withdrawing — using a sophisticated system of proprietary ledgers and record-keeping as well as the proprietary communications systems connecting all these records. The system functions sleekly, and that smoothness hides the complexity of intermediary structures, not to mention hiding the costs these intermediary systems impose on users.

Bitcoin, on the other arm, solves the identity and ownership problems with math and algorithms. It secures ownership through cryptography. Only the possessor of the correct cryptographic key can spend the bitcoins associated with a certain address, and while the possession of that key can be verified by anyone, the key itself is never exposed to anyone. (If readers want to delve into the mechanics of public/private key cryptography, it’s an interesting and challenging subject area.) The central role of cryptography in almost all digital currencies has led to them being dubbed “cryptocurrencies.” For now, these cryptographic keys are so sturdy that no existing computer technology is even theoretically capable of compromising them.

These cryptographic technologies existed long before bitcoin. Bitcoin’s real innovation was this: it created an elegant system for the maintenance of a public, universally agreed-upon ledger of bitcoin ownership, that is maintained by a distributed network of computing knots rather than by any single, proprietary institution.

Again, the technical details of how bitcoin accomplishes this objective are abstruse. The bottom line is that every bitcoin transaction that has ever occurred is included in a ledger called the “blockchain,” and the blockchain itself is not held by any central institution, but exists in thousands of independent “nodes” around the world. These knots rival with one another to verify fresh transactions being added to the blockchain, and winners are rewarded with freshly created bitcoins. The competition involves a race to solve extraordinarily difficult mathematical puzzles. When a fresh, valid block is added to the blockchain, it propagates among all knots from peer to peer and is adopted as the basis for work kicking off on the next block. (To fraudulently rewrite or alter the blockchain, or introduce bogus transactions, would require an amount of computing power that’s far beyond anything presently available.) Thus the system maintains a universally agreed-upon ledger describing the ownership of every bitcoin in existence — without the need for any central authorities or intermediaries.

Every digital currency solves these problems with an treatment similar to that used by bitcoin. They use cryptography to solve the identity problem, and a distributed ledger (some form of blockchain) to solve the ownership problem.

Digital Currencies: Are They What They Seem?

Digital currency creators set out to make digital gold — an asset that, like gold, needs no central authorities to back it, or to its certify ownership; but unlike gold, takes up no space, can’t be stolen, and can be instantly transmitted anywhere in the world. Did they succeed?

Yes and no. Here are some skeptical thoughts on potential cryptocurrency weaknesses — questions we think speculators and investors should ask themselves as they determine whether they eventually want to hold some of their wealth in the form of digital currency.

Very first, digital currencies claim to do away with intermediaries. But do they? Albeit we’ve sketched an utterly high-level view of how digital currencies operate, a real understanding of these systems requires a lot of intellectual sweat — and possibly, for deep comprehension, a decent grab of several fields of mathematics and computer science. Therefore, a real-world user has two options: acquire the detailed, precise skill of how the systems operate — or trust the understanding of a third party, whether a friend or an advisor acting in some formal capacity.

Personally, we would not want to hold assets about which we or a trusted advisor don’t have deep understanding. So any normal person who doesn’t have the time or inclination to become an fledgling computer scientist is relying not on the bitcoin system’s supposedly sturdy independence, but on some trusted authority who facilitates their interaction with the bitcoin system. Despite bitcoin’s theoretical security, for almost all investors its real security will be tied to intermediaries whose trustworthiness they must judge. Sounds rather like we’re back to square one.

Even in a bitcoin world, real-life users will depend on the trustworthiness of other actors in the financial system. So trustworthy intermediaries create value, and will proceed to create value. And as unforeseen troubles occur for cryptocurrencies, that truth will, we believe, become more apparent. Of course, while physical gold in one’s individual possession may present risks, those risks are much more lightly comprehended and mitigated than the risks associated with sophisticated and novel computer networks.

A 2nd trouble with digital currencies is privacy. Astute readers may have reflected on the public nature of the bitcoin blockchain. This is noteworthy: every bitcoin transaction that has ever occurred is preserved in the blockchain, publicly available and held in its entirety in every knot. Those transactions are identified with bitcoin addresses, which are simply long alphanumeric strings — not names. Still, data mining — especially using artificial intelligence and machine learning — may well be able to find patterns in the blockchain and marry those discoveries with outward data to tie transactions to real-world identities. (Intelligence agencies are undoubtedly already working on this. This is not idle speculation; worries about privacy have led to the creation of several bitcoin alternatives. Those alternatives, however, end up creating problems and weaknesses of their own.)

