Cannabis and Crypto-Currency-The Blind Leading the Blind

A few weeks back I wrote a blog article where I stated that I was not interested in preparing the legal paperwork for any company that was raising funds for a cannabis related company. In the same article I said that I would also decline the opportunity to prepare the paperwork for an initial coin offering (ICO).  Either would be lucrative for me but in both cases I saw significant problems for the investors.

I might have predicted that people would start sending me the paperwork for ICOs that were looking to fund cannabis businesses seeking my thoughts and comments. Two stick out as examples of how not to raise money for your cannabis business.

In July, the US Securities and Exchange Commission (SEC) issued a report on ICOs. Crypto-currency is all the rage this year with some offerings raising millions of dollars in a matter of minutes and coins when issued quickly appreciating in price. Bitcoins for example have been appreciated significantly this year and some people think that Bitcoins are a legitimate investment, an assertion that is questionable at best.

The SEC correctly concluded that most crypto-currency offerings would fall within the definition of a security and thus its jurisdiction.  There was really no surprise as the SEC initiated about a dozen enforcement actions against crypto-currency issuers before it wrote its report.

Because an ICO is the offering of securities it is required by law to either 1) register with the SEC or 2) be exempt from registration assuming that an exemption is available. In either case, the issuer of the coins is required to give potential investors all the facts that would be material to making an investment decision.

If investors who purchased the coins got a discount on an ounce or two of marijuana the coins might not be securities. These two cannabis ICO offerings are clearly offering securities.  In both of these cases, investors profit if the underlying business profits which is more than enough for these to be securities and the SEC to have jurisdiction.

There are some facts which the SEC and any securities lawyer would consider to be material. This would include who is running the company; how much money is being raised and what will it be used for; the basic structure of the company’s ownership; how investors get paid and how much they might expect; an idea of the size of the market in which the company intends to compete and the names of the companies that are its major competitors.

Nothing really earth shattering,but the SEC has been reviewing offerings and ruling on how these facts are disclosed for decades. Making the disclosures correctly requires a fairly good idea of what the SEC expects and an equally good idea of the operation of the business offering the securities which is why securities lawyers who prepare offerings really have to know what we are doing.

The first cannabis ICO I looked at was for a company called Growers International.  Like all ICOs it uses a “White Paper” (which it prefers to call a “Green Paper”) instead of a traditional prospectus.  I doubt that it was prepared by a securities attorney. (I would suggest that you might add the words “Like, cool” or Yeah, man” between the sentences and it would read like the script of an old Cheech and Chong movie but I do not want to insult Cheech or Chong.)

From the Green Paper: “Q: Why should I trust the team? How do I know this isn’t a Pump & Dump situation?  A: We ask that all investors do their research on the people behind Growers International. Our lead developer has found success in both the cryptocurrency arena as well as in the cannabis industry. If there is any question regarding the legitimacy of the project, we encourage investors to reach out to Ryan (Lead Dev) personally on slack.”

It is always a good idea to research the people who are running any company into which you are making an investment.  In this case the “Green Paper” discloses the management to be: “Lead Developer: Ryan Wright (34, California / Taipei); Blockchain Programmer: Eddie E. (48, New Zealand); Web / API Developer: Michael J. (32, Maidenhead, England); Social Media Director: Devvie @Devnullius (40, Sweden); Community Coordinator: Jeremy Toman @MadHatt (37, Canada) who prefers the name ‘Tyler Dirden’ or ‘MadHatt’;Graphic Designer & Cryptocurrency Consultant: Chris S. @Elypse (26, Detroit); Community Manager: @DayVidd and Bitcointalk Manager & Financial Consultant: Dr. Charles @drcharles (26, USA).”

I suspect that if you contact Mr.Wright as suggested he will vouch for them all if he bothered to ask their last names. Do not bother to ask about Members of the Board of Directors as they have apparently not yet been appointed, so one Director might turn out to be Pablo@Escobar.

