General

For instance, the British paper The Guardian, which was involved in breaking the Snowden scandal, had this to say: “Bitcoins are an anonymous, decentralised, peer-to-peer digital currency.”

If you take Bitcoin for what it really is, it’s very easy to understand why it continues to rise in value; why the government is so seemingly willing to let it slide and even leans toward supporting it; and why its widespread adoption would ultimately lead to exactly the opposite of the libertarian utopia that many of its proponents believe it will usher in.

It all starts with Ross Ulbricht, a smart and driven University of Pennsylvania alumnus better known to his customers as Dread Pirate Roberts. Roberts, er, Ulbricht, ran the infamous Silk Road website, which dealt predominantly in the trafficking of illegal drugs around the world.

An eBay clone run on the peer-to-peer “darknet” Tor, designed to give users true anonymity on the Web, Silk Road was as far from the mainstream as a website can get. Despite the hurdles to be jumped to gain access, the site’s main products drew thousands of users, eager to take advantage of the ease of ecommerce in a traditionally back-alley kind of business.

The site used the breakaway digital currency, Bitcoin, for its transactions, since it was going to be hard to accept Visa for that kind of business.

However, early in October, the website was seized by the US government, and Ulbricht was arrested. FBI agents then proceeded to take control of the hundreds of thousands of bitcoins that Ulbricht had collected as transaction fees on Silk Road.

Those “coins” are highly likely to lead the FBI to a long list of additional people to prosecute—namely the buyers and sellers who frequented Silk Road.

Just how did the FBI—known for having the technical might of a 1987 elementary-school computer lab—manage to not only track down Ulbricht, but to seize his supposedly anonymous and highly secure digital fortune?

It didn’t call in the NSA to start cracking codes and dig through its sweeping communications logs.

The former part—finding Ulbricht—was easy. It just took some good old-fashioned detective work. Ulbricht spent much of his time in the months before launching Silk Road working on public Internet forums to understand Bitcoin and recruit helpers. Once that trail was untangled, the FBI was able find and arrest him, seizing the equipment used to run the illegal enterprise in the process.

The latter is a little more complex… but not by much. You see, thanks to the very design of the Bitcoin currency, it’s almost as vulnerable as cash held in a home safe. The safe might take sophisticated and expensive tools to crack it or it might not, depending on its quality. Similarly, with a Bitcoin “wallet”—i.e., the computer program that stores the digital coins a user has amassed and communicates with other users to send them—it can be easier or harder to get at them.

By default, a wallet is just a simple program that can be opened with a password. Give someone else that password, and that person can simply transfer the coins to him- or herself. Though there are stronger ways to secure a wallet—such as by hiding a key file on a different device and only connecting them when needed (called two-factor authentication)—it can still be compromised.

Of course, once you’ve been arrested, you can bet federal prosecutors will be hard at work trying to crack that digital safe. Stronger-quality encryption might take longer to crack—months, even years. But if they want in badly enough, they’ll get in eventually. Besides, at the same time they’ll be working on the shortcut: pressing on you to give away the combination. The threat of a long stay in federal prison usually loosens up lips on subjects like that.

Nearly as easily as cash or a bank account is grabbed, bitcoins can be too, if the authorities know where you keep them.

If you don’t encrypt the device that holds them, then they’re about as secure as cash in a wallet or a duffle bag. Once the police get their hands on it, it’s theirs. Plain and simple.

However, even if you’re encrypted and they cannot open the wallet in which you keep your bitcoins to transfer them away, so long as they control the device where the coins are stored, then you cannot spend them, either—those coins are effectively out of circulation.

This is how the FBI seized something like $10 million to $50 million in bitcoins (depending on what exchange rate you use to value them) from Ulbricht. It just took his computer, and the coins on it came along.

That’s because from the beginning, bitcoins were meant to serve a similar role to cash in a digital society. In other words, they could be exchanged from person to person without having to put a processor like Visa or American Express in the middle. This, for obvious reasons, made them attractive to those dealing in alternative products and services… the kind that remain cash businesses today.

