Bitcoin transaction reversal and arbitration is built in. How it works.

Eli Dourado has a well written and easy to understand article about how Bitcoin transaction reversal and arbitration works. The feature built into Bitcoin is known as m-of-n or “multisignature” transactions. Here’s a brief extract:

The simplest variant is a 2-of-3 transaction. Let’s say that I want to buy goods online from an anonymous counterparty. I transfer money to an address jointly controlled by me, the counterparty, and a third-party arbitrator (maybe even Amex). If I get the goods, they are acceptable, and I am honest, I sign the money away to the seller. The seller also signs, and since 2 out of 3 of us have signed, he receives his money. If there is a problem with the goods or if I am dishonest, I sign the bitcoins back to myself and appeal to the arbitrator. The arbitrator, like a credit card company, will do an investigation, make a ruling, and either agree to transfer the funds back to me or to the merchant; again, 2 of 3 parties must agree to transfer the funds. This is not an escrow service; at no point can the arbitrator abscond with the funds.

The full article is on Eli’s blog.

Another feature of the currency that adds intrinsic value, along with no intermediaries, very fast transaction time and negative inflation which makes it a great value store.

How to Buy Bitcoin

As someone who recently purchased Bitcoin and two other crypto currencies using three different methods, I thought I’d share how to buy Bitcoin because I know there’s precious little information out there:

Coinbase:

The easiest way I found without leaving your computer is to sign into Coinbase.com and add your bank account. They’ll do 2 small deposits, you need to wait around 2 days for them to show up, then you verify your account by telling them what the deposits were. Once that’s done you can make your first Bitcoin buy using coinbase.

NOTE that when buying with Coinbase, you only get to make one purchase until it clears which takes around 7 days right now. So buy whatever the maximum bitcoin is that you want to purchase on Coinbase in the next week. The good news is that the bitcoin price will lock in at the time of purchase so even though you’ll only be able to spend your bitcoin after the transaction is approved 7 days later, you still benefit from locking in the price at the time of purchase. For me that meant several hundred dollars in gains because the price was rising steeply when I bought and it continued to rise over the next week.

The benefit of Coinbase is that you don’t need to leave your computer to do it and you don’t need to meet strangers in a dark alley (see below). The down side is that it takes 7 days before you can spend your bitcoin and you need to give them your bank account details.

In Person:

LocalBitcoins.com is a reputable site which is popular with the Reddit community and they have ads for people local to you who are selling Bitcoin. The sites popularity has grown enormously in the last few months and every town world-wide (including South Africa) that I’ve checked has bitcoin for sale.

LocalBitcoins has a reputation system similar to eBay that lets you find someone who has a good reputation for not scamming folks. I found someone in Denver, Colorado yesterday and within about 30 minutes of contacting them via the site they phoned my cellphone. We arranged to meet in a parking lot outside a well known computer store. The guy was a typical twenty-something computer geek type – really nice guy actually. I was happy to give my first name but he seemed to want to go by his online handle. I handed him a rather large stack of cash and then we spent a few minutes figuring out what the best way was to send the Bitcoin. I ended up using the Bitcoin wallet for Android, he scanned my QR code, sent me the coins at the current localbitcoins.com exchange rate (which was quite good) and within 10 seconds my phone went KACHING and I had my Bitcoin. We said our goodbyes and that was it. Except…..

PRO TIP: If you’re buying Bitcoin from someone in person, make sure they include a small transaction fee with the Bitcoin when they send you the coins. If they don’t, the coins will show up in your wallet but it may take several days until you can actually spend them. The guy I was buying from had a wallet that added zero transaction fee and I had to wait just under 5 hours until the transaction was finally completed by the network and the coins became spendable. I did a few tests later and added everything from 10 US cents to $9 as a transaction fee and it radically improved the processing time. The $9 transaction fee took 30 minutes to complete and when adding a few cents it takes about an hour. Many wallets don’t give you the option of adding a transaction fee. The Bitcoin-QT client does give you that option and I understand that the “Mycelium wallet” for android lets you modify the transaction fee but I haven’t verified this. The miners who process your transaction get the fee and they prioritize transactions with fees associated with them first.