The other cannabis related ICO I reviewed is prepared more professionally but still, in my opinion, misses the mark by a good country mile. The company is called Paragon Coin, Inc. It is in the process of raising $100 million through the ICO. Just to be clear Paragon supports the cannabis industry, it does not appear that it intends to grow or distribute cannabis itself.

Paragon intends to bring block chain to the cannabis industry.  It intends to use a distributed ledger to bring order to this fragmented industry. According to the White Paper the company intends to “offer payment for industry related services and supplies through ParagonCoin; establish niche co-working spaces via ParagonSpace; organize and unite global legalization efforts through ParagonOnline; bring standardization of licensing, lab testing, transactions, supply chain and ID verification through apps built in ParagonAccelerator.”

All that is fair enough and the names and pictures of the operating personnel are included. Their education and work histories going back 10 years which I would have expected to see are not present.

The White Paper clearly notes that cannabis is not legal at the federal level and asserts that it will only operate in states where it is legal. This is the prime oxymoron of the cannabis industry.  Illegal at the federal level is illegal everywhere. Marijuana is a Schedule I drug and possession or sale is a felony in all 50 states. That is a fact about which that the cannabis industry does not want to think and largely ignores.

The Paragon White Paper describes one of the Risks of investing in its coin offering as follows:

CERTAIN ACTIVITIES INVOLVING MARIJUANA REMAIN ILLEGAL UNDER US FEDERAL

LAWS. SUCH ACTIVITIES INCLUDE BUT ARE NOT LIMITED TO: (A) DISTRIBUTION OF MARIJUANA TO MINORS, (B) TRANSPORTING MARIJUANA FROM STATES WHERE IT IS LEGAL TO OTHER STATES, (C) DRUGGED DRIVING AND OTHER ADVERSE PUBLIC HEALTH CONSEQUENCES, (D) GROWING MARIJUANA ON PUBLIC LANDS, (E) MARIJUANA POSSESSION OR USE ON FEDERAL PROPERTY, AND

(F) OTHER CRIMINAL ACTIVITY OR VIOLENCE ASSOCIATED WITH THE SALE OF MARIJUANA. TO THE EXTENT THE COMPANY AND/OR PARAGON COIN, INC. MAY NOT PREVENT CERTAIN OF ITS USERS FROM USING PRG TOKENS IN VIOLATION OF US FEDERAL LAW, IT MAY SUBJECT THE COMPANY AND/OR PARAGON COIN, INC. TO CIVIL AND/OR CRIMINAL LIABILITY AND THE UTILITY, LIQUIDITY, AND/OR TRADING PRICE OF PRG TOKENS WILL BE ADVERSELY AFFECTED OR PRG TOKENS MAY CEASE TO BE TRADED.

This derives verbatim from the Cole Memorandum which was written in 2013 as a direction from the US Department of Justice to Federal prosecutors as to how they should allocate their resources when they decide who to prosecute and for what. It never made cannabis legal anywhere.

More importantly, the Cole Memo it is not an Act of Congress or Federal regulation and not binding on the current administration in any way. Any suggestion that it will continue to be followed under the current administration is wishful thinking given the Attorney General has repeatedly stated that it will not.

Medical marijuana has been legal in California for more than a decade. That did not stop the federal government from raiding and closing down a large medical dispensary in Oakland, CA in 2012. Parenthetically, Paragon’s initial co-working space is slated to open in Oakland, California.

Perhaps the most troubling aspect of this offering is that it intends to fund the use of block chain, a relatively unsecure distributed ledger to link the many growers and suppliers in the cannabis industry. If successful it may well deal a serious blow to the cannabis industry it is trying to support.

One of the leading ICO platforms, Coinbase, has been engaged in a two year battle with the Internal Revenue Service which wants a list of all the people who use its platform to trade Bitcoins. The IRS alleges that people are trading the coins profitably and not reporting the gains and paying the taxes. The US government has also alleged that drug cartels and other bad actors use crypto-currency to launder money.

If you are in the cannabis industry you have certainly heard stories of how the DEA would obtain the customer lists of hardware stores that sold supplies for hydroponic growing. Everyone who was a customer did not use these supplies to grow cannabis but the government used those lists to identify and prosecute people who did.