This privacy issue is something that gives us pause when we contemplate the proposed expansion of the blockchain technology beyond cryptocurrencies.

Several successful platforms are bringing blockchain to the world of business transactions and contracts, promising to reap the benefits of decentralization and digitization in diminished costs and enhanced efficiency. We think that privacy concerns here, too, may eventually provoke a backlash as consumers realize that blockchain technology permanently memorializes their activities in a public data base that is pseudonymous, but not necessarily impervious to attempts to extract private data. And of course, the risk of exposure of private data doesn’t just concern those who are fearful of government prying, or those who are engaged in illegal activities. Uncountable commercial transactions must remain private to safeguard businesses against the unfair advantage their competitors would have if, for example, they had detailed information about who their suppliers were. All of that is the kind of information that could be exposed through a public blockchain. Potential use of blockchain technology for financial and medical records also creates privacy issues. (Next week, we’ll explore the promises and potential problems of blockchain technology as a way to slick exchanges and reduce transaction costs entirely outside the world of cryptocurrencies.)

A third potential weakness is technological. We noted above that both of the central piles of digital currencies — cryptographic identity and blockchain construction — rely on mathematical problems. Those problems need to be either unlikely (in the case of cryptographic identity) or enormously difficult, time-consuming, and costly (in the case of blockchain construction). With current computer technology, all is well: the unsolvable is unsolvable, and the enormously difficult is enormously difficult.

But there’s a fresh technology coming: quantum computing. The inflection in computing power that quantum computing inaugurates could fairly possibly break all existing cryptocurrencies. Indeed, it could break all existing cryptography. We don’t know when that moment will arrive. Perhaps it’ll be like fusion power — always thirty years in the future. But the consensus of computer scientists is shifting, and many now believe that functional quantum computers are only five to ten years away. With such an oncoming potential destruction of the foundations of digital currencies within long-term view, the question is, can digital currencies be more than a gamble?

All of these considerations could be summed up in one observation: it is essential for investors, as well as for intelligent speculators, to be ruthless in realistically assessing their own ignorance. The telling that “pride goeth before a fall” is nowhere more applicable than here. The apparent plainness and straightforwardness of digital currencies masks complexities which create risks that are not trivial to understand and quantify. If we ourselves lack the technical expertise to understand and quantify these risks, we have to rely on others whom we trust. Does that reliance cut downright against the cryptocurrency grain?

Gold, Bitcoin, and Artificial Intelligence

Last week we suggested some thoughts about the imminent arrival of artificial intelligence (AI) and machine learning, and commented on the “black box” nature of this revolution. With machine learning, we’ll have enormously functional automated systems that can suggest no account of their behavior — there will be no real reaction to the question, “Why did it do that?” This is simply what happens when artificial neural networks pass the threshold of complexity that they’re passing, and begin to program themselves rather than being programmed by humans.

For most people, bitcoin and other cryptocurrencies will always be black boxes. We noted a few potential weaknesses — but we are not experts, and other weaknesses may well exist in these systems that will not manifest until a major failure occurs. This is part of the problem with elaborate systems that function as black boxes: the only way to find out when they’ll break, if they’re intractably complicated, is to use them until they do break. And then it’s too late – for those who make that mistake, if not for the people who learn from your mistake. Most investors, when they reflect, are not antsy to become everyone else’s cautionary tale.

So while cryptocurrencies are technologically, culturally, and politically fascinating, in our view they are at this stage only vehicles for speculation, not investment. We realize, however, that the tempting prospect of outsized gains and the mythic accounts of bitcoin billionaires will inexorably pull in many speculators.

Still, we don’t believe that cryptocurrencies have yet demonstrated success in their quest to be the fresh “digital gold.” For all its drawbacks, and even however we can’t store it on a flash drive, we still choose analog gold as a hedge against the malfeasance and irresponsibility of government.

Investment implications: Digital currencies are not investments. In our view, unless you have significant technical expertise, they are rank speculation. Since they marry some desirable characteristics of gold and of virtual assets, they will very likely proceed to exist — but we believe that it is unlikely to determine which of the almost 1,000 presently existing digital currencies will sustain in the medium term. Longer term, there are significant questions around privacy, public comprehensibility, and the potential for quantum computing to defeat the difficult mathematical problems on which cryptocurrencies are based. For all these reasons, we think cryptocurrencies are interesting to explore, and may be joy to trade — but are not investments, and in the long run will not supersede the need for trusted intermediaries in the financial system. We believe that most investors who want to hedge against the malfeasance of government and the vicissitudes of monetary policy should keep doing it the way they’ve been doing it for Five,000 years — with gold. Cryptocurrencies have an inherent potential to unseat gold. At their current stage of development, they have not achieved that purpose. Time will tell if they can ever build up that status.