But there’s a subtle difference between cash and bitcoins still. In order to make a digital form of cash, it needs to have some protection against being copied. In other words, I cannot just hit copy and paste and thereby turn one “coin” into two, like I can with a PDF. So each bitcoin contains a record of how it was created and when it was exchanged, which creates a digital audit trail to ensure a coin is valid.

Each individual user adds bits and bytes to the coin, passing it along with encrypted data that spells out who he got it from, where he is sending it to, and when.

It’s sort of like a transfer between two safe deposit boxes. I use my key to open my safe, hand my money to you, then you use your key to lock it safely away. However, Bitcoin must certify that what you pass along later is the actual coin I gave you. Thus, every time it changes hands, it is marked with a signature (a “hash,” in technical terms) of both the previous transaction and the future owner. This is like if every paper bill handed from me to you, across the table in the safe deposit vault, could not be exchanged without first adding a permanent, non-removable copy of both our fingerprints to each one.

That is a gross oversimplification, of course. But the system’s value lies largely in its simplicity. The original paper describing how Bitcoin works is remarkable in that regard. It outlines just how to provide a system where digital money can be used like cash, sans central intermediary, without losing trust that a coin is genuine—by making the transaction log public but anonymous.

But even the authors find fault in the method (emphasis added):

“As an additional firewall, a new key pair should be used for each transaction to keep them from being linked to a common owner. Some linking is still unavoidable with multi-input transactions, which necessarily reveal that their inputs were owned by the same owner. The risk is that if the owner of a key is revealed, linking could reveal other transactions that belonged to the same owner.”

In other words, despite the fact that a bitcoin’s embedded audit trail is anonymized and nothing more than a seemingly random set of numbers, those numbers can theoretically be traced back to a common account if coalesced from more than one recipient.

Unlike what The Guardian wrote, Bitcoin is not anonymous by default. It is pseudonymous. If you use the same pseudonym (in this case, a key pair from your Bitcoin digital wallet) in multiple locations, then all that activity can be traced back to the same place. Like a street thug with an “AKA,” it only works until you find one person who knows the alias and can say, “Yes, that guy is ‘Fat Tony’.”

Unless the user takes explicit steps when using his bitcoins to generate a new pair of keys with every transaction—something some wallets can do automatically, granted—then your activity on a site like Silk Road could theoretically be tied back to you, once the FBI pinpoints just what wallet identifiers the site’s owner used to take in and pay out the funds.

Silk Road, while trying to provide its users with anonymity from each other (and ensure it got its cut—probably far more of the motivating factor), introduced a centralized point to an otherwise decentralized system, poking yet another hole in the process.

Bitcoins themselves are both anonymous and decentralized in how they are created and exchanged, yes. But when you begin introducing online wallets, sites acting as escrow providers, and similar such intermediaries, the system loses a little of both. Then you have the equivalent of a currency where the criminals almost volunteer to start using the digital equivalent of “marked bills” from those old FBI sting movies.

Internally, Silk Road used a mathematical process called a “tumbler” to try to make sure that never happened. It rolled the encrypted codes on each coin collected through lots of accounts before sending them on to the seller, making sure the input coin could never be matched to the seller or product. That also made it hard to determine just who was depositing funds to buy illegal things, and who was innocently picking up one of the (few) legal items for sale.

The theory was: it’s not illegal to deposit money with someone like Silk Road if it cannot be traced to an illegal purchase. But that’s easily dealt with. All it would take is a zealous federal prosecutor who rebrands Silk Road as a terrorist site (a small leap given that you could buy heroin on the site, and that’s a drug often linked to Afghani groups that wear the terrorist tag, justly or not). Then all activity on the site immediately becomes illegal.

That’s not what happened. But in spite of those extra measures put into place by Silk Road, academic researchers have been able to show how transactions could be traced back to Silk Road with relative ease. Forbes presented an excellent analysis of this problem in an article published just weeks before Silk Road’s founder was nabbed by the feds.