If you have a “decentralized” list of a large group of people who are on the list only because they are affirmatively in the cannabis business as Paragon wants to create, how long do you think it will take for the US Government to obtain it? Think that will be difficult because Paragon never touches any marijuana or sells it?

The CEO of Paragon, Jessica VerSteeg, is also CEO of AuBox which the White Paper describes as “an upscale marijuana delivery service in the SF Bay area”. That is more than enough “probable cause”for the DOJ to get its hands on Paragon’s distributed ledger and the names of every company that uses it. The icing on the cake will be when they tell the judge that the cannabis industry is full of drug cartels and money launders which, of course, it is.

When you write the risk factors for a securities offering, it is important to disclose all of the things that might reasonably occur.  Assuming that this ICO raises the $100 million that it seeks, it is certainly within the realm of possibility that the Attorney General might just seize that money under the federal asset forfeiture provisions. The people behind this offering somehow refuse to accept that there was an election last November and that there is a new sheriff in town.

What I took away from these two offerings was a sense that they were prepared by amateurs who were attempting to do something that was way over their head. In this current administration, raising money for a cannabis company waves a red flag in front of the US government. Compounding that fact by raising money through an ICO just increases the size of that red flag, exponentially.

I personally do not think that there is any hope for Green International but Paragon did not demonstrate that it needed $100 million and could have certainly raised a lesser, more reasonable amount in a more traditional fashion which is what I would have advised them to do if they had asked me.

 

 

Is Technology Changing Finance?

A lot of people seem to believe that technology will fundamentally change or disrupt finance and the financial markets.  Many, if not most, of those people seem to be developing technology, selling it or using it to sell products to investors and financial consumers.  Most of these people seem to have degrees or backgrounds in technology not finance.

Having a background in technology does not give you an understanding of finance or the financial markets.  You cannot fix or disrupt what you do not understand and the lack of understanding behind many of these products is simply ridiculous.

I only write about the law and the financial markets. I spent my career as an attorney working in and around the financial markets. I also taught Economics and Finance so I have a pretty well rounded idea about how the capital markets work and how they are evolving.

So I feel perfectly justified to call out the many techies who think they understand the financial markets even though they have never worked in the markets or studied finance. Nonetheless many seem hell-bent to create products that they think are making these markets better and are quick to label the products that they sell as “disruptive”.

I call these people the “algorithms fix everything” crowd.  It is an interesting thought, except that these mathematicians have no math to back up much of what they say about finance.

At the same time, there is an ongoing narrative that suggests that everyone who works in the financial markets is evil. I find it amazing how many people actually think that all bankers and stock brokers get up in the morning thinking “who can I screw today?”  I have personally brought more than 1000 claims on behalf of aggrieved investors against Wall Street firms and written a book about some of the really bad things that Wall Street firms can do, but even I know that Wall Street firms are not evil.

The capital markets handle millions of transactions every day involving trillions of dollars and the almost all of those transactions settle with both the buyer and seller happy. Banks and stockbrokers fund schools, universities, roads and hospitals and virtually every company since WWII, again without serious problems or complaints from anyone. Banks aggregate and intermediate capital and over all they do it quite well.  So what, exactly, needs disrupting?

Still there is a never ending stream of new products and services which claim to be revolutionary and which promise to disrupt the capital markets. On closer examination many of these innovations are more hype than substance. Say what you will, there is nothing disruptive here.  A few examples for your consideration:

1) Algorithmic stock trading – This is a good place to start because it is pure technology applied to the existing markets. “Quant” traders use computers to evaluate trends and trading patterns in the market of various securities. They attempt to anticipate the price at which the next trade or subsequent trades will occur.  Logic says that computers should be able to take in more information that is pertinent to stock trading, analyze it almost instantaneously and execute transactions in micro seconds.

It sounds right, but the reality is that all stock trading is binary; every buyer requires a seller. No one buys a stock unless they believe that the price will appreciate; sellers generally will only sell shares when they think the price will appreciate no further. Both sides to any trade cannot be correct.