What Are Digital Currencies – And What Do They Mean For Gold? Guild Investment Management

What Are Digital Currencies — And What Do They Mean For Gold?

What Are Digital Currencies — And What Do They Mean For Gold?

All the competitors have their proponents. While some are clearly more serious contenders than others, at the end of the day, disagreement is heated even among technical experts and non-experts who pursue windfalls in digital currencies. While the excitement lasts, there will be enough stories of overnight digital currency millionaires to keep the process going, but eventually the music will stop. (Of course, speculation can be joy — as long as you recognize it for what it is.)

Digital Currencies Are Here To Stay

While picking winners and losers in the rapidly growing field of digital currencies is very elaborate, digital currencies as a entire are doing something for which there is request. While they share some characteristics with other assets, they combine those with unique characteristics of their own, and therefore they will appeal to users and speculators who want those characteristics. That means that they will proceed to exist (even if some governments determine they shouldn’t), so at some point after the dust lodges, intelligent speculators, and even investors, will need to determine whether digital currency is an asset class in which they want to hold some of their wealth.

Bitcoin was the model for contesting digital currencies for good reason. It came up with elegant solutions to fundamental problems of exchange, which we’ll describe below. Other digital currencies, while differing in technical details, share bitcoin’s solutions in broad strokes. Understanding the technical details is not as significant as understanding the basic nature of what digital currencies are attempting to achieve, and how they achieve it. With that clear view, speculators and investors can make the essential decision of whether participation in this fresh asset class aligns with their individual goals and risk appetite — or whether they should disregard it entirely.

The very first thing to realize about bitcoin is that the entire system is rooted in a desire to liquidate financial intermediaries, and permit people transacting business to make their exchange directly with one another. Bitcoin is anarchist money. It isn’t created by a central authority, it isn’t backed by a central authority, and transactions are not confirmed by a central authority. Indeed, the bitcoin system sets out to eliminate the need for any “central authority” — whether that’s a government, a bank, or any “trusted intermediary.”

Some readers may instantly think, “There’s an asset like that already — it’s gold.” In the contemporary economy, gold is the asset whose ownership is at bottom a vote of “no confidence” in central authorities and the stability that they create — or at least a hedge against their failure.

What bitcoin sought to do (and what its anonymous inventor largely succeeded in doing) was to create an asset that would, like gold, be independent of governments and banking systems — but that existed only digitally, and thus had a host of other characteristics that are desirable in a digitally connected world.

Gold has mass. It takes up space. It’s difficult to divide so that it can be used in exchange. It requires physical-world vigilance and security to prevent theft. It has to be carried and physically exchanged in order to conduct transactions, which could be inconvenient and dangerous. Using third parties to perform any of these functions exposes the possessor of gold to the risk of theft and fraud.

Bitcoin, on the other mitt, takes up no space, and can be exchanged instantly over any distance. While it can be stolen, that theft can only occur on the edges of the bitcoin system, where it interacts with the established financial world. As it is constructed, within itself, the bitcoin system is impervious to theft and fraud (with one significant caveat, which we’ll mention below). A bitcoin wallet — truly nothing more than a set of cryptographic keys providing you the power to allocate bitcoins from your address to some other address — in cold storage, unconnected to the internet, is fully secure.

In brief, bitcoin set out to be digital gold for the digital age. Will it succeed?

The Top twenty Digital Currencies By Market Capitalization

The mechanics of digital currencies are complicated in their actual implementation, but the broad structure is not difficult to understand.

In order to eliminate the need for financial intermediaries, any digital currency system has to solve two problems: the problem of identity and the problem of ownership.

The current global financial system also solves these problems. Central authorities — banks, governments, and courts — keep exhaustive accounts of financial assets and of the ownership of those assets, tying those accounts to identity records maintained by other authorities. When you withdraw money from your bank, the bank has a system to confirm your identity — relying on many other expansive and intrusive identity-confirmation systems within government. Then the bank has to verify your ownership of the money you’re withdrawing — using a elaborate system of proprietary ledgers and record-keeping as well as the proprietary communications systems connecting all these records. The system functions slickly, and that smoothness hides the complexity of intermediary structures, not to mention hiding the costs these intermediary systems impose on users.