The question, then, is whether or not the FBI used all of the computer records on the Silk Road system to start sniffing out buyers, or (more likely, since the buyers have no good information to snitch with in an anonymous marketplace) focused on sellers who transacted on Bitcoin. Even if they don’t show up on particular doorsteps this time around, you can be pretty sure they’ve already used those records to build a list of whom to keep close tabs on.

If receiving large payments from Silk Road isn’t probable cause enough for a wiretapping warrant, I don’t know what is.

Which is probably a large part of why Congress is holding hearings on Bitcoin, and Ben Bernanke gave it a nod of the beard in light support.

It’s not easy to trace or monitor bitcoins. And a careful user can definitely stay close to anonymous within the system—using a combination of an Internet anonymizer, new key pairs with every transaction, and a bit of tumbling to prevent patterns, for example.

But bitcoins are much more susceptible to tracking than either cash or gold, the current off-the-radar transaction tools most used to evade authorities.

The use of bitcoins, especially by most users—who tend to choose the very popular online wallet services that store your account info in a nice, easy-to-access, easy-to-subpoena, online vault—is exactly the kind of traceable activity that investigators froth over.

So from the perspective of law enforcement, there’s enormous benefit—even from a marginal improvement—in allowing Bitcoin to prosper. It just doesn’t make sense to shut it down quite yet, and may not ever.

Plus, why close down what you can tax?

How long, for instance, do you think it’ll be before Congress starts demanding that exchange and online wallet providers submit tax statements to the IRS?

Maybe they want a piece of the gains made when you bought some bitcoins at the start of this year, then sold them as the price went parabolic under the demand driven by C-SPAN’s telecast of Washington’s recent hearings on the subject:

Of course, that the price went so high with such low volume underscores why maybe, just maybe, Bitcoin will be here to stay.

The currency is finite. Only so many bitcoins can be “mined” from the digital ether, and each is harder to extract than the previous one. When the government seized Ulbricht’s accounts, by some accounts it eliminated as much as 3-5% of the total bitcoins in existence (about 12 million today), thus initiating a supply crunch which would send any commodity upward a bit.

Whether the government can crack Ulbricht’s encryptions and lay its hands on his actual coins remains unknown, but since it has his computer, they are effectively withdrawn from circulation no matter what. And how it intends to process such an unusual asset seizure is another intriguing question.

Add the current notoriety to the supply shortfall, and demand for the coins has predictably risen (albeit far more than anyone expected), largely among a group new to the asset. Those already holding it weren’t off selling while the price was still rising, like they did last April during those big red spikes on the volume indicator. Instead, as during the housing bubble before it, and the dot-com bubble before that, the paper gains that result from outsized demand and tight supply are pushing the currency ever upward in a self-reinforcing trend.

Each $100 the price rises is another 467 news stories in USA Today, Forbes, the Economist, and here at Casey Research of course, as I obviously gave in to the temptation to write. All that publicity helps create another pile of investors looking to buy the 20K to 50K coins that exchange for fiat currencies each day on the largest outlet, the Mt. Gox exchange.

Even when not getting bubblicious, as they are today, bitcoins will naturally rise in price so long as they are readily convertible to other forms of money. If that ever ends, through government intervention or for some other reason, they will quickly go to zero.

For now though, Bitcoin is flourishing. And thanks to exchanges like Mt. Gox and sites like Gyft that allow you to spend bitcoins on dollar-denominated gift cards, using bitcoins to freely move digital money between persons will likely remain in demand for some time to come. It’s especially advantageous across borders and along other avenues where it might be difficult or impossible to make such transfers without raising eyebrows, finding oneself in a room with an interrogator, or being blocked altogether.