Analyzing the information or executing faster is of no use unless each trade you make is profitable.  No one has yet figured out how to accomplish that, nor are they likely to do so.  What we are talking about is predicting the future which is difficult to do even if only a micro-second or two ahead.   And please do not suggest that artificial intelligence will change this.  If there is one right answer based on the current information, e.g. buy APPL, then who is going to sell it?

2) Robo investment advisors- These are similar but much less sophisticated. Robo-advisors do not actually attempt to anticipate future market performance. They make investment recommendations based solely on the past performance of the markets. Anyone who has ever bought a mutual fund is required by law to be told that past performance is not a basis for future results. But that is all you get with a robo-advisor.

FINRA did a study of a half dozen robo investment platforms and found that they provided widely divergent portfolios for the same types of investors. No robo is any better than any other and none is really worth anything.

3) Crypto currency- It was a discussion about Bitcoins that was the initial impetus for this article. Aficionados of crypto currency actually think that they are developing an alternative currency for an alternative financial system. People seem to want to just print their own money and on one level I can understand that.  But that level is more of a fantasy than reality.

The reality is that I can buy food or virtually anything else in most places in the world with US currency. Why do we need Bitcoins? What exactly, is their utility?   When I ask that question I get any number of weak responses. More often than not, I get a tirade about banks and/or governments being evil.

What proponents of crypto currencies never want to face is the fact that the crypto currency market has been full of people laundering money from illegal activities.  The banks that crypto currency fans love to hate are required by law to know their customers and have systems in place to prevent money laundering.  It costs money to follow the law and have those systems. It is money that the crypto currency platforms do not want to spend. If there is a common thread in the crypto currency world, it is that people want to skirt or simply ignore the regulations that keep the markets safe and functioning.

4)  Crowdfunding Platforms- Crowdfunding clearly works and works well as evidenced by the significant amount of money that it has raised for real estate and real estate development projects.  At the same time the crowdfunding industry is populated by a great many people who fall into the “I do not care what the rules say, I am in this to make a buck” crowd.  I have written several articles about how some of the crowdfunding platforms do not take the time to properly verify the facts that they give to potential investors.  Due diligence can be expensive and some of the platforms just refuse to spend what it takes to do it correctly.

Crowdfunding replaces the role that stockbrokers typically fulfill in the process of raising capital with a website and do it yourself approach.  With a stockbroker, the company that was seeking capital got that money the vast majority of the time because the brokers were incentivized to sell the shares. With crowdfunding it is very much hit or miss whether the company will get funded. Many of the better crowdfunding platforms charge close to what a brokerage firm would charge and the investors get none of the protections or insurance that they would get with a stockbroker.

5) FinTech and FinApps – I can go to my bank’s website and send a payment to my electric utility company. I can do the same at the utility company’s website. I admit that it is convenient, but it is hardly disruptive.   Remittance companies like PayPal merely move money from my bank to a vendor’s bank.  And PayPal posted a $3 billion profit in the last fiscal quarter.  So they may charge less of a fee per transaction than a bank, but is not essentially different, and again while PayPal holds my money, I get no insurance against hacking or theft.

Apps that allow me to apply for a mortgage on my phone are really doing no more than eliminating a bank employee who would enter the same information from a written application into the bank’s computer. Again, it is convenient but not necessary.  And the money for the mortgage comes from either a bank or stock brokerage firm so there is nothing disruptive here, either.

Is there nothing truly new and disruptive in finance? Of course there is. They deservedly gave the 2006 Nobel Prize in Economics to Muhammad Yunus for developing a system of micro-finance that continues to create millions of entrepreneurs and lift millions more out of poverty. I doubt that one line of computer code was needed.

Micro-finance has the ability to put globalization on steroids.  Who will be disrupted?  Quite of few people with big school pedigrees and enormous student debt who write code to disrupt finance but who never understood finance in the first place.to

Classifying Crypto-Currency

Is a Bitcoin a currency or a security?

This is a question that may interest only a small number of geeks and lawyers, but there is a lot of money already in the crypto-currency market and a lot more on the sidelines waiting to jump in if this question is answered satisfactorily.

