Mythbusting 101: Organic Farming > Conventional Agriculture

Mythbusting 101: Organic Farming > Conventional Agriculture
By Christie Wilcox on July 18, 2011


People believe a lot of things that we have little to no evidence for, like that vikings wore horned helmets or that you can see the Great Wall of China from space. One of the things I like to do on my blogs is bust commonly held myths that I think matter. For example, I get really annoyed when I hear someone say sharks don't get cancer (I'll save that rant for another day). From now onward, posts that attack conventionally believed untruths will fall under a series I'm going to call "Mythbusting 101."

Ten years ago, Certified Organic didn't exist in the United States. Yet in 2010, a mere eight years after USDA's regulations officially went into effect, organic foods and beverages made $26.7 billion. In the past year or two, certified organic sales have jumped toabout $52 billion worldwide despite the fact that organic foods cost up to three times as much as those produced by conventional methods. More and more, people are shelling out their hard-earned cash for what they believe are the best foods available. Imagine, people say: you can improve your nutrition while helping save the planet from the evils of conventional agriculture - a completewin-win. And who wouldn't buy organic, when it just sounds so good?

Here's the thing: there are a lot of myths out there about organic foods, and a lot of propaganda supporting methods that are rarely understood. It's like your mother used to say: just because everyone is jumping off a bridge doesn't mean you should do it, too. Now, before I get yelled at too much, let me state unequivocally that I'm not saying organic farming is bad - far from it. There are some definite upsides and benefits that come from many organic farming methods. For example, the efforts of organic farmers to move away from monocultures, where crops are farmed in single-species plots, are fantastic; crop rotations and mixed planting are much better for the soil and environment. My goal in this post isn't to bash organic farms, instead, it's to bust the worst of the myths that surround them so that everyone can judge organic farming based on facts. In particular, there are four myths thrown around like they're real that just drive me crazy.

Myth #1: Organic Farms Don't Use Pesticides

When the Soil Association, a major organic accreditation body in the UK, asked consumers why they buy organic food, 95% of them said their top reason was to avoid pesticides. They, like many people, believe that organic farming involves little to no pesticide use. I hate to burst the bubble, but that's simply not true. Organic farming, just like other forms of agriculture, still uses pesticides and fungicides to prevent critters from destroying their crops. Confused?

So was I, when I first learned this from a guy I was dating. His family owns a farm in rural Ohio. He was grumbling about how everyone praised the local organic farms for being so environmentally-conscientious, even though they sprayed their crops with pesticides all the time while his family farm got no credit for being pesticide-free (they're not organic because they use a non-organic herbicide once a year). I didn't believe him at first, so I looked into it: turns out that there are over 20 chemicals commonly used in the growing and processing of organic crops that are approved by the US Organic Standards. And, shockingly, the actual volume usage of pesticides on organic farms is not recorded by the government. Why the government isn't keeping watch on organic pesticide and fungicide use is a damn good question, especially considering that many organic pesticides that are also used by conventional farmers are used more intensively than synthetic ones due to their lower levels of effectiveness. According to theNational Center for Food and Agricultural Policy, the top two organic fungicides, copper and sulfur, were used at a rate of 4 and 34 pounds per acre in 1971 1. In contrast, the synthetic fungicides only required a rate of 1.6 lbs per acre, less than half the amount of the organic alternatives.

The sad truth is, factory farming is factory farming, whether its organic or conventional. Many large organic farms use pesticides liberally. They're organic by certification, but you'd never know it if you saw their farming practices. As Michael Pollan, best-selling book author and organic supporter, said in an interview with Organic Gardening,

"They're organic by the letter, not organic in spirit... if most organic consumers went to those places, they would feel they were getting ripped off."

What makes organic farming different, then? It's not the use of pesticides, it's the origin of the pesticides used. Organic pesticides are those that are derived from natural sources and processed lightly if at all before use. This is different than the current pesticides used by conventional agriculture, which are generally synthetic. It has been assumed for years that pesticides that occur naturally (in certain plants, for example) are somehow better for us and the environment than those that have been created by man. As more research is done into their toxicity, however, this simply isn't true, either. Many natural pesticides have been found to be potential - or serious - health risks.2

Take the example of Rotenone. Rotenone was widely used in the US as an organic pesticide for decades 3. Because it is natural in origin, occurring in the roots and stems of a small number of subtropical plants, it was considered "safe" as well as "organic". However, research has shown that rotenone is highly dangerous because it kills by attacking mitochondria, the energy powerhouses of all living cells. Research found that exposure to rotenone caused Parkinson's Disease-like symptoms in rats 4, and had the potential to kill many species, including humans. Rotenone's use as a pesticide has already been discontinued in the US as of 2005 due to health concerns***, but shockingly, it's still poured into our waters every year by fisheries management officials as a piscicide to remove unwanted fish species.

The point I'm driving home here is that just because something is natural doesn't make it non-toxic or safe. Many bacteria, fungi and plants produce poisons, toxins and chemicals that you definitely wouldn't want sprayed on your food.

Just last year, nearly half of the pesticides that are currently approved for use by organic farmers in Europe failed to pass the European Union's safety evaluation that is required by law 5. Among the chemicals failing the test was rotenone, as it had yet to be banned in Europe. Furthermore, just over 1% of organic foodstuffs produced in 2007 and tested by the European Food Safety Authority were found to contain pesticide levels above the legal maximum levels - and these are of pesticides that are not organic 6. Similarly, when Consumer Reports purchased a thousand pounds of tomatoes, peaches, green bell peppers, and apples in five cities and tested them for more than 300 synthetic pesticides, they found traces of them in 25% of the organically-labeled foods, but between all of the organic and non-organic foods tested, only one sample of each exceeded the federal limits8.

Not only are organic pesticides not safe, they might actually be worse than the ones used by the conventional agriculture industry. Canadian scientists pitted 'reduced-risk' organic and synthetic pesticides against each other in controlling a problematic pest, the soybean aphid. They found that not only were the synthetic pesticides more effective means of control, the organic pesticides were more ecologically damaging, including causing higher mortality in other, non-target species like the aphid's predators9. Of course, some organic pesticides may fare better than these ones did in similar head-to-head tests, but studies like this one reveal that the assumption that natural is better for the environment could be very dangerous.

Even if the organic food you're eating is from a farm which uses little to no pesticides at all, there is another problem: getting rid of pesticides doesn't mean your food is free from harmful things. Between 1990 and 2001, over 10,000 people fell ill due to foods contaminated with pathogens like E. coli, and many have organic foods to blame. That's because organic foods tend to have higher levels of potential pathogens. One study, for example, found E. coli in produce from almost 10% of organic farms samples, but only 2% of conventional ones10. The same study also found Salmonella only in samples from organic farms, though at a low prevalence rate. The reason for the higher pathogen prevalence is likely due to the use of manure instead of artificial fertilizers, as many pathogens are spread through fecal contamination. Conventional farms often use manure, too, but they use irradiation and a full array of non-organic anti-microbial agents as well, and without those, organic foods run a higher risk of containing something that will make a person sick.

In the end, it really depends on exactly what methods are used by crop producers. Both organic and conventional farms vary widely in this respect. Some conventional farms use no pesticides. Some organic farms spray their crops twice a month. Of course, some conventional farms spray just as frequently, if not more so, and some organic farms use no pesticides whatsoever. To really know what you're in for, it's best if you know your source, and a great way to do that is to buy locally. Talk to the person behind the crop stand, and actually ask them what their methods are if you want to be sure of what you're eating.

 

Myth #2: Organic Foods are Healthier

Some people believe that by not using manufactured chemicals or genetically modified organisms, organic farming produces more nutritious food. However, science simply cannot find any evidence that organic foods are in any way healthier than non-organic ones - and scientists have been comparing the two for over 50 years.

Just recently, an independent research project in the UK systematically reviewed the 162 articles on organic versus non-organic crops published in peer-reviewed journals between 1958 and 2008 11. These contained a total of 3558 comparisons of content of nutrients and other substances in organically and conventionally produced foods. They found absolutely no evidence for any differences in content of over 15 different nutrients including vitamin C, ?-carotene, and calcium. There were some differences, though; conventional crops had higher nitrogen levels, while organic ones had higher phosphorus and acidity - none of which factor in much to nutritional quality. Further analysis of similar studies on livestock products like meat, dairy, and eggs also found few differences in nutritional content. Organic foods did, however, have higher levels of overall fats, particularly trans fats. So if anything, the organic livestock products were found to be worse for us (though, to be fair, barely).

"This is great news for consumers. It proves that the 98% of food we consume, which is produced by technologically advanced agriculture, is equally nutritious to the less than 2% derived from what is commonly referred to as the 'organic' market," said Fredhelm Schmider, the Director General of the European Crop Protection Association said in a press release about the findings.12

Joseph D. Rosen, emeritus professor of food toxicology at Rutgers, puts it even more strongly. "Any consumers who buy organic food because they believe that it contains more healthful nutrients than conventional food are wasting their money," he writes in a comprehensive review of organic nutritional claims13.