Bitcoin, on the other arm, solves the identity and ownership problems with math and algorithms. It secures ownership through cryptography. Only the possessor of the correct cryptographic key can spend the bitcoins associated with a certain address, and while the possession of that key can be verified by anyone, the key itself is never exposed to anyone. (If readers want to delve into the mechanics of public/private key cryptography, it’s an interesting and challenging subject area.) The central role of cryptography in almost all digital currencies has led to them being dubbed “cryptocurrencies.” For now, these cryptographic keys are so sturdy that no existing computer technology is even theoretically capable of compromising them.

These cryptographic technologies existed long before bitcoin. Bitcoin’s real innovation was this: it created an elegant system for the maintenance of a public, universally agreed-upon ledger of bitcoin ownership, that is maintained by a distributed network of computing knots rather than by any single, proprietary institution.

Again, the technical details of how bitcoin accomplishes this aim are abstruse. The bottom line is that every bitcoin transaction that has ever occurred is included in a ledger called the “blockchain,” and the blockchain itself is not held by any central institution, but exists in thousands of independent “nodes” around the world. These knots rival with one another to verify fresh transactions being added to the blockchain, and winners are rewarded with freshly created bitcoins. The competition involves a race to solve extraordinarily difficult mathematical puzzles. When a fresh, valid block is added to the blockchain, it propagates among all knots from peer to peer and is adopted as the basis for work commencing on the next block. (To fraudulently rewrite or alter the blockchain, or introduce bogus transactions, would require an amount of computing power that’s far beyond anything presently available.) Thus the system maintains a universally agreed-upon ledger describing the ownership of every bitcoin in existence — without the need for any central authorities or intermediaries.

Every digital currency solves these problems with an treatment similar to that used by bitcoin. They use cryptography to solve the identity problem, and a distributed ledger (some form of blockchain) to solve the ownership problem.

Digital Currencies: Are They What They Seem?

Digital currency creators set out to make digital gold — an asset that, like gold, needs no central authorities to back it, or to its certify ownership; but unlike gold, takes up no space, can’t be stolen, and can be instantly transmitted anywhere in the world. Did they succeed?

Yes and no. Here are some skeptical thoughts on potential cryptocurrency weaknesses — questions we think speculators and investors should ask themselves as they determine whether they eventually want to hold some of their wealth in the form of digital currency.

Very first, digital currencies claim to do away with intermediaries. But do they? Albeit we’ve sketched an enormously high-level view of how digital currencies operate, a real understanding of these systems requires a lot of intellectual sweat — and possibly, for deep comprehension, a decent take hold of of several fields of mathematics and computer science. Therefore, a real-world user has two options: acquire the detailed, precise skill of how the systems operate — or trust the understanding of a third party, whether a friend or an advisor acting in some formal capacity.

Personally, we would not want to hold assets about which we or a trusted advisor don’t have deep understanding. So any normal person who doesn’t have the time or inclination to become an fledgling computer scientist is relying not on the bitcoin system’s supposedly sturdy independence, but on some trusted authority who facilitates their interaction with the bitcoin system. Despite bitcoin’s theoretical security, for almost all investors its real security will be tied to intermediaries whose trustworthiness they must judge. Sounds rather like we’re back to square one.

Even in a bitcoin world, real-life users will depend on the trustworthiness of other actors in the financial system. So trustworthy intermediaries create value, and will proceed to create value. And as unforeseen troubles occur for cryptocurrencies, that truth will, we believe, become more apparent. Of course, while physical gold in one’s private possession may present risks, those risks are much more lightly comprehended and mitigated than the risks associated with complicated and novel computer networks.

A 2nd trouble with digital currencies is privacy. Astute readers may have reflected on the public nature of the bitcoin blockchain. This is noteworthy: every bitcoin transaction that has ever occurred is preserved in the blockchain, publicly available and held in its entirety in every knot. Those transactions are identified with bitcoin addresses, which are simply long alphanumeric strings — not names. Still, data mining — especially using artificial intelligence and machine learning — may well be able to find patterns in the blockchain and marry those discoveries with outward data to tie transactions to real-world identities. (Intelligence agencies are undoubtedly already working on this. This is not idle speculation; worries about privacy have led to the creation of several bitcoin alternatives. Those alternatives, tho’, end up creating problems and weaknesses of their own.)

This privacy issue is something that gives us pause when we contemplate the proposed expansion of the blockchain technology beyond cryptocurrencies.

