Getting to the Bottom of Bitcoin

Bitcoin is defined as an open source of peer to peer digital cryptocurrency. It is distributed through public databases throughout a Blockchain. Today, it is the most popular digital currency but since there is no real supervision over the cryptocurrency, does it really have any value? And how is this affecting the finance world?

William Black, Associate Professor of Economics and Law at the University of Missouri-Kansas City shared his knowledge and expertise with us to showcase how Bitcoin is, in fact, losing value each day and attributing to fraud.

Buzz: Bill, you have a lot of knowledge and experience in the finance world. I am sure you have seen first-hand a lot of changes in the economy due to currency. Bitcoin seems to have caused a lot of conversation over the last year or so. Can Bitcoin be a reason for recent fraud?

Bill: Bitcoin does, in fact, make fraud possible. Because it is an alternative way of paying people, in which its very easy to keep secret, specifically larger transactions, like anyone involved in fraud, likes doing.

It is no surprise to me that Bitcoin has been found heavily associated in Silk Road which was a part of the dark web in illegal drug sales. Bitcoin itself is also vulnerable to fraud. It is easy to steal large amounts of Bitcoins. Cryptocurrency like Bitcoin is not kept in a usual way in a regular, insured bank. Bitcoins are typically placed in special exchanges and those exchanges have had massive thefts and loss – to the tune of the hundreds of millions of dollars.

Buzz: You mentioned the loss of Bitcoin; can you explain that further?

Bill: It may not be fraud, but Bitcoin can easily be lost. When you think of the dollar currency, people go to the bank, they make deposits and it is accounted for. With Bitcoin, people lose track of it because the only true way to keep track of it is through special codes. So, let’s say your computer crashed or you forgot your password – you cannot access your Bitcoin. It is estimated 1 out of 4 or 5 Bitcoins have been lost. It is not fraud, but that is an astonishing loss of money. There is no easy way you can retrieve your lost Bitcoin.

Buzz: Now that people are discovering the risks of Bitcoin do you think it will lose value?

Bill: It has already lost an enormous portion of its market price this year. One of those reasons is that these huge Bitcoin exchanges thefts cause the market price to fall. There is an academic research that says the price of Bitcoin has been manipulated enormously by the largest Bitcoin holders to artificially inflate its value. Research suggests that more than half of the Bitcoin price rise in 2017 was due to manipulation. I find this very interesting because it suggests two things about Bitcoins…

1) It is so opaque as opposed to transparent that it makes manipulation possible

2) That they actually use another cryptocurrency as a means of manipulation

Buzz: What do you mean by another cryptocurrency?

Bill: There are key players in Bitcoin who are doing the manipulation and those players created this other cryptocurrency to inflate the value of Bitcoin. Another thing to remember is there is no there, there. It is like that famous Oakland saying, “once you get there; there is no there, there.” There is nothing of value to those cryptocurrencies. We know that a United States dollar bill has value because it is a sovereign currency and is, by law, “legal tender.” It pays debts and most importantly, it pays debts to the IRS. That is what gives sovereign currency an obvious value. Bitcoin only has the value that people think other people will value it at.  It is an inherently speculative value that can fall to zero.

Like any speculative play, the price can go up. But, as soon as sentiment becomes negative, it is any speculative investment is a terrible thing to be a part of. When it does go up, it will not be because it rose in value due to any intrinsic value but because it benefited from a speculative bubble. We already had a huge bubble of cryptocurrency possibly due to the manipulation we spoke about earlier but like we have seen in 2006, bubbles do not last. They can last for years and one may feel unwise for not having bought real estate in Vegas in 1988, for example. But I bet someone was really happy that they did not purchase real estate in Vegas in 2006.

Buzz: So, what does that mean for the Blockchain industry?

Bill: Blockchain is in its early stages.  It may be improved considerably, but today it is one of the most over-hyped things in the business world. The hype is that it “makes fraud impossible.” It does not.  It is inherently incapable of preventing (or even making difficult) any of the fraud schemes that drove the 2008 financial crisis. Lenders and their agents can still extort appraisers to inflate their appraisals. Lenders and their agents can still inflate the borrower’s income if they make “liar’s” loans that did not require income verification. Entities that owned loans, MBS, or CDOs could still make false ‘reps and warranties’ that the mortgage product they were selling was underwritten in a manner that prevented the inflation of appraisals and the borrowers’ income. All of this could still allow the sale of trillions of dollars in toxic mortgage products.

The three big credit rating agencies could still give an “AAA” to 80% of the dollar volume of the CDO ‘tranches’ composed of the most toxic MBS. That financial alchemy, purporting to convert toxic to “AAA,” would faithfully be reported by blockchain technology to all the purchasers – facilitating the fraudulent sales rather than preventing them. AIG could still sell CDS ‘protection’ for the toxic mortgage products as if it were actual insurance – but set aside zero loss reserves. Monoline insurers could still purport (with grotesquely inadequate capital) to ‘ensure’ the toxic mortgages against loss even though they would quickly be bankrupted in any crisis. Complacency creates a catastrophe in finance. Believing that blockchain prevents fraud creates false complacency.

Buzz: There has been talk about the real estate industry eventually growing towards a system of payment like Bitcoin. How do you think this all will affect the future of the real estate industry?

Bill: I do not think anything special would happen to the real estate industry because of Bitcoin but that bad news is that it does make real estate an easy target for money laundering through cryptocurrency. You really cannot use cryptocurrency for regular transactions at the drugstore, it takes too long for blockchain to verify a transaction. Blockchain technology may improve and become more efficient but remember that the distributive verification process is inherently at risk of a coordinated captive bot attack that would corrupt files and cause the verification process to fail. Americans forget that Delaware is that largest tax haven in the world. Real estate is frequently used to launder money and there are many warning signs to the government that cryptocurrencies could aid money laundering.

Buzz: Bill, thank you for taking the time to talk with us. We appreciate all of the information. We look forward to hearing more from you at Valuation Expo in Las Vegas Oct 1st-3rd. 

Bill: Thank you! It was a pleasure.

If you would like to submit an article to the Appraisal Buzz, please contact us at comments@appraisalbuzz.com 

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About William Black

William Black
Bill Black is an Associate Professor of Economics and Law at the University of Missouri – Kansas City (UMKC) and the Distinguished Scholar in Residence for Financial Regulation at the University of Minnesota Law School. He is a white-collar criminologist. He was the Executive Director of the Institute for Fraud Prevention from 2005-2007. He taught previously at the LBJ School of Public Affairs at the University of Texas at Austin and at Santa Clara University, where he was also the distinguished scholar in residence for insurance law and a visiting scholar at the Markkula Center for Applied Ethics. He was litigation director of the Federal Home Loan Bank Board, deputy director of the FSLIC, SVP and General Counsel of the Federal Home Loan Bank of San Francisco, and Senior Deputy Chief Counsel, Office of Thrift Supervision. He was deputy director of the National Commission on Financial Institution Reform, Recovery and Enforcement. His regulatory career is profiled in Chapter 2 of Professor Riccucci’s book Unsung Heroes (Georgetown U. Press: 1995), Chapter 4 (“The Consummate Professional: Creating Leadership”) of Professor Bowman, et al’s book The Professional Edge (M.E. Sharpe 2004), and Joseph M. Tonon’s article: “The Costs of Speaking Truth to Power: How Professionalism Facilitates Credible Communication” Journal of Public Administration Research and Theory 2008 18(2):275-295.

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