With cyptocurrencies all the rage these days, I figured I should weigh in. I've done a few dozen posts about the monetary theory behind cryptocoins, so rather than write another, in this post I'm going to describe my somewhat zany experience over the last fourteen or so months with litecoin, one of the bitcoin clones.
Curious about bitcoin, I figured I should gain some practical experience with the medium of exchange on which I planned to write over the next few months. So one cold autumn day in 2012 I bit the bullet and transferred some money to VirtEx, Canada's largest online bitcoin exchange, bought a few coins (a small enough amount that I wouldn't wince if their price fell to $0), and then transferred those coins from my Virtex account to my newly downloaded wallet residing on my laptop. Voilà! I was now officially a bitcoiner.
...which wasn't as exciting as I had anticipated. There was little for me to do with my fresh digital pile of coins. I'm not a huge shopper, and the places where I do buy stuff, like grocery stores, don't accept bitcoin. I don't do drugs, so I couldn't use Silk Road, the now-shuttered online drug marketplace. And I don't gamble, the gambling website SatoshiDice being one of the big drivers of bitcoin transactions. So my coins just sat there in my wallet gathering electronic dust.
Later that autumn I read somewhere that bitcoin had a smaller cryptocurrency cousin called litecoin, which traded for a fraction of the price of bitcoin. Curious, and with little other avenue for my bitcoins, I sent a small chunk of my already small stash of bitcoin to BTC-e, a Russian online exchange specializing in bitcoin-to-litecoin trades, and proceeded to buy some litecoins for around 5 cents each (I can't remember their price in bitcoin). I transferred these to my freshly downloaded litecoin wallet, and voilà, I was also now officially a litecoiner.
Much like my experience with bitcoin, I was tad bit disappointed. As a medium of exchange, litecoin was even less liquid than bitcoin. Whereas a few online sites accepted bitcoin, no one seemed to want litecoin, providing me with little opportunity to play around with my new toys. Along with my bitcoins, my tiny hoard of litecoins gathered dust.
A few weeks later, however, I stumbled on an interesting avenue for my litecoins: an online litecoin-denominated stock exchange called LTC-Global. At the time, it listed around 20-25 stocks and bonds. I gleefully opened an account (which took seconds) to which I transferred about 75% of my stash of litecoins, and started to invest. I use the term "invest" very loosely, even sheepishly. Because the dollar-value of the shares I was purchasing amounted to a few bucks, it was hardly a large enough sum to merit a true analysis of the companies in which I was investing in. I glanced through the summaries of the various listed companies, picked some that I found interesting, and bought their shares. My investments included a website that published litecoin charts, a bond issued by a litecoin miner, a few passthroughs*, and some other companies.
Over the next months I'd get periodic notifications that my companies had paid me dividends. I bought a few more shares here and there, and some of them even rose in value. But when the novelty of this was over, I forgot about my investments. Then in March 2013 litecoin prices really started to race, quickly moving from $0.05 to $0.50. This amounted to a 900% rise since my autumn 2012 entrance into the litecoin universe, a far larger percent return than I'd ever made on my "real life" investments. My stash of litecoin had graduated from the "tiny" to the "smallish" category.
I hastened to LTC-Global to check the price of my investments, and much to my horror discovered that many of them had fallen in value by the exact amount of litecoin's rise. My 900% return was not to be. And as litecoin's price crossed the symbolic $1 mark, the price of my stocks continued to fall! After a few frenzied inquiries posted to the litecoin forums, I was informed by some savvy cryptocoin investors why this was occurring. Many of the companies into which I'd invested my litecoins earned fiat returns. My litecoin chart website, for instance, received advertising income in euros. As litecoin prices exploded, the website continued to earn the same amount of euros, but this equated to a much smaller litecoin equivalent. Thus the price of my stocks in terms of litecoin had declined, though they were still worth the same amount of dollars or euros. Better had I kept my funds in litecoin than ever investing them!
This made me wonder: in a world in which cryptocoins are expected to rise by 900% in a few days (why else would someone hold them), is there any point in investing one's litecoins? The expected return on hoarding far exceeds the return from investing litecoin in companies that by-and-large earn fiat returns. Yes, companies that earn litecoin income will not suffer a fall in share price, but at the time I was making my investments the litecoin universe was so small that few companies earned a pure litecoin revenue stream.