The key concern is regulation especially if crypto-currencies are ruled to be securities. The securities markets are regulated in virtually every country and the penalties for issuing securities without following those regulations can be severe.

The history of crypto-currencies traces back to Bitcoins which were introduced in Japan in 2009. The coder who introduced them wanted Bitcoins to be considered to be a currency and used as such, hence the name “coins”.  Had he called them “Bitcode” many of the questions about what they are might never have been asked. At the same time much the market for Bitcoins might not have developed.

Part of the allure of crypto-currencies is the fact that some people see them as part of an alternative financial universe. These people seem to believe that crypto-currencies are part of a trend to replace traditional banks and banking.

Bitcoins store value and are a medium to exchange value,which are two prime attributes of currencies.  But having attributes of currencies does not make them currencies.  That point seems lost on many of the people who are insistent that Bitcoins and similar crypto-currencies are currencies. They are not.

Historically, most people who hated fiat currency preferred to use precious metals such as gold or silver for trade, although other commodities, most notably salt have been used over the centuries. But the simple fact is that fiat currencies work because they are almost universally accepted.

Proponents of crypto-currencies argue that they are becoming more and more accepted and that acceptance will increase.  But accepting crypto-currencies as an exchange of value will not make them currencies in the strictest sense. Salt, after all is just salt, no matter how it is used.

If we accept the fact that Bitcoins were mislabeled to give them the appearance that they were currency that is “mined” and kept in electronic “wallets” strictly is a marketing ploy we can free our thoughts for the real issue; are crypto-currencies a security?

The US Securities and Exchange Commission (SEC) has issued several Investor Alerts warning people to avoid investments and especially Ponzi Schemes that are funded by or which purchase Bitcoins and other crypto-currencies.  But the SEC has not come out and said the coins themselves are securities and that is significant.

The SEC has statutory jurisdiction over securities and the securities markets but not all investments are securities. Your home, for example, or other real estate can be a good investment, but is not a security. The same is true of gold bars or bullion; works of art or collectables and all commodities that trade on commodity exchanges.  All are investments, just not securities or the SEC’s problem.

I wrote a blog article about Bitcoins a few weeks back that got a lot more views than most of my articles because crypto-currency is a very hot topic. Several people forwarded legal opinions to me that specifically addressed the issue of whether or not crypto-currencies were a security.  Several of those legal opinions were written by excellent lawyers at excellent law firms. I was not really surprised to see that they reached opposite conclusions; some thought the coins were securities; some thought they were not.

Each of the opinions was interpreting one US Supreme Court case, SEC v. Howey, which basically defines a security as the “investment of money in a common enterprise with an expectation of profits predominantly from the efforts of others.” Law school students studying securities law spend a considerable amount of time with this case and later cases that applied it.  Any legal opinion asking the question “is this a security” will certainly review Howey and apply its reasoning to the facts at hand.

Personally, I do not think that the Howey test applies to crypto-currencies at all.

Let me take a step back and re-frame the question. If a crypto-currency is not a security, what is it?  I think that if a crypto-currency is clearly something other than a security, especially if it is something already regulated under different statutes, it should go a long way to settling the question. So what, exactly, are we dealing with?

Any crypto-currency is nothing more or less than multiple lines of computer code; a long string of ones and zeros.  Computer code is recognized by law as intellectual property which can be copyrighted and is covered by a substantial body of law both in the US and internationally. No one classifies computer code as a security.

The shares of Microsoft Corp. are a security, not the operating system that it sells. That distinction is why I believe that the coins themselves are not a security.

The last time that I heard so many securities lawyers asking the question “is this investment a security” was in the late 1970s.   At that time the marginal tax rate on the highest earners in the US was 50%-70%. If you earned over a certain amount you would pay one-half of the overage to the IRS.  Perhaps not surprisingly, there seemed to be a lot of doctors, business owners and entertainers with this problem.