Strong organic proponents also argue that organic food tastes better. In the same poll where 95% of UK organic consumers said they buy organic to avoid pesticides, over two-thirds of respondents said organic produce and meats taste better than non-organic ones. But when researchers had people put their mouths to the test, they found that people couldn't tell the difference between the two in blind taste tests14, 18.

So, in short, organics are not better for us and we can't tell the difference between them and non-organic foods. There may be many things that are good about organic farming, from increased biodiversity on farms to movement away from monocultures, but producing foods that are healthier and tastier simply isn't one of them.

Myth #3: Organic Farming Is Better For The Environment

As an ecologist by training, this myth bothers me the most of all three. People seem to believe they're doing the world a favor by eating organic. The simple fact is that they're not - at least the issue is not that cut and dry.

Yes, organic farming practices use less synthetic pesticides which have been found to be ecologically damaging. But factory organic farms use their own barrage of chemicals that are still ecologically damaging, and refuse to endorse technologies that might reduce or eliminate the use of these all together. Take, for example, organic farming's adamant stance against genetically modified organisms (GMOs).

GMOs have the potential to up crop yields, increase nutritious value, and generally improve farming practices while reducing synthetic chemical use - which is exactly what organic farming seeks to do. As we speak, there are sweet potatoes are being engineered to be resistant to a virus that currently decimates the African harvest every year, which could feed millions in some of the poorest nations in the world15. Scientists have created carrots high in calcium to fight osteoperosis, and tomatoes high in antioxidants. Almost as important as what we can put into a plant is what we can take out; potatoes are being modified so that they do not produce high concentrations of toxic glycoalkaloids, and nuts are being engineered to lack the proteins which cause allergic reactions in most people. Perhaps even more amazingly, bananas are being engineered to produce vaccines against hepatitis B, allowing vaccination to occur where its otherwise too expensive or difficult to be administered. The benefits these plants could provide to human beings all over the planet are astronomical.

Yet organic proponents refuse to even give GMOs a chance, even to the point of hypocrisy. For example, organic farmers apply Bacillus thuringiensis (Bt) toxin (a small insecticidal protein from soil bacteria) unabashedly across their crops every year, as they have for decades. It's one of the most widely used organic pesticides by organic farmers. Yet when genetic engineering is used to place the gene encoding the Bt toxin into a plant's genome, the resulting GM plants are vilified by the very people willing to liberally spray the exact same toxin that the gene encodes for over the exact same species of plant. Ecologically, the GMO is a far better solution, as it reduces the amount of toxin being used and thus leeching into the surrounding landscape and waterways. Other GMOs have similar goals, like making food plants flood-tolerant so occasional flooding can replace herbicide use as a means of killing weeds. If the goal is protect the environment, why not incorporate the newest technologies which help us do so?

But the real reason organic farming isn't more green than conventional is that while it might be better for local environments on the small scale, organic farms produce far less food per unit land than conventional ones. Organic farms produce around 80% that what the same size conventional farm produces16(some studies place organic yields below 50% those of conventional farms!).

Right now, roughly 800 million people suffer from hunger and malnutrition, and about 16 million of those will die from it17. If we were to switch to entirely organic farming, the number of people suffering would jump by 1.3 billion, assuming we use the same amount of land that we're using now. Unfortunately, what's far more likely is that switches to organic farming will result in the creation of new farms via the destruction of currently untouched habitats, thus plowing over the little wild habitat left for many threatened and endangered species.

Already, we have cleared more than 35% of the Earth's ice-free land surface for agriculture, an area 60 times larger than the combined area of all the world's cities and suburbs. Since the last ice age, nothing has been more disruptive to the planet's ecosystem and its inhabitants than agriculture. What will happen to what's left of our planet's wildlife habitats if we need to mow down another 20% or more of the world's ice-free land to accommodate for organic methods?

The unfortunate truth is that until organic farming can rival the production output of conventional farming, its ecological cost due to the need for space is devastating. As bad as any of the pesticides and fertilizers polluting the world's waterways from conventional agriculture are, it's a far better ecological situation than destroying those key habitats altogether. That's not to say that there's no hope for organic farming; better technology could overcome the production gap, allowing organic methods to produce on par with conventional agriculture. If that does occur, then organic agriculture becomes a lot more ecologically sustainable. On the small scale, particularly in areas where food surpluses already occur, organic farming could be beneficial, but presuming it's the end all be all of sustainable agriculture is a mistake.

Myth #4: It's all or none

The point of this piece isn't to vilify organic farming; it's merely to point out that it's not as black and white as it looks. Organic farming does have many potential upsides, and may indeed be the better way to go in the long run, but it really depends on technology and what we discover and learn in the future. Until organic farming can produce crops on par in terms of volume with conventional methods, it cannot be considered a viable option for the majority of the world. Nutritionally speaking, organic food is more like a brand name or luxury item. It's great if you can afford the higher price and want to have it, but it's not a panacea. You would improve your nutritional intake far more by eating a larger volume of fruits and vegetables than by eating organic ones instead of conventionally produced ones.

What bothers me most, however, is that both sides of the organic debate spend millions in press and advertising to attack each other instead of looking for a resolution. Organic supporters tend to vilify new technologies, while conventional supporters insist that chemicals and massive production monocultures are the only way to go. This simply strikes me as absurd. Synthetic doesn't necessarily mean bad for the environment. Just look at technological advances in creating biodegradable products; sometimes, we can use our knowledge and intelligence to create things that are both useful, cheap (enough) and ecologically responsible, as crazy as that idea may sound.

I also firmly believe that increasing the chemicals used in agriculture to support insanely over-harvested monocultures will never lead to ecological improvement. In my mind, the ideal future will merge conventional and organic methods, using GMOs and/or other new technologies to reduce pesticide use while increasing the bioavailability of soils, crop yield, nutritional quality and biodiversity in agricultural lands. New technology isn't the enemy of organic farming; it should be its strongest ally.

As far as I'm concerned, the biggest myth when it comes to organic farming is that you have to choose sides. Guess what? You don't. You can appreciate the upsides of rotating crops and how GMOs might improve output and nutrition. You, the wise and intelligent consumer, don't have to buy into either side's propaganda and polarize to one end or another. You can, instead, be somewhere along the spectrum, and encourage both ends to listen up and work together to improve our global food resources and act sustainably.

 
See more on this, in response to critiques: In the immortal words of Tom Petty: "I won't back down"

More Mythbusting 101:

Sharks will cure cancer

*** Oh, it turns out Rotenone got re-approved for organic use in 2010. See for yourself.

Regarding the use of GMOs: perhaps Andy Revkin from The New York Times says it better.

Based on the responses, I just want to make this clear: this is NOT a comprehensive comparison of organic and conventional agriculture, nor is it intended to be. That post would be miles long and far more complex. My overall belief is that there shouldn't be a dichotomy in the first place - there are a variety of methods and practices that a farmer can use, each with its pros and cons. The main point here is that something "organic" isn't intrinsically better than something that isn't, and that you have to approach all kinds of agriculture critically to achieve optimum sustainability.

Ok, and while I'm adding in notes: stop citing Bedgley et al. 2007 as evidence that organic farming produces equal yields: this study has been shown to be flawed (see my comments in the follow up post to this article), and was strongly critiqued (e.g. this response article).

 
References

National Center for Food and Agricultural Policy, National Pesticide Use Database. Available from http://www.ncfap.org (Viewed 19 Nov, 2009).

Gold, L., Slone, T., Stern, B., Manley, N., & Ames, B. (1992). Rodent carcinogens: setting priorities Science, 258 (5080), 261-265 DOI:10.1126/science.1411524

Rotenone: Resource Guide for Organic and Disease Management. Cornell University. Available at www.nysaes.cornell.edu/pp/resourceguide/mfs/11rotenone.php (Viewed 19 Nov, 2009).

Caboni, P., Sherer, T., Zhang, N., Taylor, G., Na, H., Greenamyre, J., & Casida, J. (2004). Rotenone, Deguelin, Their Metabolites, and the Rat Model of Parkinson's Disease Chemical Research in Toxicology, 17 (11), 1540-1548 DOI: 10.1021/tx049867r

EFSA 2009. Pesticides used in organic farming: some pass and some fail safety authorization. European Food Safety Authority (EFSA). Available from: www.ecpa.eu (Viewed 19 Nov, 2009).

Reasoned opinion of EFSA prepared by the Pesticides Unit (PRAPeR) on the 2007 Annual Report on Pesticide Residues. EFSA Scientific Report (2009) 305, 1-106

Consumer Reports 1998. Organic produce. Consumer Reports 63(1), 12-18.