Several successful platforms are bringing blockchain to the world of business transactions and contracts, promising to reap the benefits of decentralization and digitization in diminished costs and enlargened efficiency. We think that privacy concerns here, too, may eventually provoke a backlash as consumers realize that blockchain technology permanently memorializes their activities in a public data base that is pseudonymous, but not necessarily impervious to attempts to extract private data. And of course, the risk of exposure of individual data doesn’t just concern those who are fearful of government prying, or those who are engaged in illegal activities. Innumerable commercial transactions must remain private to safeguard businesses against the unfair advantage their competitors would have if, for example, they had detailed information about who their suppliers were. All of that is the kind of information that could be exposed through a public blockchain. Potential use of blockchain technology for financial and medical records also creates privacy issues. (Next week, we’ll explore the promises and potential problems of blockchain technology as a way to slick exchanges and reduce transaction costs entirely outside the world of cryptocurrencies.)

A third potential weakness is technological. We noted above that both of the central poles of digital currencies — cryptographic identity and blockchain construction — rely on mathematical problems. Those problems need to be either unlikely (in the case of cryptographic identity) or utterly difficult, time-consuming, and costly (in the case of blockchain construction). With current computer technology, all is well: the unsolvable is unsolvable, and the utterly difficult is utterly difficult.

But there’s a fresh technology coming: quantum computing. The inflection in computing power that quantum computing inaugurates could fairly possibly break all existing cryptocurrencies. Indeed, it could break all existing cryptography. We don’t know when that moment will arrive. Perhaps it’ll be like fusion power — always thirty years in the future. But the consensus of computer scientists is shifting, and many now believe that functional quantum computers are only five to ten years away. With such an emerging potential destruction of the foundations of digital currencies within long-term view, the question is, can digital currencies be more than a gamble?

All of these considerations could be summed up in one observation: it is essential for investors, as well as for intelligent speculators, to be ruthless in realistically assessing their own ignorance. The telling that “pride goeth before a fall” is nowhere more applicable than here. The apparent simpleness and straightforwardness of digital currencies masks complexities which create risks that are not trivial to understand and quantify. If we ourselves lack the technical expertise to understand and quantify these risks, we have to rely on others whom we trust. Does that reliance cut downright against the cryptocurrency grain?

Gold, Bitcoin, and Artificial Intelligence

Last week we suggested some thoughts about the imminent arrival of artificial intelligence (AI) and machine learning, and commented on the “black box” nature of this revolution. With machine learning, we’ll have enormously functional automated systems that can suggest no account of their behavior — there will be no real response to the question, “Why did it do that?” This is simply what happens when artificial neural networks pass the threshold of complexity that they’re passing, and begin to program themselves rather than being programmed by humans.

For most people, bitcoin and other cryptocurrencies will always be black boxes. We noted a few potential weaknesses — but we are not experts, and other weaknesses may well exist in these systems that will not manifest until a major failure occurs. This is part of the problem with sophisticated systems that function as black boxes: the only way to find out when they’ll break, if they’re intractably elaborate, is to use them until they do break. And then it’s too late – for those who make that mistake, if not for the people who learn from your mistake. Most investors, when they reflect, are not impatient to become everyone else’s cautionary tale.

So while cryptocurrencies are technologically, culturally, and politically fascinating, in our view they are at this stage only vehicles for speculation, not investment. We realize, however, that the tempting prospect of outsized gains and the mythic accounts of bitcoin billionaires will inexorably pull in many speculators.

Still, we don’t believe that cryptocurrencies have yet demonstrated success in their quest to be the fresh “digital gold.” For all its drawbacks, and even tho’ we can’t store it on a flash drive, we still choose analog gold as a hedge against the malfeasance and irresponsibility of government.

Investment implications: Digital currencies are not investments. In our view, unless you have significant technical expertise, they are rank speculation. Since they marry some desirable characteristics of gold and of virtual assets, they will most likely proceed to exist — but we believe that it is unlikely to determine which of the almost 1,000 presently existing digital currencies will get through in the medium term. Longer term, there are significant questions around privacy, public comprehensibility, and the potential for quantum computing to defeat the difficult mathematical problems on which cryptocurrencies are based. For all these reasons, we think cryptocurrencies are interesting to examine, and may be joy to trade — but are not investments, and in the long run will not supersede the need for trusted intermediaries in the financial system. We believe that most investors who want to hedge against the malfeasance of government and the vicissitudes of monetary policy should keep doing it the way they’ve been doing it for Five,000 years — with gold. Cryptocurrencies have an inherent potential to unseat gold. At their current stage of development, they have not achieved that purpose. Time will tell if they can ever build up that status.