An industry grew up to provide this group with a series of “tax sheltered” investments.  These transactions were intended to take advantage of IRS rules that provided tax credits and accelerated depreciation when certain physical items were purchased in a business context.  To qualify for the favorable tax treatment, the item purchased had to have a business purpose, be placed in service during the calendar year and not be a security.

In many cases leverage was employed. A doctor would put down $20,000 and sign an $80,000 non-recourse note for the item.  If the tax credit was 50% of the purchase price, then the doctor would save $50,000 from his tax bill for his $20,000 investment; more in subsequent years when he depreciated the value of his $100,000 item over time.

One of the more famous of these tax shelters was a company that sold lithographic masters of artwork from famous artists.  If you bought the master that had been created by an artist such as Andy Warhol, you might make 500 prints from the master before it wore out. If you could sell the lithographs for $200 a piece you could pay back your note, recoup your $20,000 down payment and still save $50,000 on your taxes.

If you sold those lithographs over a period of years, the price might fluctuate. A Warhol lithograph would likely at least retain its value and it could be exchanged for other works of art if you dealt with the right gallery or broker. That did not make the lithographs into a currency even though they had these key attributes of a currency.

Most of these investment programs came with an opinion letter written by a securities attorney that attested to the fact that selling a physical “item” did not involve the sale of securities because the sale did not satisfy the Howey test.  I wrote a few of those opinion letters back in the day because the law was pretty clear that a “thing” was not a security. As far as I can remember the SEC never brought a regulatory action against one of these investment programs taking the position that the items were securities.

The IRS did, however, take issue with a number of these tax sheltered investment programs. They disallowed the credits and deductions that the programs offered and ultimately changed its rules to close the loopholes.  The IRS is not bound to legal opinions and frequently judges the tax treatment of any investment long after the investment is made.

A key issue was whether you were buying a thing or a business. The same is true today. A coin offering might be a security if the coin owner receives a portion of the profits of that company when they purchase the coin.

The SEC is not bound by a legal opinion on the question “is this a security “.  As I said I read several opinions regarding crypto-currencies that went both ways, albeit on slightly different facts. What I did find surprising is that none of the opinion letters that I read, mentioned the fact that the IRS categorized crypto-currency tokens as “property”, not a “security” back in 2014.

The IRS’s classification is also not binding on the SEC.  But given the fact that the IRS had made this determination that the sale of a crypto-currency would be treated as property for tax purposes and the US Copyright Office will issue a copyright on computer code (but not on a stock certificate) I think any legal opinion regarding the classification of a crypto-currency under securities law should mention both.

Several of these opinions were rendered in connection with specific Initial Coin Offerings (ICO). Again this term is intended to create the look and feel of an initial public stock offering (IPO).  This is marketing and it is intended to create the impression (falsely) that an ICO is just like the offering of a security. Of course, if the SEC should assert that these ICOs were actually selling securities because they had the look and feel of securities and attempt to sanction the people behind them, these same people would be screaming that they did no such thing.

In most of the offerings that I reviewed, buying a coin in the ICO neither conferred ownership of the project nor did it promise any payments, so it would not be difficult to opine that all you were getting was a digital coin, not a security. If coin purchasers receive anything other than just the digital coin, then the issue gets murky.  Given that there have already been close to 1000 coin offerings, some very different from others, it can get very murky.

Just to be clear, this article is my opinion of a fairly new legal issue. It is not intended to be specific legal advice as regards one coin offering or another.

If someone came to me with a proposed ICO and sought my opinion I would probably counsel them as follows, just to keep them out of potential legal difficulty.

1) If you intend to use the proceeds of your coin offering to fund your new business then call the coins what they are: “Great New Tech Company Start-up Commemorative Digital Medallions”. This is just truth in packaging. Why call them coins or currency when they are not?

2) Account for the sale proceeds on your books as if you were selling any intellectual property.  If you wrote and sold a book about writing computer code and used the proceeds to fund your code writing business, you would not enter the sale proceeds on your books as an investment.