Check out the following links for more information on developments related to Bitcoins:

China Bans Financial Companies From Bitcoin Transactions

Greenspan Says Bitcoin a Bubble Without Intrinsic Currency Value

Bitcoin Market Gets a Lift From China

Bankers Balking at Bitcoin in U.S. as Real-World Obstacles Mount

Bitcoin: its future as a platform and protocol

http://versiononeventures.com/bitcoin-observations-thoughts/

Prices of Different Digital Currencies

http://coinmarketcap.com/

How Much Does that Burger Cost in Bitcoins?

https://www.mtgox.com/

Bitcoin drops 50 overnight as chinas biggest btc exchange stops deposits in chinese yuan

Bitcoin Tops $1,000 Again as Zynga Accepts Virtual Money

Bitcoin’s Future Foretold By Developer Momentum

Beware Bitcoin: US Brokerage Regulator

 

The Nasdaq index’s year-to-date gain of more than 33% is far outpacing the Dow Jones Industrial Average’s rise of 23% and the 27% rally in the S&P 500. Fueling the Nasdaq’s rally is a hunt by investors to find faster-growing companies in an economy that has yet to show a sustained acceleration.

But unlike the Dow and the S&P 500, which are far into record territory, the Nasdaq remains roughly 20% below its dot-com-era peak. The index hit its all-time high of 5048.62 on March 10, 2000. On Tuesday it closed at 4017.75, up 23 points or 0.58% for the day.

Data showed demand for home building permits jumped 6.2% in October to an adjusted annual rate of 1.034 million, the highest level in more than five years. Economists had projected a rise to a pace of 930,000. The S&P/Case-Shiller 20 City home-price index for September rose 13.3% on the year, slightly better than expectations for it to show a rise of 13%.

The Conference Board’s consumer-confidence index for November unexpectedly fell to 70.4 from 71.2 in October. Economists expected the index to show a rise to 73.0. The Conference Board said uncertainty about future employment and income prospects could make this a challenging holiday season for retailers.

Below is a post from the Chief Economist of First Trust, Brian Wesbury, talking about QE, that resonates with my own thinking on this subject:

The most frequent question we get lately is “what happens to long-term interest rates when quantitative easing ends?” Many analysts argue that the Federal Reserve is buying and holding a huge share of Treasury debt and once QE ends other buyers will suddenly have to absorb more. This will cause interest rates to soar, bust the housing market, undermine stocks, and possibly cause a recession.

We disagree with this analysis in major ways. To respond, we crafted some charts which you will be able to find on our blog, here. In addition, a friend and one of our favorite economists, Scott Grannis at Calafia Beach Pundit, tackled the same topic last week. We urge you to read his take as well.

Much of what people believe about QE is mistaken. It has boosted the monetary base, but not M2. Interest rates are low because of the zero fed funds rate policy, not QE. And most importantly, despite trillions in purchases, the share of Treasury debt held by the Fed is not out of line with history.

Don’t get us wrong. We expect interest rates to move higher in the years ahead, but not because QE ends and not as quickly as the QE-bears say. Until the Fed raises short-term rates, it’s unlikely the 10-year Treasury yield will rise above 4%. QE is a signal of the Fed’s commitment to hold short-term rates near zero, not a direct driver of rates. The longer investors expect the Fed to keep rates near zero, the lower longer-term yields will be. QE itself is not as important as many think.

The Fed has not cornered the Treasury market. The Fed now owns 18% of marketable Treasury debt. This is not an unusually large share; the recent peak was 20% in 2002 and the Fed still held 17% in 2008. Borrowing exploded upward in the Panic, the Fed’s share of debt fell to 8%, but, with QE, it’s back up to 18%. If the Fed still bought $45B/month of Treasuries for the next twelve months – which is very unlikely – we estimate the Fed’s share of Treasury debt would rise to just 21%, slightly above the peak in 2002.

Interest rates have moved in the same direction as the Fed’s share of Treasury debt. Those who see QE as the driver of interest rates have a huge problem – the facts. From late 2007 through early 2009 the Fed’s share of the debt plummeted while interest rates fell. From late 2009 through early 2011, the Fed used QE to push its share back up, but interest rates trended up slightly. From early 2011 through the end of 2012, the Fed’s share of the debt gradually fell. In theory, interest rates should have risen; instead, they fell. So far this year, the Fed’s share of Treasury debt has risen while interest rates have gone up.