FDA Center for Food Safety and Applied Nutrition (2000). Pesticide Program: Residue Monitoring 1999. Available at http://vm.cfsan.fda.gov (Viewed 19 Nov, 2009)

Bahlai, C., Xue, Y., McCreary, C., Schaafsma, A., & Hallett, R. (2010). Choosing Organic Pesticides over Synthetic Pesticides May Not Effectively Mitigate Environmental Risk in Soybeans PLoS ONE, 5 (6) DOI:10.1371/journal.pone.0011250

Mukherjee A, Speh D, Dyck E, & Diez-Gonzalez F (2004). Preharvest evaluation of coliforms, Escherichia coli, Salmonella, and Escherichia coli O157:H7 in organic and conventional produce grown by Minnesota farmers. Journal of food protection, 67 (5), 894-900 PMID: 15151224

Dangour, A., Lock, K., Hayter, A., Aikenhead, A., Allen, E., & Uauy, R. (2010). Nutrition-related health effects of organic foods: a systematic review American Journal of Clinical Nutrition, 92 (1), 203-210 DOI:10.3945/ajcn.2010.29269

EFSA 2009. Study finds no additional nutritional benefit in "organic" food. European Food Safety Authority (EFSA). Available from: www.ecpa.eu (Viewed Jul 2011)

Rosen, J. (2010). A Review of the Nutrition Claims Made by Proponents of Organic Food Comprehensive Reviews in Food Science and Food Safety, 9(3), 270-277 DOI: 10.1111/j.1541-4337.2010.00108.x

Fillion, L., & Arazi, S. (2002). Does organic food taste better? A claim substantiation approach Nutrition & Food Science, 32 (4), 153-157 DOI:10.1108/00346650210436262

Qaim, M. The Economic Effects of Genetically Modified Orphan

Commodities: Projections for Sweetpotato in Kenya. Agricultural Economist Center for Development Research (ZEF), No. 13-1999. PDF

Mader, P. (2002). Soil Fertility and Biodiversity in Organic FarmingScience, 296 (5573), 1694-1697 DOI: 10.1126/science.1071148

Fedoroff, N. (1999). Plants and population: Is there time? Proceedings of the National Academy of Sciences, 96 (11), 5903-5907 DOI:10.1073/pnas.96.11.5903

Basker, D. (2009). Comparison of taste quality between organically and conventionally grown fruits and vegetables American Journal of Alternative Agriculture, 7 (03) DOI: 10.1017/S0889189300004641

The views expressed are those of the author(s) and are not necessarily those of Scientific American.

ABOUT THE AUTHOR(S)

Christie Wilcox

Christie Wilcox is a postdoctoral researcher in cellular and molecular biology at the University of Hawaii, where she studies venom. She is also a science blogger and communicator.

Nick Higgins

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Mining Bitcoin Has Become A Ruthlessly Competitive Business

A huge aircraft hangar in Boden, in northern Sweden, big enough to hold a dozen helicopters, is now packed with computers--45,000 of them, each with a whirring fan to stop it overheating.

The machines work ceaselessly, trying to solve fiendishly difficult mathematical puzzles.

The solutions are, in themselves, unimportant. Yet by solving the puzzles, the computers earn their owners a reward in bitcoin, a digital "crypto-currency".

The machines in Boden are in competition with hundreds of thousands more worldwide. The first to solve a puzzle earns 25 bitcoins, currently worth $6,900. Since bitcoin's invention in 2008 by a mysterious figure calling himself Satoshi Nakamoto, people have increasingly traded it for real money, albeit at a wildly varying price (see chart).

Although there are only $3.8 billion-worth of them in circulation--about twice the value of Paraguayan guaraníes in use--bitcoins have three useful qualities in a currency: they are hard to earn, limited in supply and easy to verify.

But stability is important too: just over a year ago a bitcoin was worth four times as many dollars as now. But then Mt Gox, the crypto-currency's biggest exchange, collapsed and the bitcoin bubble burst.

Critics make comparisons with 17th-century "tulip mania", and predict that bitcoin mania will fizzle out in similar fashion. On January 5th Bitstamp, another bitcoin exchange, halted operations and reported that 19,000 of the currency units had vanished in an apparent hacking attack.

The price collapse and the exchanges' woes do not tell the whole story, though: increasing numbers of businesses are accepting payment in bitcoin, including Time Inc and Microsoft; and whatever the fate of bitcoin, the technology may spawn a range of alternative crypto-currencies and provide the basis for other businesses involving such things as the transfer of assets.

When Mr Nakamoto announced his invention (but not his true identity, see book reviews, "Bitcoin: Much more than digital cash"), several digital-cash schemes, including DigiCash and e-gold, had failed, or were in their death throes. But whereas some had tried to create the electronic equivalents of bills and coins, bitcoins only exist as entries in a giant electronic ledger called the "blockchain".

This contains the history of every transaction in the coin, and copies of it are held on many computers around the world. What this means is that unlike conventional currencies and earlier digital ones, bitcoins do not need trusted third parties to handle flows of money or a "central bank" to issue it.

The computers that solve the puzzles also process transactions in the currency and update the blockchain. Every ten minutes each machine or group of machines takes a block of pending transactions, and uses it as the input for a mathematical puzzle. The first to find a solution announces it to the rest, which check that it is right, and that the transactions are valid. If a majority approve, the block is cryptographically attached to the ledger and the computers move on to a new set of transactions.

If a fraudster wanted to spend a bitcoin twice, he would need to disguise it by rewriting the ledger. To do this he would single-handedly have to control more than half of the network's computing capacity. But such a "51% attack" would be prohibitively expensive: Coinometrics, a data provider, reckons it would cost $425m in equipment and electricity.

The Economist

The enigmatic Mr Nakamoto designed the system to keep everybody honest.

For instance, successful miners have to wait for a further 99 blocks of transactions to be processed before they get their rewards--so there is a constantly refreshed pool of participants with an interest in ensuring that everyone else keeps to the rules.

The system of rewarding successful miners with bitcoin has proved an effective way to get the currency into circulation.

Operators of conventional payment systems live on transaction fees, but that business model would not have worked for bitcoin in its early days, because of a lack of users.

However, as bitcoin becomes more popular, the idea is that miners will be able to start charging significant transaction fees, and that these will become their main source of income. It will need to: the system cuts the reward for solving puzzles every four years or so.

Despite the slump in bitcoin's value--last year it performed even worse than the Russian rouble and Ukrainian hryvnia--the combined mining power on the network is still increasing, and some miners are still investing in upgrading their machines, making this one of the fastest-moving parts of the IT industry.

Brew your own money

In the crypto-currency's early days, most miners were small-scale, trying to mint money on their home computers. This was Mr Nakamoto's libertarian dream: home-brewed money, without the need for central authorities. But as bitcoin's value rose, it all became more businesslike. Individual miners started to combine their computing power and share the rewards. Most mining today is provided through such "pools".

Startups from all over the world began building specialised hardware powered by custom-built chips, known as application-specific integrated circuits (ASICs). Leaving the amateurs behind, these firms soon became locked in a digital arms race. Microprocessors usually double their power every 18 months, a rhythm called Moore's law. In the case of mining ASICs, this doubling has occurred every six months.

Mining has also moved into the cloud. Firms have started selling online mining capacity in "gigahashes per second", or Gh/s--that is, for a fee they will provide enough computing power to make one billion attempts a second to solve a "hash function", as the puzzles are called. For instance, Genesis Mining charges $702 for 1,000 Gh/s plus a small fee for electricity.

Given the nature of the business, one would expect the bosses of bitcoin-mining firms to be super-geeks. But instead of coming from Silicon Valley, they typically hail from places like Sweden and Georgia--and talk (and often look) more like real miners. "I'm no libertarian but a businessman," says Sam Cole, the "C" in KnCMiner, the operator of the giant mining facility in Boden and a maker of mining computers.

Like other energy-intensive industries such as smelting aluminium, minting bitcoins is more efficiently done at scale, and in places where electricity is cheap and reliable.

It also helps to be somewhere cold, to reduce the cost of cooling the machines. KnCMiner's hangar is near the Arctic Circle and right next to a hydroelectric dam.

The makers of mining computers benefit from the way the bitcoin system adjusts the difficulty of the puzzles, every two weeks, according to how much computing power is hooked up to the system.

In theory the difficulty can be adjusted in both directions: upwards, to ensure that the system does not get swamped by an excess of prize-seeking machines; and downwards, to encourage miners to keep their machines online when things get too quiet.

But until now the difficulty has mostly gone upwards: since the first ASIC chips were introduced in early 2013, it has increased by a factor of 10,000. As a result, new mining computers, which each cost several thousand dollars, have been becoming obsolete in a matter of months.

When the bitcoin price was rising, many of its fans thought investing in mining equipment was a better bet than simply buying and holding the currency. They were willing to plunk down top dollar months ahead of delivery of the computers. These advance payments allowed KnCMiner and other makers to manage without having to raise any financing.

What happens in the wake of the bitcoin price collapse is unclear. The long queues for mining rigs have dispersed. Demand for renting cloud-based hashing-power is stagnant.

Many equipment-makers have ended up running the machines for their own benefit--and selling some of their stock of bitcoins to cover costs. Some people say this is why the currency has kept falling.

People in the industry are already discussing at what price mining becomes unprofitable. But Mr Cole is unfazed. Where others see a weak price, he just sees all the bitcoin yet to be mined, and lots of struggling rivals set to exit the business.