3) Go about your business and stay under the radar. There are certainly regulators who believe that the whole idea of crypto-currency is a scam.  At the same time, it does not seem to be difficult to raise money using these digital coins. There are multiple reports of multi-million dollar raises being accomplished within hours.  I can see no reason why anyone trying to raise money in this market would write numerous articles or give interviews bashing banks or Wall Street firms or proclaiming crypto-currencies as the new form of unregulated capitalism.  The best way to attract regulators is often to publicize how much money you are making in an “unregulated” business.

If you do want a formal legal opinion letter that your ICO is not the offering of securities, I would be happy to review the facts and prepare one for you. I probably charge a little less than the big Wall Street law firms.  I know that you will understand that I will need to be paid in US dollars not whatever coin you are issuing.  I cannot use your coins at the market, gas station or movies and it is probably going to be a long, long time before I can.

 

 

The Bitcoin Bubble

In the normal course, I do not do requests for this blog.

I have a job writing articles for a reputable publication. I write the articles that my editor assigns to me.  For the blog, I generally write about something that interests me. Usually, it is based on something that I have read or a conversation that I have had.

In the last few weeks, several people have asked me for my opinion regarding Bitcoins. The truth is I really do not have one. I think that they are a fad. They may be around for a while but ultimately I do not see that they will become a legitimate part of mainstream finance.

More and more people are investing in Bitcoins and more and more businesses are accepting them for payment. The recent run-up in their price has generated a lot of interest. Note that I said price, not value. Bitcoins have no inherent value.

A lot of people seem to confuse Bitcoins with blockchain. Blockchain or distributive ledger technology is just that ledgers; bookkeeping records of transactions that are created by parties to the transactions. Blockchain ledgers are public and every transaction is broadcast to everyone to reduce cheating.  Both FINRA and the US Federal Reserve have looked at blockchain and essentially yawned.

There is nothing inherently wrong with keeping various parts of transactional ledgers disbursed but I fail to see the benefit. The idea is to replace the institutional intermediaries like banks with digital ledgers where a lot of people enter their own transactions. This assumes that everybody in the system is honest.

Using blockchain, it is possible to effect transactions instantaneously everywhere in the world.  If I make an on-line purchase from a merchant they may not get my payment for a day or more.  The transaction is in fact, instantaneous, but the bank or banks in between slow it down so that they can have use of that money overnight.  With a large bank that can result in an enormous profit.

It would seem logical that a blockchain is only as secure as its weakest link and more susceptible to hacking and data breaches than any of the large banks or the US Federal Reserve.  And no matter where and how the ledgers are kept, every bank and public company that uses the blockchain system will still have to be audited once a year.

This brings us to Bitcoins which is essentially a string of computer code and which touts itself as a cryptocurrency. Bitcoins are not the only cryptocurrency. There appear to be more than 100 but Bitcoins seem to have the lion’s share of the market and are subject to the most hype.

I have some experience trading currencies in the foreign exchange market and teaching about them. When I was very much younger, I bought and sold currencies on the black market in Mexico and Italy.  So I think that I am qualified to peel back the curtain and take a reasonable look at Bitcoins and to size them up against other currencies.

When I did, what I found was essentially nothing.

Perhaps a unique aspect of Bitcoins is where they come from.  Bitcoins exist only on a distributed ledger and are the brainchild of an unknown computer programmer who first published the idea in 2008 and then the software to create the system in 2009.

The number of Bitcoins in the world increases every time someone, usually a cryptographer I suspect, solves a complicated mathematical puzzle. If you perform any task and receive a reward for doing it, I suspect that the IRS will consider that to be a taxable event.  I have yet to see IRS guidance on the subject, but I have no doubt that the IRS will catch up to this.

If you looked at this from the outside and said that a group of sophisticated cryptographers was going to create a code and that code would be accepted as money, you would be right to be skeptical.  Who, besides another cryptographer would want it?

Records of Bitcoin transactions are kept on blockchain ledgers and a lot of the trading is anonymous. A lot of people seem to think that most Bitcoin transactions are being made by criminals seeking anonymity. That may or may not be true, but the anonymity that comes with Bitcoin transactions would certainly attract a criminal element.