By April, litecoin had advanced another 900% to $5, giving me a return of 9,900% in just a few months. My shares, however, continued to deteriorate in value. To compound the problem, one of the companies I'd blindly invested in turned out to be a scam. I suppose in hindsight I might have guessed that a company called "Moo Cow Mining" might be a poor candidate for investing. The owner of Moo Cow had stopped paying dividends and absconded with the investors' assets. In the bricks & mortar world such actions would have very real consequences, but in the nascent litecoin universe there seemed to be little that could be done except make loud threats on the forums. This caused me some consternation because though my initial investment had been tiny, as litecoin prices advanced from $0.05 to $5 what had been a small scam in real terms quickly became a not-so-small one.
Once again I forgot about my litecoins. Without warning, this September LTC-Global announced it would be shutting its doors. One of the hazards of running an online stock exchange is that it probably breaks hundreds of SEC regulations. No doubt the exchange owners had decided to call it quits before they got in trouble. Worried that my funds might be confiscated or blocked, I quickly logged into my account. My shares had fallen in value (see this post) upon the announcement, but I was still able to sell everything I owned. I limped out of LTC-Global having lost 65% or so of the litecoins I'd invested. I vowed never again to spend away my hoard of coins on silly investments.
This November litecoin prices experienced another buying rush as they rose from $5 to just shy of $50, pushing litecoin up by a ridiculous 99,900% since I'd initially bumbled into them. Although I'd lost a large chunk of my litecoins by investing in stocks, the remaining stash now summed up to an amount that was no longer smallish (but not gigantic, either). Even tiny amounts of capital will grow into something substantial at those sorts of rates of return. Let's not kid ourselves though, this wasn't a canny trade, it was just dumb luck.
Getting out of litecoin isn't an easy task. I'll have to send my coins back to BTC-e where I can exchange them into bitcoin, incurring a 0.05% transaction cost on the deal. Then I have to transfer these bitcoins back to Virtex to buy Canadian dollars, which will exact a fat 2% commission on the trade. Then I'll have to wait a few days for my dollars to be transferred to my bank account. It's a lengthy and expensive process. Alternatively I could try and find someone who makes a market in litecoin, go to their house or a café, and consummate the trade there. But that just sounds awkward.
I also now have the headache of figuring out the tax implications of all of this. Which makes me wonder: how can litecoin and bitcoin ever be useful media-of-exchange if, for tax purposes, one must calculate the capital gain or loss incurred on every exchange? Even if I was able to buy groceries with my litecoin, I'm not sure I'd bother. The laborious process of going through my records in order to determine my capital gain/loss would probably have me reaching for my fiat wallet. The advantage of fiat money is that there are no capital gains taxes or capital loss credits, obviating the need for bothersome calculation.
The tax issue, combined with the general difficulty I experienced buying anything with my litecoins, topped off by the complexity of getting back into fiat all conspire to drive home the point that the main reason to hold litecoins for any period of time isn't because they make great exchange media—it's because they're the best speculative vehicles to hit the market since 1999 Internet stocks. I'll admit straight up that the speculative motive is why I'm still holding my litecoins, the educational motive having receded into the background some time ago. After all, if these little rockets can rise from $0.05 to $50, why not to $500, or $5000? All that's needed is a greater fool. I'm fully aware that the odds are that litecoin's value will fall to zero before $500 is ever reached, but my litecoin gains are so unreal to me that I wouldn't lose any tears if that particular worst-case scenario were to occur.
And it's millions of folks like me who explain the incredible volatility of cryptocoins, since we are the marginal buyers and sellers of the stuff. Since first starting to write this post, litecoin has lost over 60% of its value, falling back to below $20. These speculative-driven spikes and crashes don't seem like a very durable state of affairs to me, at least if cryptocurrencies are to take a more serious role in the world of exchange media. To be useful, an inventory of exchange media should be capable of purchasing the same amount of goods on Wednesday that it bought on Monday, but with cryptocoins one has little clue what tomorrow's purchasing power will be, let alone next week's.
Although I'm skeptical of cryptocoin mania, let me end on a positive note. Cryptocoin 2.0, or stable-value cryptocoins, is probably not too far away. It may take a price crash before they emerge, but I do think that stable value crypto coins will prove to be far better exchange media than the current roster of roller coasters.
*a passthrough is a bit like an ETF. Anyone who invests in a passthrough receives a stream of dividends thrown off by an underlying stock, one that is usually listed on another crypto stock exchange.