He recently raised $14m in venture capital, looking forward to a bigger slice of a less competitive market. If other miners do give up, the difficulty of the puzzles may fall--so winning bitcoins would get easier.

Perhaps it is a good thing that the breakneck growth of a year ago has ended: had it continued, the system would soon have hit the limits of its capacity. The bitcoin protocol in its current form can only process seven transactions per second--nothing compared with the capacity of conventional payment systems such as Visa, which can handle 10,000.

Not very green

A more fundamental worry is that digital-currency mining, like other sorts of mining, has environmental costs: all that number-crunching uses a lot of electricity, and not all of it comes from renewable sources, as it does in Boden.

The rapid development of the ASICs chips has made the machines more efficient, but even if all mining worldwide were carried out in modern facilities like Boden's, the combined electricity consumption would be 1.46 terawatt-hours per year--the consumption of about 135,000 average American homes.

A bigger concern is that, as the mining pools have got bigger, it no longer seems inconceivable that a bunch of miners might amass enough capacity to dominate the system and become capable of mounting a 51% attack. Last June one pool, GHash.IO, had the bitcoin community running scared by briefly touching that level, before some users switched to other pools.

Such is the complexity of the system that some analysts wonder if it might be possible for a rogue pool to launch an attack with a much smaller share. And the truth is that no one is sure how concentrated the industry already is. About a fifth of mining power is classified as "unknown", meaning it is not clear who owns it.

Chances are that many of these mystery machines live in China. At any rate, mining is likely to grow rapidly there. Miners in Inner Mongolia--where electricity is cheap thanks to abundant coal, over-investment in power plants and lax environmental rules--are reportedly building data centres much bigger than any in the West.

"I've always feared that mining will concentrate in a few countries," says Yifu Guo, a founder of Avalon, a designer of mining chips. He even worries that a hostile government might seize control of the bitcoin system. Others worry that it might, at least, end up as a monopoly.

Whether the bitcoin system can avoid such outcomes will depend on whether its participants can agree on reforms to stop it becoming too concentrated. However, it may have become too successful for its own good: when billions are at stake, vested interests tend to defend the status quo.

As with the internet, the governance of bitcoin follows the principle of "rough consensus and running code". Everybody can pitch in on online forums. If there is general agreement and the solution has proved workable, the system's software code is updated by one of its five main developers--who "emerged" as pre-eminent figures during bitcoin's early days.

Then follows the real test: whether miners accept the changes. They "vote" in favour of a software update by installing it on their machines. And it only becomes part of the system if a large majority do so. That has not been a problem so far. But miners may still balk at any future changes they fear could cost them money.

Gavin Andresen, one of the five main developers, is optimistic this can be avoided. If miners did block better solutions, there would be a "fork", meaning that a part of the bitcoin community would start a new currency.

Some groups have already launched their own crypto-currencies. Many of these "altcoins" are the bitcoin equivalent of stock markets' highly speculative "penny stocks". But some offer real innovation: Ripple and Stellar do away with mining altogether and use other mechanisms, such as voting, to create the currency and update the blockchain.

Now there is much talk about "side-chains", new blockchains pegged to that of bitcoin in such a way that the currency and other assets can be transferred between them, which could unleash even more experimentation.

Other groups are using the blockchain in ways Mr Nakamoto never intended. Some, such as CoinSpark, are offering services to transact in any asset over the network, including stocks and bonds, or use it for notarized messaging (by embedding the location and a summary of the message in a bitcoin transaction).

Where all this may lead to is a constellation of linked crypto-currencies and blockchains, with all sorts of uses: stores of value, means of exchange, mechanisms for transferring assets and verifying transactions, whatever. The original bitcoin may remain at the centre of this constellation--or not.

Whether its price recovers from last year's slump may not matter. Whoever and wherever he is, Mr Nakamoto can be proud of having unleashed a wave of financial innovation, and founded what looks set to become a sizeable new branch of the global IT industry.

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Is Bitcoin the Future?

Below is the November 30th Thoughts from the Frontline, republished in full.

Bitcoin is a topic of discussion almost everywhere I go. My introduction to Bitcoin came when I was speaking at a gold conference in Palm Springs and three bright-eyed, bushy-tailed college students approached me with a video camera and asked for my thoughts on Bitcoin. Noting my confusion, they began to evangelistically espouse the virtues of Bitcoin and tell me how it would save us from the evils of the Federal Reserve. I kept from rolling my eyes (you do want to encourage passion in the young) and mentioned a meeting that I had to go to – at that very moment as it turned out.

Since that time Worth Wray and I and our entire team at Mauldin Economics have done a great deal of research on Bitcoin.  We will soon release a video documentary that is one of the best productions I've ever been involved with and that does a good job of explaining both the controversy around Bitcoin and its considerable promise. We talked with skeptics, enthusiasts, and people willing to put up tens of millions of dollars betting on the future of Bitcoin.

Worth Wray has written this week's letter as a summary of what we know about Bitcoin. Delving into its history and bringing us up to date, he also offers a glimpse of the future. At the end of the letter I offer a few of my own thoughts on the relationships among gold, fiat money, Bitcoin, and financial transactions.

If nothing else, Bitcoin offers a provocative way to think of the future of money. Now let me turn it over to Worth.

Is Bitcoin the Future?

By Worth Wray

"Growth demands a temporary surrender of security."

– Gail Sheehy

"When people write the history of this thing, of bitcoin, they are not going to write the story of 6 million to a billion. What is truly remarkable is the story of zero to 6 million. It has already happened! And we're not paying attention! That's incredible. That's what had one chance in a million, and it already happened."

– Wences Casares, Founder & CEO of Xapo

"[Virtual currencies] may hold long-term promise, particularly if the innovations promote a faster, more secure and more efficient payment system."

– Ben Bernanke, Chairman of the Federal Reserve, USA

Yusko's Rule

Before I teamed up with John Mauldin in July 2013, I worked as the portfolio strategist for an $18-billion money manager in Houston that, among its other businesses, co-managed (with an elite team of investors from the university endowment world) one of the largest registered funds of funds in the United States.

I had a front-row seat for every investment decision in a multi-billion-dollar portfolio for almost five years, and for a bright-eyed kid from South Louisiana it was a life-changing experience that no graduate school in the world could have offered… an opportunity to learn from some of the most experienced minds in finance and hone the skills I would need to identify disruptive macro trends and build more balanced portfolios with those forces in mind.

That opportunity to learn, not just about investments but also how to think about emerging trends, continues to inform everything I do today; and Morgan Creek Capital Management's Mark Yusko – a man who has built his career on incorporating investment talent and macro themes into highly diversified portfolios – continues to be one of my most important teachers.

In the course of his daily business (which involves bouncing around the world searching for new ideas and world-class talent), Yusko has evolved a rule for vetting new ideas:

If I hear something once, I remember it. If I hear it twice, I write it down. If I hear it three times, I do something about it.

It sounds simple, as the most valuable investment insights usually are; but Mark is not just talking about "new" ideas that appear on the front page of the New York Times or the opening segment of CNBC's Squawk Box. He's saying that in the course of tapping into a large pool of truly world-class thinkers – who range from hedge fund legends like Julian Robertson and Stanley Druckenmiller to venture capitalists like David Hornik and Marc Andreesson – it pays to pay attention.

Innovative ideas can grow into consensus views and missed investment opportunities before our very eyes in a world awash with information. With constant access to the web through our computers, tablets, and smart phones, it's easy for investors to filter out valuable information in an effort to cut through all the noise; but even still, it's possible to catch emerging trends early enough in their life cycles by holding to a homework rule: When an idea comes up over and over again – especially when it's validated by experienced investors who command and influence vast sums of capital – it's not necessarily time to buy, but it's time to do your homework.

And when it comes to Bitcoin, I should have done my homework earlier.

Thank goodness it's still early…

What is Bitcoin, Anyway?

Bitcoin is a peer-to-peer digital currency that trades on public exchanges and can be instantly transferred between any two people anywhere in the world with the speed of an email… and at FAR lower cost than for transactions processed through the traditional financial system.

While a lot of people have experimented with digital currencies in the internet age, Bitcoin's mysterious creator, "Satoshi Nakamoto," was the first person to solve the issue of "double spending" in a completely decentralized network, meaning that all transactions are made directly between parties, with no middlemen, yet in a way that is verifiable across the entire network and virtually impossible to counterfeit.

Much like the internet itself, the Bitcoin hive is essentially a distributed network of computers and people that are relying on a common technological process – the Bitcoin protocol – to confirm and validate every transaction made, using a unit of account called a "bitcoin" that can be broken down into fractions, thereby enabling previously impossible micro-transactions.

The genius behind the Bitcoin protocol is an element of the system called the "blockchain" – essentially a giant, globally shared ledger of every bitcoin and every transaction in the history of the network. Whenever two people follow through with a transaction, it is broadcast throughout the entire network, and the blockchain expands as that exchange is automatically lumped together with other transactions in a new "block."

While it requires a MASSIVE amount of computing power to verify, confirm, and record every transaction that occurs within the network, it's basically a self-funding system.