What Are Digital Currencies – And What Do They Mean For Gold? Guild Investment Management

What Are Digital Currencies — And What Do They Mean For Gold?

What Are Digital Currencies — And What Do They Mean For Gold?

All the competitors have their proponents. While some are clearly more serious contenders than others, at the end of the day, disagreement is heated even among technical experts and non-experts who pursue windfalls in digital currencies. While the excitement lasts, there will be enough stories of overnight digital currency millionaires to keep the process going, but eventually the music will stop. (Of course, speculation can be joy — as long as you recognize it for what it is.)

Digital Currencies Are Here To Stay

While picking winners and losers in the rapidly growing field of digital currencies is very elaborate, digital currencies as a entire are doing something for which there is request. While they share some characteristics with other assets, they combine those with unique characteristics of their own, and therefore they will appeal to users and speculators who want those characteristics. That means that they will proceed to exist (even if some governments determine they shouldn’t), so at some point after the dust lodges, intelligent speculators, and even investors, will need to determine whether digital currency is an asset class in which they want to hold some of their wealth.

Bitcoin was the model for rivaling digital currencies for good reason. It came up with elegant solutions to fundamental problems of exchange, which we’ll describe below. Other digital currencies, while differing in technical details, share bitcoin’s solutions in broad strokes. Understanding the technical details is not as significant as understanding the basic nature of what digital currencies are attempting to achieve, and how they achieve it. With that clear view, speculators and investors can make the essential decision of whether participation in this fresh asset class aligns with their individual goals and risk appetite — or whether they should overlook it entirely.

The very first thing to realize about bitcoin is that the entire system is rooted in a desire to eliminate financial intermediaries, and permit people transacting business to make their exchange directly with one another. Bitcoin is anarchist money. It isn’t created by a central authority, it isn’t backed by a central authority, and transactions are not confirmed by a central authority. Indeed, the bitcoin system sets out to eliminate the need for any “central authority” — whether that’s a government, a bank, or any “trusted intermediary.”

Some readers may instantaneously think, “There’s an asset like that already — it’s gold.” In the contemporary economy, gold is the asset whose ownership is at bottom a vote of “no confidence” in central authorities and the stability that they create — or at least a hedge against their failure.

What bitcoin sought to do (and what its anonymous inventor largely succeeded in doing) was to create an asset that would, like gold, be independent of governments and banking systems — but that existed only digitally, and thus had a host of other characteristics that are desirable in a digitally connected world.

Gold has mass. It takes up space. It’s difficult to divide so that it can be used in exchange. It requires physical-world vigilance and security to prevent theft. It has to be carried and physically exchanged in order to conduct transactions, which could be inconvenient and dangerous. Using third parties to perform any of these functions exposes the holder of gold to the risk of theft and fraud.

Bitcoin, on the other palm, takes up no space, and can be exchanged instantly over any distance. While it can be stolen, that theft can only occur on the edges of the bitcoin system, where it interacts with the established financial world. As it is constructed, within itself, the bitcoin system is impervious to theft and fraud (with one significant caveat, which we’ll mention below). A bitcoin wallet — truly nothing more than a set of cryptographic keys providing you the power to allocate bitcoins from your address to some other address — in cold storage, unconnected to the internet, is fully secure.

In brief, bitcoin set out to be digital gold for the digital age. Will it succeed?

The Top twenty Digital Currencies By Market Capitalization

The mechanics of digital currencies are elaborate in their actual implementation, but the broad structure is not difficult to understand.

In order to eliminate the need for financial intermediaries, any digital currency system has to solve two problems: the problem of identity and the problem of ownership.

The current global financial system also solves these problems. Central authorities — banks, governments, and courts — keep exhaustive accounts of financial assets and of the ownership of those assets, tying those accounts to identity records maintained by other authorities. When you withdraw money from your bank, the bank has a system to confirm your identity — relying on many other expansive and intrusive identity-confirmation systems within government. Then the bank has to verify your ownership of the money you’re withdrawing — using a sophisticated system of proprietary ledgers and record-keeping as well as the proprietary communications systems connecting all these records. The system functions slickly, and that smoothness hides the complexity of intermediary structures, not to mention hiding the costs these intermediary systems impose on users.