The benefits of buying in person are that you get your bitcoin immediately and you usually get a better price that you do if you’re buying at an exchange or a service like Coinbase. The down-side is obviously that you might get mugged or scammed. But with a reputation system like LocalBitcoins and meeting in a crowded place, there are ways to minimize that risk.

Buying on exchanges:

After buying bitcoin I wanted to buy some Litecoin and found BTC-e exchange which offers trading in several other Crypto currencies. Note that BTC-e is based in Bulgaria and no one knows who the owner is so it’s highly risky. You’ll notice that all crypto currencies are cheaper on this site and it’s because of the risk premium. So I send them some Bitcoin as a deposit and started trading – bought some Litecoin which has yielded a nice profit along with some Feathercoin which is still extremely cheap and new and has also behaved quite nicely since the purchase.

I haven’t used Mtgox, but I understand that it only offers Bitcoin trading at this point which seems a little pointless because that doesn’t really make it an exchange – more of a place to buy Bitcoin like Coinbase.

Conclusion and my recommendation:

If you’re going to buy Bitcoin in the USA at this point, and if I buy again, I’ll definitely buy in person. It’s very fast, fun and with the reputation management that LocalBitcoins offers it seems fairly safe. If you have patience, Coinbase seems like a good option but in a fast moving market it moves a little too slowly for my liking.

Happy crypto currency trading!!!

Update:

Since I posted this 6 days ago, I’m still trading occasionally on BTC-e, but only alternative crypto currencies. I do all my Bitcoin buying on Coinbase. Today there were claims on Reddit that some folks couldn’t get their money out of BTC-e. Turns out BTC-e’s email servers were down for a while, so anyone who had email verification for withdrawals couldn’t withdraw their money. Sounds like an honest bug that hit BTC-e. I’m still quite happy there although I never leave a positive balance on the system. I’ll deposit, trade and then get out. Also note that they charge 0.1 Litecoins (About $4 today) for a litecoin withdrawal and .001 Bitcoins (About $1.20 today) for a Bitcoin withdrawal. The Litecoin folks are up in arms about this.

Since I wrote this I’ve made another trade on Coinbase on Dec 1st and am happy, although the delay to get coins is 6 days, even for your second trade. [Rather than the 4 days I wrote in the comments below]

I’ll also note that since the writing of this article I have been trading more alternative crypto currencies including Litecoin, PrimeCoin and Feathercoin. There is a lot of “pump and dump” activity around these currencies. They’re being treated like penny stocks. A cartel of people will get together, spend a few hours either boosting or insulting a particular currency to try and generate buy or sell activity, take the opposite action, and then send the opposite message. They use forums, live chat, twitter, blogging and so on. Litecoin is getting too large in market capitalization to do this (passed $1 billion compared to Bitcoin’s $13 billion and the third place Peercoin’s $136 million market cap). But smaller crypto currency perception is being manipulated by groups of folks, so beware. I still think it’s fine to trade in these currencies, but wait for a drop to buy and ignore the intra-day noise you see on forums and social media.

 

To borrow or not to borrow: Thoughts on US government debt

A reputable investment bank approaches you and says they’ll lend you as much money as you want for a very low interest rate. The rate depends on how long you want to hang onto the cash:

  • 1 Month will cost you 0.01% APR interest
  • 6 months: 0.07%
  • 1 years: 0.11%
  • 5 years: 0.88%
  • 10 years: 2.02%

If you earn 3.5% on the money over 5 years which simply keeps pace with US inflation, when you pay back the principle you will be able to keep a 2.62% annual return on whatever you borrowed, based on the 5 year borrowing rate above. So if you borrow 1 million over 5 years you earn $138,046.62 in pure interest over 5 years (compounded annually).

Sounds like a pretty good deal right? $138K earned 5 years from now for nothing. I’d take it, assuming I could find somewhere to invest the money that would give me a 3.5% return, which shouldn’t be too hard.