Bitcoins are created through a process called "mining," which happens to be the same mathematical process that seals blocks of new transactions onto the blockchain by verifying that every exchange is valid and using real bitcoins. By rewarding "miners" with new bitcoin for devoting their time and computing power to maintenance of the blockchain, the Bitcoin protocol provides the incentive for the network to continue running in a completely decentralized manner.

In the early days, the mining process could be competitively and profitably run from a series of graphics cards linked to a home computer, but in recent years bitcoin mining has become a BIG business. Today, a lot of the mining is done on massive server farms in places like Iceland, where temperatures are cool and power is cheap.

There is an upper limit of 21 million bitcoins that can ever be minted, and the protocol is designed to release a "reward" of a new bitcoin every 10 minutes until every unit of the digital currency has been created. As of today, roughly 13.5 million bitcoins have been mined, with roughly 7.5 million to go.

Source: Coinbase

On paper, Bitcoin is an elegant and efficient way to streamline a global payments system; but in practice, the web of businesses and support structures around the Bitcoin protocol must pass a wide range of tests, from storage security and compliance to the creation of tradable derivatives and merchant adoption, before any kind of digital revolution can begin.

That said, Bitcoin – or something like it – has the potential to do for finance what the internet has done for communications and commerce… and we're already six years into the process.

Bit by Bit

When I heard about Bitcoin for the first time, I dismissed it almost immediately. It seemed like a half-baked scheme cooked up by a bunch of technically skilled but financially naïve computer nerds to disrupt a global financial system that none of them really understood.

Early adopters espoused ideas about freeing the individual from the tyranny of a government-controlled money supply; but in order to pull off their grand vision, Bitcoin's programming forefathers had to convince enough people to put their trust in the system – without governments shutting them down in the process. It seemed unlikely.

In the early days – 2009 and 2010 – a single bitcoin traded for pennies… – but its value was basically unknowable. The digital currency had virtually no daily trading volume; its price swung around wildly (volatility that only became more pronounced over time); and aside from experimental transactions within a small online community, it was virtually useless as a reliable unit of account or medium of exchange.

Internet legend has it that the first real-world Bitcoin transaction was a long-distance arrangement made on May 18, 2010, between an American programmer named Laszlo Hanyecz and a fellow enthusiast he met on the Bitcoin Talk forum. Apparently, Hanyecz offered to pay 10,000 bitcoins to anyone willing to buy him pizza, and an Englishman took him up on the offer… making an international phone call to a Papa John's in Jacksonville, Florida, in exchange for roughly $25 in bitcoins at the then-current exchange rate.

I can't help but wonder if that Englishman turned around and spent his 10,000 bitcoins or saved them for a rainy day. At today's US dollar exchange rate, they would be worth nearly $3.8 million.

 

The second time I heard about Bitcoin (about a year later), it sounded a lot more interesting as a medium of exchange; but it seemed imminently doomed by regulation. The virtual currency had risen from a price around of $0.0025 the day of Laszlo Hanyecz's pizza purchase to nearly $30 in early 2011 as Bitcoin became the basis for real-world transactions within the Bitcoin community… and the preferred medium of exchange for nefarious activities on the web.

 

Following the embarrassing release of US diplomatic cables to the general public in late 2010, the US government organized a financial blockade against the hacker/whistleblower Julian Assange and his nonprofit firm WikiLeaks. When Bank of America, Visa, Mastercard, PayPal, and Western Union refused to transmit donations to WikiLeaks, the nonprofit started accepting donations in Bitcoin.

As the price of Bitcoin began to rise, it saw another big uptick in volume when an online black market named Silk Road launched in early 2011, enabling the sale of illicit drugs and forged IDs exclusively in exchange for Bitcoin.

Business boomed, and the Bitcoin community expanded from computer nerds to mischievous hackers and anonymous drug dealers who wished to skirt the financial system and/or the eyes of the law. And for the libertarians and anarchists who embraced Bitcoin as an anti-QE investment at this stage, it essentially became an enlightened bet against corrupt governments.

Matt Habel

Teething Issues

Within a few months the price of Bitcoin surged to nearly $30… and then Mt. Gox, the most popular Bitcoin exchange, was hacked and trading suspended for several days in June 2011.

In the following months the price collapsed by roughly 90% to less than $3, but that was not the end of Bitcoin.

"Naturally there were teething issues," my friend Grant Williams explained in his April 2013 letter, "Bit Happens," "exchanges were hacked and wallets full of bitcoins stolen after being left unprotected on users' computers; and [there was] much bad press… but slowly and steadily the marketplace weathered the growing pains and, as more and more merchants began accepting payment in bitcoins, the community broadened into something more than just a weird underground movement."

Trading volume increased in the months that followed, and the price of Bitcoin trended upward, albeit in volatile fashion with two 35%+ drops in 2012:

 

But Bitcoin generally stayed under most investors' radars until March 16, 2013, when a banking crisis in Cyprus sent savers across southern Europe scrambling for a way to get their money out of harm's way.

Google searches for the word bitcoin surged to all-time highs.

Source: Google Trends

Although the financial risks to the Cypriot banking system were rather obvious to economists in the months leading up to the panic, it struck almost without warning for most citizens, explains Sovereign Man's Simon Black:

On Friday, March 15, 2013, practically everyone in [Cyprus] went to bed thinking that everything was just fine. Many had probably gone to the bank that very day to do business, or logged on to an Internet banking platform.

Yet the very next morning, they woke to a completely new reality: the nation's banks were broke, and the government was in no position to rescue them.

All the promises they had been told about government guarantees and having a 'well-regulated', sound banking system turned out to be lies. The government proclaimed a bank holiday, and banks remained closed for the next several days. Accounts were frozen and ATM withdrawals were limited to only 100 euros a day.

Eventually the plan materialized [as a hard-line demand from the island nation's German creditors]: substantial portions of deposits over 100,000 euros would be confiscated in exchange for equity in the banks. (Just imagine – Bank of America, RBC, or Lloyds takes your money and gives you stock certificates that subsequently plummet in value!)

And for everyone else, severe capital controls were instituted – some of the worst in decades.

Here again we see a peculiar property of Bitcoin: its value is bid up in a time of desperate uncertainty, and it is able to circumvent the traditional banking system and government-imposed restrictions on capital flows.

Savers in Cyprus could convert their cash to Bitcoin in an effort to escape local capital controls, but most of their funds had already been locked up in the bank holiday, aside from 100 euros a day, which in aggregate had a meaningful effect on Bitcoin's price.

The burning question at that moment was how much Cypriot savers could expect to recover. Their fate was a warning to savers in other fragile Eurozone member states. With the rising fear that the same kind of policies could be imposed on their countries next, savers in Greece, Spain, Portugal, etc. started abandoning their euro-denominated bank accounts for the "safety" of Bitcoin.

In the event of contagion and banking collapse, Bitcoin balances could be moved out of the country rather than getting clogged in the system… and so the price naturally surged to a peak of $230 by early April 9, 2013.

But with more trading volume than the exchange could handle, problems arose, and hackers attacked, forcing another trading halt and making off with over $8.5 million in customer bitcoins. Then the idea of widespread levies on Cypriot bank accounts was dropped, and fears subsided across the Euro area. The price of a bitcoin fell more than 60%, although it remained far above its pre-crisis peak of $47.

With the virtual currency in the news and on the periphery of my radar screen, this was the third time I was forced to think about Bitcoin. I assumed the price surge would be the beginning of a government crackdown and the likely legal death of the experiment… so I continued to ignore it as an investment opportunity. Wrong again.

Bitcoin fell back into relative obscurity for several months, as indicated by Google searches:

 

Source: Google Trends

But rather than cracking down on Bitcoin itself, the US government went after nefarious dealers like Silk Road and effectively found itself invested in the virtual currency (which it later auctioned off to the general public).

Despite the price collapse, Bitcoin had caught the world's attention, and venture capitalists started pouring real money ($88 million in 2013 compared to $36 million in 2012) into a wide range of related businesses, from wallet providers and exchanges to payment processing and other financial services. That meant not only an injection of capital but also a massive influx of expertise into an industry still dominated by inefficient and/or poorly run firms.

At that moment, it started to seem that Bitcoin might just change the world.

Bitcoin downloads spread like wildfire across the emerging world by the summer of 2013…

… and the search term bitcoin was suddenly more popular than ever:

 

Then China's state-owned TV station, CCTV, aired a documentary on the crypto-currency around the same time that serious cracks started to show in China's "miracle" economy. Suddenly China's credit markets were acting more erratically than during the global financial crisis, and Bitcoin saw its greatest surge in demand to date – again as a way of circumventing the traditional banking system and the limited mix of financial assets available to Chinese investors.

As China's interbank market began to freeze in the summer of 2013, John and I were watching closely. Here's an excerpt from the August 31, 2013 Thoughts from the Frontline, "How Do I Hate Thee":

The next chart shows the recent price spike in the Chinese SHIBOR (their short-term interbank rate, more or less equivalent to LIBOR). It is difficult to trust any of the economic data (positive or negative) coming out of China, so we really do not know whether China's growth story is simply moderating or whether we are seeing a hard landing in progress; but the sudden shock in interbank lending rates is an important sign that all is not well in the Middle Kingdom. The big question: is the recent SHIBOR spike a harbinger of a banking crisis, or does it presage an RMB devaluation? Interbank rates do not spike from 3% to 13% (in about 2.5 weeks) in a healthy economy, and a big event along these lines in China would have enormous implications for global growth.