Bitcoin, on the other arm, solves the identity and ownership problems with math and algorithms. It secures ownership through cryptography. Only the possessor of the correct cryptographic key can spend the bitcoins associated with a certain address, and while the possession of that key can be verified by anyone, the key itself is never exposed to anyone. (If readers want to delve into the mechanics of public/private key cryptography, it’s an interesting and challenging subject area.) The central role of cryptography in almost all digital currencies has led to them being dubbed “cryptocurrencies.” For now, these cryptographic keys are so sturdy that no existing computer technology is even theoretically capable of compromising them.

These cryptographic technologies existed long before bitcoin. Bitcoin’s real innovation was this: it created an elegant system for the maintenance of a public, universally agreed-upon ledger of bitcoin ownership, that is maintained by a distributed network of computing knots rather than by any single, proprietary institution.

Again, the technical details of how bitcoin accomplishes this purpose are abstruse. The bottom line is that every bitcoin transaction that has ever occurred is included in a ledger called the “blockchain,” and the blockchain itself is not held by any central institution, but exists in thousands of independent “nodes” around the world. These knots challenge with one another to verify fresh transactions being added to the blockchain, and winners are rewarded with freshly created bitcoins. The competition involves a race to solve extraordinarily difficult mathematical puzzles. When a fresh, valid block is added to the blockchain, it propagates among all knots from peer to peer and is adopted as the basis for work beginning on the next block. (To fraudulently rewrite or alter the blockchain, or introduce bogus transactions, would require an amount of computing power that’s far beyond anything presently available.) Thus the system maintains a universally agreed-upon ledger describing the ownership of every bitcoin in existence — without the need for any central authorities or intermediaries.

Every digital currency solves these problems with an treatment similar to that used by bitcoin. They use cryptography to solve the identity problem, and a distributed ledger (some form of blockchain) to solve the ownership problem.

Digital Currencies: Are They What They Seem?

Digital currency creators set out to make digital gold — an asset that, like gold, needs no central authorities to back it, or to its certify ownership; but unlike gold, takes up no space, can’t be stolen, and can be instantly transmitted anywhere in the world. Did they succeed?

Yes and no. Here are some skeptical thoughts on potential cryptocurrency weaknesses — questions we think speculators and investors should ask themselves as they determine whether they eventually want to hold some of their wealth in the form of digital currency.

Very first, digital currencies claim to do away with intermediaries. But do they? Albeit we’ve sketched an enormously high-level view of how digital currencies operate, a real understanding of these systems requires a lot of intellectual sweat — and possibly, for deep comprehension, a decent grip of several fields of mathematics and computer science. Therefore, a real-world user has two options: acquire the detailed, precise skill of how the systems operate — or trust the understanding of a third party, whether a friend or an advisor acting in some formal capacity.

Personally, we would not want to hold assets about which we or a trusted advisor don’t have deep understanding. So any normal person who doesn’t have the time or inclination to become an inexperienced computer scientist is relying not on the bitcoin system’s supposedly sturdy independence, but on some trusted authority who facilitates their interaction with the bitcoin system. Despite bitcoin’s theoretical security, for almost all investors its real security will be tied to intermediaries whose trustworthiness they must judge. Sounds rather like we’re back to square one.

Even in a bitcoin world, real-life users will depend on the trustworthiness of other actors in the financial system. So trustworthy intermediaries create value, and will proceed to create value. And as unforeseen troubles occur for cryptocurrencies, that truth will, we believe, become more apparent. Of course, while physical gold in one’s private possession may present risks, those risks are much more lightly comprehended and mitigated than the risks associated with complicated and novel computer networks.

A 2nd trouble with digital currencies is privacy. Astute readers may have reflected on the public nature of the bitcoin blockchain. This is noteworthy: every bitcoin transaction that has ever occurred is preserved in the blockchain, publicly available and held in its entirety in every knot. Those transactions are identified with bitcoin addresses, which are simply long alphanumeric strings — not names. Still, data mining — especially using artificial intelligence and machine learning — may well be able to find patterns in the blockchain and marry those discoveries with outward data to tie transactions to real-world identities. (Intelligence agencies are undoubtedly already working on this. This is not idle speculation; worries about privacy have led to the creation of several bitcoin alternatives. Those alternatives, tho’, end up creating problems and weaknesses of their own.)

This privacy issue is something that gives us pause when we contemplate the proposed expansion of the blockchain technology beyond cryptocurrencies.