Don’t worry; private markets can absorb debt normally. Since 1975, the amount of marketable Treasury debt held outside the Federal Reserve (known as privately-held debt) has increased $9.3 trillion, or $242 billion per year. During this time, annual GDP averaged $8.1 trillion per year. So, on average, the private markets have absorbed Treasury debt equal to 3% of GDP, sometimes more and sometimes less.

If the Fed goes “cold turkey” on QE, but rolls over the debt it already owns, private purchasers of Treasury debt would have to absorb an amount roughly equivalent to the budget deficit, which we forecast to be about 3% of GDP in fiscal year 2014. That’s no different than the long-term average.

More likely, the Fed will taper purchases in 2014 rather than going cold turkey. Assuming the Fed bought $250 billion (about $20 billion per month), private markets would be left to absorb debt equal to about 1.5% of GDP. Easy peasy.

We don’t believe deficits drive interest rates, but for those who do, the idea that QE itself is the driving force behind long-term rates is seriously flawed. The Fed owns no greater share of the debt than normal, and, deficits are shrinking.

While we expect interest rates to head higher, the bottom line is that QE was never that important and ending it is not the Armageddon event that the Bearish clan wants to believe.

The S&P 500 climbed 8.91 points, or 0.5%, to 1804.76. The index is up 27% this year, on pace for its biggest annual gain since 1998, when it climbed 31%. It took more than 13 years for the Index to climb past 1,600 and this year has risen past 1,700 and now 1,800.

An accommodative Federal Reserve, paltry returns in assets such as bonds and steady expansion in corporate profits continue to draw investors to equities. Bulls say the U.S. economy’s expansion—muted as it is—stands out when compared with conditions in other parts of the globe and is liable pick up next year.

Meanwhile, individual investors appear to be regaining comfort with stocks. Mutual funds investing in U.S. shares took in a net $548 million in new cash in the week ended Wednesday, according to fund tracker Lipper, the sixth-straight week of inflows.

Thanks to fracking and shale oil production, the United States is becoming a leading producer of Oil and Gas in 2013, overtaking Russia. Some facts:

• Average oil production in October 2013 was 7.8 mbpd, 19% higher than last year.
• Rising crude supplies from North Dakota’s Bakken shale and Eagle Ford shale in Texas have helped the U.S. become the world’s largest exporter of refined fuels.
• Per EIA, Texas pumped 2.575 mbpd in June-if Texas were its own country, it would rank 15th in the world in terms of oil production.
• The U.S. met 87% of its energy needs in the first five months of 2013 and is on target to hit the highest annual rate since 1986.
• Exports are surging from 1 mbpd in 2006 to 3 mbpd recently.
• Imports are falling from a high of 14 mbpd in 2007 to under 10 mbpd recently. If you take out the re-export of refined products, the Net Imports have fallen even faster to 6 mbpd from 13 mbpd.

Can this declining U.S. net import of Oil and Gas have an impact on the U.S. dollar through its linkages to Current Account Deficits? Generally, a declining Current Account Deficit should be a tail wind for that country’s currency. Also, cheap and abundant natural gas in the U.S. is becoming a competitve advantage to begin bringing offshore production back onshore, which can further impact trade flows and deficits.

Can the once mighty U.S. dollar regain its footing again?

The Dow Jones Industrial Average closed above 16,000 for the first time Thursday, extending a rally that has the blue chip-index on pace for its best year in a decade. With Thursday’s gain, the Dow has advanced 22% so far this year, putting it on pace for the biggest annual rally since a 25% gain in 2003. The blue-chip index is up 144% from its 2009 low. The latest 1,000-point move in the Dow took just 139 trading days, the sixth-fastest 1,000-point gain for the Dow.

Among Dow components, Boeing Co. has led the way higher over the last 1000 points, rallying 40%, highlighting strong demand for commercial aircraft as the global economic recovery takes hold. 3M Company, meanwhile, has risen 20.6% during the same time frame.