 

As I've written over the course of the past year, John and I have been nervously watching China's slowdown and have voiced real concern over the possibility of capital flight if and when a debt crisis bubbles over; but we clearly underestimated the role that Bitcoin was already playing in China.

By late November 2013 demand for the virtual currency had grown so fast in the People's Republic that BTC China quickly became the largest Bitcoin exchange in the world, and over 100,000 bitcoins were trading every day in China alone:

The price of Bitcoin surged by more than 10x, from $87 to over $1000, as Chinese savers piled in…

 

… until emerging-market central banks in places like China, India, Taiwan, and Thailand started to grasp the threat that Bitcoin's rise posed in a world where US monetary policy was tightening and capital flows could reverse dramatically.

While the People's Bank of China did not explicitly ban owning or mining Bitcoin, it issued a statement in December 2013 saying that the virtual currency was "not a currency in the real meaning of the word" and that "it cannot and should not be used as a currency circulating in the market."

In addition to firm language intended to cool the speculative fever among Chinese investors, the State Council mandated a series of prohibitions on Bitcoin trading and forced banks and other payment institutions to refrain from dealing in the cryptocurrency… warning that virtual currencies like Bitcoin posed "a risk to the public interest and legal status of the renminbi."

In other words, the People's Bank of China all but spelled out that Bitcoin was an avenue by which local savers could circumvent long-standing Chinese capital controls. If Chinese investors continued to pile into Bitcoin, they could set up a situation where capital could leave very quickly in the event of a panic… or, in the meantime, the money could leave temporarily and then "round-trip" its way back into the Chinese economy, seeking the benefits afforded only to foreign investors.

From its peak in early December 2013, the price of Bitcoin fell more than 40% before finding its bottom. And the average daily trading volume in China fell from over 100,000 in November 2013 to only 2,000 today.

As if the crackdowns in China and other emerging markets in December 2013 and January 2014 were not enough, rumors began to swirl in February that the world's largest Bitcoin exchange, Mt. Gox, had been hacked and more than $460 million in customer Bitcoin had been stolen.

In a Wired magazine article published in March 2014, "The Inside Story of Mt. Gox, Bitcoin's $460 Million Disaster," Robert McMillan explained it was not just one-time event but a "years-long hack," dating back to the June 2011 incident. "According to a leaked Mt. Gox document… hackers had been skimming the company for years."

Mt. Gox quickly went offline and collapsed into bankruptcy. It was a devastating blow to confidence in the entire Bitcoin system. With the shock that client accounts could be so insecure for so long, the value of Bitcoin plummeted another 60%+ in the following months.

With the successive blows, Bitcoin fell from nearly $1,200 in early December 2013 to less than $360 by April 2014 – a whopping 70% loss.

And then I really started paying attention.

At a dinner following John's annual Strategic Investment Conference in San Diego, Raoul Pal (author of Global Macro Investor and co-founder of Real Vision TV) helped me to see Bitcoin in a totally different light. He explained that Bitcoin could be as transformative for finance as the internet has been for commerce and communication, and it could happen FAST… especially if central banks and governments mismanage the next global downturn to the detriment of a highly leveraged, highly interconnected financial system. Or, in a less extreme scenario, the Bitcoin protocol could quietly but steadily replace the decades-old payment system that underpins the current system.

Up to that moment I had never really taken the time to understand the technology behind Bitcoin or how it could change the world… but the sudden fall in valuation was interesting. I had seen a lot of chatter about Bitcoin's wild price swings in the media and on Twitter (feel free to follow us at @WorthWray and @JohnFMauldin), and I had heard wild claims from Libertarians and anarchists that this Bitcoin would soon replace the US dollar and all other forms of fiat money. I knew Bitcoin was an interesting way that money could flow freely around government-imposed capital controls in the emerging world. But until that moment I completely failed to grasp what Bitcoin could really mean for the global financial system.

I'll omit the finer details of my conversation with Raoul, but suffice it to say that it kicked off the six-month research project that has inspired and enabled this letter… and pushed my wife, Adrienne, and me to start buying some Bitcoin of our own… not as an all-out bet on Bitcoin's future but as an option on its development. Either Bitcoin becomes a new foundation stone of the global financial system – delivering a handsome return in the process – or it will give way to something even more powerful. It's a pretty binary range of outcomes, but it's worth taking on some exposure with a small percentage of our savings.

The Five Phases of Adoption

In an effort to understand how Bitcoin could continue to mature, I sat down with Barry Silbert, founder of the Bitcoin Investment Trust. As one the most active venture capitalists in the industry (with investments in over 30 bitcoin-related portfolio companies through the Bitcoin Opportunity Corp), Barry has gone all-in on Bitcoin and Bitcoin-related businesses.

He believes the halting rise of Bitcoin from 2009 to 2014 is just the beginning… and that the virtual payment system may be approaching a big inflection point as Wall Street takes the baton from Silicon Valley.

Barry thinks about Bitcoin adoption in five general phases:

1. Experimentation phase (2009 – 2010)
   • No real value associated with Bitcoin. Hackers & developers playing around with the source code. Experimenting with Bitcoin as a medium of exchange.

2. Early adopters phase (2011 – 2013)
   • Interest from investors and entrepreneurs started to grow with substantial press coverage in the wake of the Silk Road bust. First generation of Bitcoin-related companies (exchanges, merchant processors, wallet providers, etc.) started. Potential began to shine through poor management.

3. Venture capital phase (2013 – present)
   • World-class VCs started investing in Bitcoin companies, and rapid ramp-up is already outpacing the early days of the internet. VCs poured more than $90 million into Bitcoin-related businesses in 2013 and are on track to invest more than $300 million in 2014 (compared to $250 million invested in internet-related businesses in 1995).

4. Wall Street phase (2015?)
   • Institutional investors, banks, and broker-dealers begin moving money into Bitcoin. Rising price and volume (in addition to development of derivatives) become the catalyst for mass adoption as retail investment follows.

5. Global consumer adoption phase (?)
   • Only happens if (a) companies continue to innovate and make it easier for consumers to buy, hold, and spend Bitcoin, (b) volume expands dramatically so that large merchants can start accepting payment in Bitcoin, and (c) Bitcoin awareness continues to rise with these developments.

If Barry is right, Bitcoin's continued rise depends on (1) Wall Street money flowing in to deepen the digital currency's trading volume and fuel the development of hedging instruments, (2) continued innovation to make Bitcoin more secure and more user friendly, (3) broad acceptance by merchants as a medium of exchange, and (4) an explosion in public awareness.

It's impossible to know for sure yet… but it looks like all four of those are taking place.

Satoshi's Revolution Crosses the Chasm

While search volumes have moderated, the trend in broad public interest is rising.

Source: Google Trends

And while the price of Bitcoin has continued its downward trend, it seems that the network continues to deepen and mature.

 

Over time, many investors have realized that it was not a problem with the Bitcoin protocol that allowed the security breach at Mt. Gox or the frequent theft of unsecured bitcoins, it was inadequate security – basically, poor business practices – at the exchanges and wallet providers. Rather than exposing some flaw in Bitcoin, the collapse of Mt. Gox revealed the desperate need for better management and the opportunity for improving the services that surround the Bitcoin network. And the venture capital community has certainly responded.

This year, by the end of Q3 2014, over $290 million of venture investments had flowed into Bitcoin-related businesses, compared to the $250 million that poured into internet-related businesses in 1995.

 

Source: CoinDesk

And the trend toward greater average daily trading volume has continued to rise.

Source: Blockchain.info

Not only is real money starting to flow into the growth industries surrounding Bitcoin, but real businesses are starting to accept bitcoins as payment. At the end of Q3 2014, the top eight companies accepting payments in Bitcoin had annual revenues totaling more than $85 billion, and among them was Dell.

 

Source: CoinDesk

The price of Bitcoin may swing dramatically in the coming days, months, quarters, and years. The currency may not survive in its current form… but the technology underpinning it is not going away any time soon.

Thoughts on Bitcoin from John

If you ask me whether I truly believe that in 2050 the main medium of exchange will be paper money, the very quick answer is that I don't. I also think there is a better than reasonable chance that it won't be a fiat currency. But will it be Bitcoin? My best guess is that it will not be Bitcoin as currently constructed but rather an evolved version.

I know the following will be somewhat controversial, but work through with me on what I hope will be a helpful way to think about money in general. The current structure of Bitcoin carries the same inherent flaw that gold does (and to some extent the euro, too): in a world of ever-increasing abundance, gold is massively deflationary and provides unreasonable "rents" to those who hold it. Even given that inherent flaw, it has been the most stable store of value for millennia.