People who swear that Bitcoins will soon become the currency of choice usually make several arguments. When you examine them, it is obvious that none hold any water.

Bitcoin advocates argue that Bitcoins are no worse than any fiat currency. If the government can just keep printing money without anything behind it, why should not the marketplace be able to do the same?  As a member of the generation that first coined the phrase “question authority,” I think I am qualified to respond.

There was a lot of debate when President Richard Nixon took the US off of the gold standard in 1971.  Most of the people who favor Bitcoins today were not yet born and know nothing of the debate that took place then.  While it is true that the US no longer exchanges currency for gold at a fixed rate of $35 per ounce there is still a lot of gold stored at Fort Knox and elsewhere.  Most of it was purchased at $30 an ounce or less and at current prices would still back some portion of outstanding US currency.

Gold itself is a monetary fiction.  People have sought it and accepted it as an exchange for other items of value going back into antiquity. In reality, it is a rock. Once or twice every year someone walks along the bank of California’s Sacramento River and picks up a sizeable nugget. Any monetary system needs a hitching post and for centuries gold has been it.

Gold and all currencies are based on our willingness to accept them for things we consider to be valuable.  All currency is about perception.

In addition to gold, and perhaps more importantly, the largest asset held by the US government is land. Land has had value going back to feudal estates because they were places where you could grow crops and later build factories. Land adjacent to a river or shoreline has always had extra value.

The US government owns millions of acres of valuable land.  You might speculate about how much it would get if it sold the 98% of Alaska that it still owns but it is easier to add up the value of the someplace like Camp Pendleton, California with its miles of Pacific shoreline just waiting to be turned into high-rise condos, theme parks, and golf courses.

What is behind Bitcoins? Nothing. All fiat currencies are not created equal.

Currencies must be accepted in exchange for other goods and services. While more and more merchants are accepting Bitcoins, in most cases average wage earners in the US are required to pay their rent or mortgage in dollars and also their health and car insurance, groceries, cable, and phone bills.  There is not a lot left over for Bitcoin transactions.

I can get a meal from most street vendors in almost every country in the world with a US $20 bill.  In the aggregate street vendors sell a lot more meals every day than does McDonalds and McDonalds does not accept Bitcoins either.

Currencies function as a place to store value.  The recent run-up in the price of Bitcoins is an example of how poorly they perform that function.  There has been no countervailing deflation of the dollar to justify the increase in Bitcoin prices nor underlying economic events to explain it. The price of Bitcoins has run up based purely on speculation. The hype has created demand and the run-up has fed off of itself.

If the price of Bitcoins can increase that quickly, certainly the price can decrease that quickly. Would you want to contract to perform a service for one Bitcoin, perform that service today, send an invoice at the end of the month and be paid 30 days later?  The purchasing power of that one Bitcoin 30 or 60 days from today could be substantially less. Without stability Bitcoins are essentially useless as currency.

That is why many articles about Bitcoins refer to the tulip bubble in the 1600s. In both cases, prices were based upon what economists call the greater fool theory.  Everyone believed that the price would increase and bid the price up until there were no more buyers.  The bubble burst and the last fool got left holding the bag. I do not care if Bitcoins continue to go up until they reach $10,000 each or higher.  At the end of the day, someone will get left holding the bag.

A more recent twist on Bitcoins is their use in venture capital. Several companies have claimed to have raised millions of dollars by selling stock for Bitcoins or other cryptocurrencies.  They call them initial coin offerings (ICOs). Several companies profess that they have raised millions in a matter of hours. That may be because holders of Bitcoins cannot spend their coins in very many other places.

I could not locate a prospectus for one of these offerings. I do not believe that any were registered with the SEC. I would particularly like to see how the attorneys who wrote the disclosures handle the “risk factors” relating to the Bitcoins that the company received for its shares. Call it professional curiosity.

If I took anything away from my look at Bitcoins it is that there is a lot more hype than substance.  A lot of people seem to think that it is possible to create wealth by solving a mathematical puzzle. But Money for Nothing is a song by Dire Straits, not an economic reality.