Several successful platforms are bringing blockchain to the world of business transactions and contracts, promising to reap the benefits of decentralization and digitization in diminished costs and enhanced efficiency. We think that privacy concerns here, too, may eventually provoke a backlash as consumers realize that blockchain technology permanently memorializes their activities in a public data base that is pseudonymous, but not necessarily impervious to attempts to extract private data. And of course, the risk of exposure of private data doesn’t just concern those who are fearful of government prying, or those who are engaged in illegal activities. Uncountable commercial transactions must remain private to safeguard businesses against the unfair advantage their competitors would have if, for example, they had detailed information about who their suppliers were. All of that is the kind of information that could be exposed through a public blockchain. Potential use of blockchain technology for financial and medical records also creates privacy issues. (Next week, we’ll explore the promises and potential problems of blockchain technology as a way to slick exchanges and reduce transaction costs entirely outside the world of cryptocurrencies.)

A third potential weakness is technological. We noted above that both of the central poles of digital currencies — cryptographic identity and blockchain construction — rely on mathematical problems. Those problems need to be either unlikely (in the case of cryptographic identity) or enormously difficult, time-consuming, and costly (in the case of blockchain construction). With current computer technology, all is well: the unsolvable is unsolvable, and the enormously difficult is enormously difficult.

But there’s a fresh technology coming: quantum computing. The inflection in computing power that quantum computing inaugurates could fairly possibly break all existing cryptocurrencies. Indeed, it could break all existing cryptography. We don’t know when that moment will arrive. Perhaps it’ll be like fusion power — always thirty years in the future. But the consensus of computer scientists is shifting, and many now believe that functional quantum computers are only five to ten years away. With such an oncoming potential destruction of the foundations of digital currencies within long-term view, the question is, can digital currencies be more than a gamble?

All of these considerations could be summed up in one observation: it is essential for investors, as well as for intelligent speculators, to be ruthless in realistically assessing their own ignorance. The telling that “pride goeth before a fall” is nowhere more applicable than here. The apparent plainness and straightforwardness of digital currencies masks complexities which create risks that are not trivial to understand and quantify. If we ourselves lack the technical expertise to understand and quantify these risks, we have to rely on others whom we trust. Does that reliance cut entirely against the cryptocurrency grain?

Gold, Bitcoin, and Artificial Intelligence

Last week we suggested some thoughts about the imminent arrival of artificial intelligence (AI) and machine learning, and commented on the “black box” nature of this revolution. With machine learning, we’ll have utterly functional automated systems that can suggest no account of their behavior — there will be no real reaction to the question, “Why did it do that?” This is simply what happens when artificial neural networks pass the threshold of complexity that they’re passing, and begin to program themselves rather than being programmed by humans.

For most people, bitcoin and other cryptocurrencies will always be black boxes. We noted a few potential weaknesses — but we are not experts, and other weaknesses may well exist in these systems that will not manifest until a major failure occurs. This is part of the problem with elaborate systems that function as black boxes: the only way to find out when they’ll break, if they’re intractably complicated, is to use them until they do break. And then it’s too late – for those who make that mistake, if not for the people who learn from your mistake. Most investors, when they reflect, are not anxious to become everyone else’s cautionary tale.

So while cryptocurrencies are technologically, culturally, and politically fascinating, in our view they are at this stage only vehicles for speculation, not investment. We realize, however, that the tempting prospect of outsized gains and the mythic accounts of bitcoin billionaires will inexorably pull in many speculators.

Still, we don’t believe that cryptocurrencies have yet demonstrated success in their quest to be the fresh “digital gold.” For all its drawbacks, and even tho’ we can’t store it on a flash drive, we still choose analog gold as a hedge against the malfeasance and irresponsibility of government.

Investment implications: Digital currencies are not investments. In our view, unless you have significant technical expertise, they are rank speculation. Since they marry some desirable characteristics of gold and of virtual assets, they will very likely proceed to exist — but we believe that it is unlikely to determine which of the almost 1,000 presently existing digital currencies will sustain in the medium term. Longer term, there are significant questions around privacy, public comprehensibility, and the potential for quantum computing to defeat the difficult mathematical problems on which cryptocurrencies are based. For all these reasons, we think cryptocurrencies are interesting to examine, and may be joy to trade — but are not investments, and in the long run will not supersede the need for trusted intermediaries in the financial system. We believe that most investors who want to hedge against the malfeasance of government and the vicissitudes of monetary policy should keep doing it the way they’ve been doing it for Five,000 years — with gold. Cryptocurrencies have an inherent potential to unseat gold. At their current stage of development, they have not achieved that aim. Time will tell if they can ever build up that status.

Related video:

Leave a Reply