This year, all but two of the 30 Dow stocks have gained ground this year except two: Caterpillar Inc. and International Business Machines Corp. and have declined 8.5% and 4.1%, respectively year to date.

Gains on Thursday came after Janet Yellen moved a step closer to becoming the next Federal Reserve leader and a better-than-expected report on the jobs market boosted sentiment.

Behind the broader push that took the Dow through this latest milepost: seemingly greater confidence in the stock market’s ability to withstand a scaling back by the Federal Reserve of the bond-market purchases it has been employing to stimulate the economy. More broadly, bulls point to continued expansion in the U.S. economy and recovery in corporate profits as drivers of the rally. Years of ultralow interest rates have bolstered corporate balance sheets and boards have rewarded investors by buying back stock and boosting dividends.

As such, investors are paying more for stocks relative to the underlying companies’ earnings, making it harder to argue stocks are cheap. The price to earnings ratio for the S&P 500, a broader measure of large U.S. companies’ stocks, stands at about 16.1, up from 13.7 at the start of the year but little above its 10-year average of 15.6, according to FactSet.

The Paris-based World Federation of Exchanges (WFE), an association of 58 publicly regulated stock market exchanges around the world, recently released updated data on its monthly measure of the total market capitalization of the world’s major equity markets through the end of October. Here are some highlights:

1. As of the end of October, the total value of equities in those 58 major stock markets reached $62.64 trillion. That was just slightly below the all-time record monthly high of $62.77 trillion for global equity valuation in October 2007, several months before the global economic slowdown and financial crisis started, and caused global equity values to plummet by more than 50% (and by almost $34 trillion), from $62.8 trillion at the end of 2007 to only $29.1 trillion by early 2009 (see chart above).

2. Global equities gained almost $2 trillion in value during the month of October, and increased by 3.2% from September.

3. Compared to a year earlier, October’s world stock market capitalization increased by 19.6%, led by a 22.2% gain in the Europe-Africa-Middle East region, followed by gains of 20.8% in the Americas and 15.4% in the Asia-Pacific region.

4. By individual country, the largest year-over-year gains for October were recorded in Greece (118%), Ireland (53.2%), Bermuda (47.3%), the UAE (40.4%) and Taiwan (37.3%). In the US, the NYSE capitalization increased by 25.7% and the NASDAQ by 27.2%. The biggest losses in equity value over the last year were posted in Peru (-15.9%), Turkey (-14.5%) and Cyprus (-14.5%).

Compared to the recessionary low of $29.1 trillion in February 2009, the total world stock market capitalization more than doubled (115.3% increase) to the current level of $62.64 trillion, recapturing almost all of the global equity value that was lost due to the severe global recession and the various financial, mortgage and housing crises in 2008 and 2009. The global stock market rally over the last five years has added back more than $33.5 trillion to world equity values since 2009, and demonstrates the incredible resiliency of economies and financial markets to recover and prosper, even following the worst financial crisis and global economic slowdown in generations.

U.S. household debt climbed 1.1 percent during the third quarter as borrowing for mortgages, education, car purchases and on credit cards all increased, according to a Federal Reserve Bank of New York survey.

Consumer indebtedness rose $127 billion to $11.28 trillion, the biggest increase since the first quarter of 2008, according to a quarterly report on household debt and credit released today by the Fed district bank. Mortgage balances climbed $56 billion, student loans increased $33 billion, auto loans were up $31 billion and credit-card debt rose by $4 billion.

“We observed an increase of household balances across essentially all types of debt,” Donghoon Lee, senior research economist at the New York Fed, said in a statement. “With non-housing debt consistently increasing and the factors pushing down mortgage balances waning, it appears that households have crossed a turning point in the deleveraging cycle.”

Americans have slashed their debt from a peak of $12.68 trillion in the third quarter of 2008, according to the New York Fed.

Delinquency rates continued to drop in the third quarter, with 7.4 percent of outstanding debt in “some stage of delinquency,” down from 7.6 percent in the second quarter, the New York Fed said. There were about 355,000 new bankruptcies during the period, about the same as in the comparable timeframe in 2012.