To think about what money will be in the future you have to shake off the chains of the past and your preconceived notions of what money is. Money is not just, or should I say, is more than a medium of exchange. It is also a medium of information. It tells us what the marketplace wants and the price it is willing to pay for a particular good or service. The (often fatal) flaw in fiat currencies is that they manipulate and distort the information contained within the currency, thereby damaging the information flows involved in the exchange of goods and services. For instance, the practice of quantitative easing engaged in by major central banks has encouraged money to go into certain markets (such as stocks), distorting the information reflected in the price.

Rather than looking for the information provided by the market and adjusting our investments and purchases accordingly, we are forced to focus on the information provided by the Federal Reserve and its quantitative easing. To confuse the actions of the Federal Reserve with the actions of the market is to miss the point that the Federal Reserve is actively manipulating the market for its own purposes, however positively motivated.

Advocates of gold believe that a gold-backed currency would eliminate that price distortion, and they have a point. However, if we were to decide to use gold as the sole basis for our currency, we would have to value it at some order of magnitude higher than it is today in order not to create massive deflationary instability. I'm not sure that $10,000 or even $20,000 per ounce of gold would be nearly high enough, given the massive amount of sovereign debt in the world.

But even supposing that we (as a global system) could somehow manage to deal with the logistical nightmare of moving to a single, physical, commodity-backed currency, future growth in the world would soon overwhelm the limited supply of gold, and the prices of goods and services would deflate over time, creating their own backlash. History buffs will recall William Jennings Bryan and his famous cry, "We [mostly referring to farmers] will not be crucified on a cross of gold!"

Now some might see ever-falling prices as a good thing, but they would induce a different type of instability in the system. Given the overwhelming extent of global debt, I think the chances of moving to a physical currency based on gold are slim to none, and Slim left on the morning train. Go back and read the economic history of the latter half of the 1800s in the US. From one point of view it was a golden era of growth and prosperity driven by huge leaps in technology. But it created serious problems for many of those on the lower economic rungs. If you think income inequality is a problem today, then you won't like what happened in the late 1800s.

The leaders of that era came together to try to create a new system that could prevent the frequent panics and crashes that were inherent in the financial system of the day, and eventually we got the Federal Reserve and other ostensible improvements. But that does not mean the current system of central banks and fiat currencies does not have its own flaws. We should not limit our thinking to the economic systems of the past or present as we think about a future economic system. How do we create a truly stable, equitable, and efficient basis for exchange?

While I think that Bitcoin as currently configured has limitations, the technology of the blockchain is one of the most potentially revolutionary developments of the last century. I think we evolve to Bitcoin 2.0 or 3.0, using the same blockchain technology, but with a way to make the new currency a truly stable medium of information that can be easily exchanged for goods and services.

Why not create a currency that is backed by a number of commodities, with gold perhaps as the backbone? Why even limit ourselves to commodities? Bitcoin as currently configured could be part of the basket. Anything that can be represented in a digital form and has a reasonably stable long-term value could be considered.

All I want from my currency is to be able to buy and sell goods and services, make investments, and have a reasonable expectation as to what my currency will be worth in terms of purchasing power if I hold it for months or years.

I think that some of the clever venture capitalists who are exploring Bitcoin will join forces with one or more large international investment banks and create something along those lines. And once someone shows the way, breaking the chains of the past, we will have a period of innovation rivaling the Cambrian explosion.

The vast majority of my purchases are electronic today. I think that percentage will continue to grow. Frankly, I really don't care what happens inside "the system" after I wave my iPhone over the new Apple Pay device (or use my credit card). I just want to walk out of the store with my purchases. (In the not too distant future there will be an extremely tiny RFID chip embedded in my hand, or at least on my person, which will also serve 100 other purposes.)

The Bitcoin blockchain technology allows for the most secure electronic transactions ever devised. Its adoption and acceptance seem inevitable to me. It will be used to validate everything we purchase: stocks, homes, investments, airplane tickets, etc. It will be a far cheaper and much more secure way to validate your ownership of anything, from your home to your stocks.

The blockchain will form the basis for the perfect medium of information exchange (at least as perfect as we humans can create), which in turn will be the basis for whatever electronic medium of financial exchange we evolve in the future. The market (that would be you and me) will move to whatever new medium serves our purposes best.

Satoshi, as technologically brilliant as he (or she or they) was, was limited in his understanding of economic exchange. He was trying to create electronic gold. To some degree, he was confusing technology with money. He was trying to overcome the flaws of our current monetary system (a very laudable goal, I might add) but limited himself to thinking within the box in which the current monetary system placed him.

The next generation of Bitcoin developers are going to crawl out of that box and create whole new realms of possibilities. Once you realize that money is just information, and all you need to do is to provide the most stable mechanism of the transfer of information, you turn thinking about money on its head.

This is going to be massive amounts of fun to watch.

Staying Close to Home

Thanksgiving and its aftermath has been a relaxing time for me, letting me charge my batteries for the rather large amount of work that I must do before the end of the year. There is a lot to think about. While there are a few potential trips in December, I will spend the bulk of my time here in Dallas before my travel schedule picks up next year.

It's time to hit the send button. I think I will close the letter without my usual personal comments. Have a great week!

Your excited about all the innovations coming in our future analyst,

John Mauldin

subscribers@mauldineconomics.com

The article Thoughts from the Frontline: Is Bitcoin the Future? was originally published at mauldineconomics.com.

Cryptocurrency

The bitcoin, a virtual medium of exchange, could be a real alternative to government-issued money—but only if it survives hoarding by speculators.
By James Surowiecki on August 23, 2011

When the virtual currency bitcoin was released, in January 2009, it appeared to be an interesting way for people to trade among themselves in a secure, low-cost, and private fashion. The Bitcoin network, designed by an unknown programmer with the handle "Satoshi ­Nakamoto," used a decentralized peer-to-peer system to verify transactions, which meant that people could exchange goods and services electronically, and anonymously, without having to rely on third parties like banks. Its medium of exchange, the bitcoin, was an invented currency that people could earn—or, in Bitcoin's jargon, "mine"—by lending their computers' resources to service the needs of the Bitcoin network. Once in existence, bitcoins could also be bought and sold for dollars or other currencies on online exchanges. The network seemed like a potentially useful supplement to existing monetary systems: it let people avoid the fees banks charge and take part in noncash transactions anonymously while still guaranteeing that transactions would be secure.

Yet over the past year and a half Bitcoin has become, for some, much more. Instead of a supplement to the dollar economy, it's been trumpeted as a competitor, and promoters have conjured visions of markets where bitcoins are a dominant medium of exchange. The hyperbole is out of proportion with the more mundane reality. Tens of thousands of bitcoins are traded each day (some for goods and services, others in exchange for other currencies), and several hundred businesses, mostly in the digital world, now take bitcoins as payment. That's good for a new monetary system, but it's not disruptive growth. Still, the excitement is perhaps predictable. Setting aside Bitcoin's cool factor—it might just as well have leapt off the pages of Neal ­Stephenson's cult science-fiction novel Snow Crash—a peer-to-peer electronic currency uncontrolled by central bankers or politicians is a perfect object for the anxieties and enthusiasms of those frightened by the threats of inflation and currency debasement, concerned about state power and the surveillance state, and fascinated with the possibilities created by distributed, decentralized systems.

Bitcoin is not going to make government-backed currencies obsolete. But while the system's virtues, such as anonymity and the lack of bank fees, may not matter much to most consumers, one can envision it being useful in a variety of niche markets (some legal, others not, like recreational drugs). Where anonymity is valuable, where trusted third parties are hard to find or charge high rates, and where persistently high inflation is a problem, it's possible that bitcoins could in fact flourish as an alternative currency.

Before they become such an alternative, though, the system will have to overcome a major, and surprising, problem: people have come to see it primarily as a way to make money. In other words, instead of being used as a currency, bitcoins are today mostly seen as (and traded as) an investment. There's a good reason for that: as people learned about Bitcoin, the value of bitcoins, in dollar terms, skyrocketed. In July 2010, after the website Slashdot ran an item that introduced the currency to the public (or at least the public enthusiastic about new technologies), the value of bitcoins jumped tenfold in five days. Over the next eight months, the value rose tenfold again. This attracted an enormous amount of publicity. More important, it also made people think that buying and holding bitcoins was an easy way to make a buck. As a result, many—probably most—Bitcoin users are acquiring bitcoins not in order to buy goods and services but to speculate. That's a bad investment decision, and it also hurts Bitcoin's prospects.

Thing Reviewed:

Bitcoin

www.bitcoin.org

True believers in Bitcoin's usefulness prefer to deny that speculation is driving the action in bitcoins. But the evidence suggests otherwise. The value of the currency has been tremendously volatile over the past year. A bitcoin has been worth as little as a few pennies and as much as $33, and after seeming to stabilize at around $14 over the summer, the bitcoin's value tumbled by almost 50 percent in a matter of days in August. Media coverage has had an outsized impact on the value of bitcoins, even when it has not had a major impact on the number of transactions conducted. Blog posts in which people talk about buying bitcoins because of how much they've increased in value are common. In May, Rick Falkvinge, founder of the Swedish Pirate Party, which focuses on patent and copyright reform, posted that he had decided to put all his savings into Bitcoin. Although he had previously published a series of posts arguing for the bitcoin's viability as a currency, his first listed reason for investing in bitcoins was that their value had risen a thousandfold against the U.S. dollar in the previous 14 months. That's classic speculative thinking.

The problem with having the Bitcoin economy dominated by speculators is that it gives people an incentive to hoard their bitcoins rather than spend them, which is the opposite of what you need people to do in order to make a currency successful. Successful currencies are used to transact day-to-day business and lubricate commerce. But if you buy bitcoins hoping that their value will skyrocket (as anyone investing in bitcoins would), you're not going to be interested in exchanging those bitcoins for goods, since then you'll lose out when the value of bitcoins rises. Instead, you're going to hold onto them and wait until you can cash out.

This kind of hoarding is made more likely by the way Bitcoin is set up. Whereas the supply of modern, "fiat" currencies is controlled by central banks, the supply of bitcoins is permanently limited; there will never be more than 21 million bitcoins in existence. (The total number of coins is a result of the system's initial rules governing how many bitcoins miners could earn, and how often.) Bitcoin's limited money supply is one of the things that people like about it: the currency cannot be debased, as money can when central bankers print more of it. But the flip side is that if the demand for bitcoins rises, for whatever reason, then the value of bitcoins will necessarily rise as well. So if you think that bitcoins are going to become more and more popular, then—again—it's foolish to spend your bitcoins today. The rational thing to do is hoard them and eventually sell them to new users. But that means there will be fewer bitcoins in circulation (and more in people's virtual wallets), making them less useful as an actual medium of exchange and making it less likely that businesses and consumers will ever see Bitcoin as legitimate.

Now, even traditional currencies can be subject to this kind of cycle, which economists call a "deflationary spiral"—although with conventional currencies, the cycle occurs when falling prices lead people to start hoarding cash in the expectation that prices will keep falling (which in turn holds down demand and makes prices fall further). The quintessential recent case is Japan after its real-estate bubble burst in the 1990s.

With ordinary currencies, though, there's a limit to how far down the spiral can go, since people still need to eat, pay their bills, and so on, and to do so they need to use their currency. But these things aren't true of bitcoins: you can get along perfectly well without ever spending them, so there's no imperative for people to stop hoarding and start spending. It's easy to imagine a scenario in which the vast majority of bitcoins are held by people hoping to sell them to other people.

We may already be living in that scenario, since despite all the buzz about Bitcoin, the number of actual transactions conducted in bitcoins, and the value of those transactions, has been shrinking. According to bitcoinwatch.com, the best source of Bitcoin data, more than a million dollars' worth of bitcoins were traded on June 13. By early August, less than half a million dollars in bitcoins were being used in transactions; even the currency's value had been cut in half. Successful network technologies do not tend to see usage plateau, let alone shrink, this early in their history. And the lack of growth in the number of transactions conducted via Bitcoin is not what you'd expect to see if the technology were, as Falkvinge said, on its way to being a part of "normal daily commerce." It's true that there aren't all that many goods and services one can (or would want to) buy with bitcoins. But in a way, that's the real problem: a falling rate of use makes businesses less, not more, interested in accepting bitcoins, and ordinary consumers less interested in spending them.

So just now the bitcoin boom of the past year looks not so much like the birth of a new currency as like a classic bubble. And this has created a real paradox for bitcoin enthusiasts. The best thing for bitcoins would be for people to stop thinking of them as an investment and start thinking of them as a currency. That probably requires the bubble to burst, as it may be doing right now. But if the bubble bursts, it's possible that people's interest in Bitcoin will just fade away. After all, would you accept bitcoins in exchange for your work or products if you knew their value had fallen 50 percent in a matter of days? The challenge for Bitcoin now is whether, having become popular because of the cycle of hype, it can somehow avoid being devoured by it. Only then might we be able to say, Good-bye, asset; hello, currency.

Putting the Greek back into Stoicism

However the Greek crisis pans out, it's likely that for the Greeks, things will get worse before they get better - and this is on top of years of austerity, declining incomes and collapsing public services. How do you cope with calamities like this? Stoicism, a Greek-inspired school of philosophy, may hold some answers, writes professor William Irvine.

It was the Greeks who gave us the word "crisis". It is derived from the Greek krinein, meaning "decide", and indeed, the Greek government now has lots of important decisions to make, as the result of years of reckless borrowing from overly-eager lenders.

Its citizens also have some important decisions to make, including how best to deal with the lean times that likely lie ahead. Fortunately for them, the ancient Greeks, besides giving us our word for crisis, provided us with a splendid strategy for dealing with crises: the philosophy known as Stoicism.

Contrary to popular belief, Stoicism does not advocate that we keep a stiff upper lip - that we stand there mutely and impassively, and take whatever the world throws at us. It instead provides us with a number of specific strategies which, if practised, can make our days go better, in both good times and bad.

One component of the Stoic strategy is to distinguish between things we can control and things we can't. Our life, say the Stoics, will be miserable if we spend our time worrying about things over which we have no control. That time and energy is far better spent thinking about things we can affect. To quote Roman Stoic Marcus Aurelius, "Nothing is worth doing pointlessly."

One of the things we have no control over is the past. We cannot alter it. We therefore need to decide whether we are going to spend our life filled with regret over choices we have made in the past, or whether we are going to let go of that past and instead focus our attention on the choices that lie ahead. It ought to be an easy decision to make. It is also a decision that many people, tragically, fail to make.

The Stoics have a simple technique for making our days go better: we should think about how they could have been worse. Notice that I didn't say dwell on how they could have been worse; that would be a recipe for a miserable existence. Instead, we should allow ourselves to entertain flickering thoughts about the loss of our friends, money, lover, job, health - all the things we value.

If we do lose any of these things, we will have been prepared by our negative thinking, and this will likely lessen the blow of our loss; we will, in a sense, have seen it coming. And if we don't lose these things, we will find ourselves far more appreciative of them than would otherwise have been the case.

A life filled with people and things that we appreciate is easy to enjoy. The Stoics were smart enough to realise that we have it in our power to appreciate the life we find ourselves living if we can just bear in mind that things are a lot better than they could have been.

The Stoics valued self-control, as did most ancient philosophers. If we have self-control, we control ourselves; lack it, and it is someone or something else that controls us. Do we really want to spend the one life we have controlled by someone or something else?

The current Greek crisis can be attributed to a lack of self-control: the Greek government borrowed more money than it could comfortably pay back. Borrowing money, unfortunately, is like using drugs: it feels good at first and feels bad later on. This makes it easy for borrowers to focus their attention on the pleasant present and put off thoughts about a future in which the only choices open to them are painful.

The Stoics thought people could develop self-control by engaging in acts of self-denial. They didn't advocate anything extreme: it was their philosophical rivals the Cynics who suggested doing such things as hugging statues on cold winter days. The Stoics instead advocate that we periodically go out of our way to make ourselves somewhat uncomfortable. Fail to do this, and we will lose our tolerance for discomfort, meaning that the slightest inconvenience will have the power to ruin our day. Those inured to discomfort, the Stoics realised, are almost always happier than those who lead a pampered existence.

Star Trek creator Gene Roddenberry said he thought of Spock as a Stoic, but Stoics are not unemotional - they cultivate positive emotions and avoid negative ones

The current Greek crisis will doubtless cause people much discomfort. Many Greeks will respond, as people often do, by bemoaning their fate. The Stoics among them, though, will treat a time of economic austerity as a kind of test. When life throws an obstacle in their way, Stoics do their best to take it in their stride or even to profit from it.

Zeno of Citium was a merchant who found himself in Athens as the result of a shipwreck. While there, he took an interest in philosophy and ended up founding his own school, which became known as the Stoics because he gave his lectures at the Stoa Poikile, a colonnade in the Agora of Athens.

Regarding this turn of events, Zeno subsequently commented that "I made a prosperous voyage when I suffered shipwreck."

Zeno of Citium

The Roman philosopher Musonius Rufus is another example of a Stoic who profited from what others would take to be misfortune. This occurred after he somehow managed to annoy Emperor Nero (Tacitus says it was because Nero envied his fame as a philosopher) and was banished to the Greek island of Gyaros, in the Aegean Sea. The island was desolate, bleak, and nearly waterless, a miserable place to be put; indeed, even in the 20th Century, the Greek government used Gyaros as a dumping ground for its leftist enemies.

Instead of letting himself be crushed by his circumstances, Musonius took an interest in Gyaros and its inhabitants, mostly impoverished fishermen. He discovered a new spring and thereby made the island more habitable. Those who visited him reported that they never heard him complain or saw him disheartened. He had transformed what could have been a personal tragedy into a personal triumph.

As they suffer privations in the coming months and years, Greeks should keep Musonius in mind. They may have it bad, but it beats banishment to Gyaros - beats it by a long shot.

Three Stoical strategies

• Focus on things you can control - get over things that you cannot control

• Bear in mind that things could have been worse

• Learn self-control through occasional acts of self-denial