However, if I’m fiscally irresponsible and rather than investing the cash I’m likely to spend it on hookers and blow, then it’s probably a bad idea for me to borrow as much as I can.

However, if I am that irresponsible and have a history of being a nut job, the interest rate that the investment bank charges me on my borrowings will reflect my lifestyle and will be more like 30% APR which is what many credit card companies charge once you’ve missed a payment.

The interest rates above are what America currently pays to borrow money. It’s the treasury yield curve rates. They are below inflation which means that the rest of the world pays the United States to store their money. And the United States makes money if they can get a very moderate return on any of that cash they invest. If the return simply keeps pace with inflation, they’re rolling in dough.

The interest rate the United States gets charged reflects how investment banks, sovereign wealth funds, companies and individuals feel about the United States “lifestyle” or fiscal and monetary level of responsibility.

So the question is: Can our country borrow trillions of dollars, put it to work in a responsible way and make out like a bandit? Or will it spend it all on hookers and blow and leave our grandkids in the hole struggling to pay off the principle?

Footnote: The answer to this question is usually along ideological lines. Keynsian economists like Paul Krugman who dominate the Democratic party will say Hell Yes! Government knows best and should borrow like there’s no tomorrow. Hayekian economists like Russ Roberts and economic conservatives on the other hand will tell you that the private sector knows best, government should limit it’s size and balance sheet and should never engage in massive borrowing no matter how low the interest rate or the potential return on investment, because it’s not government’s place to act like an investment bank.

Footnote2: I’m still feeling pretty good about my bull market prediction yesterday and am now long Apple (AAPL). I’m expecting it to churn during the next 6 months and have a 18 to 24 month price target of $550 (bought at $418).

Unemployment is lower? Bull.

Last Friday and again today the DJIA got a nice bump from data showing unemployment has dropped from 9% to 8.6%. This number is known as U3 and only counts those actively looking for work. U4 is what the government should publish which counts U3 + those who have given up looking.

We “added 120,000 jobs in November” and have added over 100,000 jobs per month for the last 5 months.

I found the birth, death and marriage rate on the CDC website. For December 2009 we had 344,000 live births per month, 216,000 deaths per month and 138,000 marriages per month.

Our population is increasing by roughly 128,000 per month, which is 8000 more than the number of jobs we added. Looking at marriages per month gives you an indication of how many new couples are starting life and presumably expecting full employment. That’s 18,000 more than the maximum number of jobs we added per month in the last 5 months.

I don’t think we’re ever going to get the jobs we lost back because the financial crisis of 2008 was a trigger that caused companies that have become more efficient to cut a workforce that is no longer needed. That is why corporate revenue has not declined even though unemployment has increased. The grey marks the recession, click the graph to go to ycharts for a live version.

The only way to solve this is to bring our education syllabus up to date. The chinese have a few ideas how to do that: They’re cutting majors that produce unemployable graduates. 

Can you build a Big Business on Apple’s App Store?

A good friend refers to the Apple App Store as the California Lottery. So I thought I’d do some rough numbers on how feasible it is to build a big software business creating apps for iPad and iPhone and selling them in Apple’s App Store.

The Apple App Store will still own three quarters of mobile app revenue by the end of 2011. It’s the place to be if you want to develop paid mobile applications.

According to Apple, they had paid out developers $2.5 billion since the creation of the app store until July this year. I’m including this as a sanity check on my numbers below.

According to this article, the combined revenue of all app stores will be $3.8B in 2011, with Apple owning 75% market share. That’s $2.85B total revenue for the app store in 2011 with 30% going to developers so total payout to devs will be approximately $1.995B for 2011 (which roughly gels with the total all time payout number above).

The app store just passed 500,000 approved apps in May 2011. (Edit: fixed a typo. Apps, not developers)

In May of this year:

  • $3.64 was the average price for paid apps.
  • There were 244,720 paid apps.
  • There were 85,569 unique developers.
If those paid apps split Apple’s projected 2011 revenue to developers of $1.995B between them, they each earn $8152.17 per year. There will be more paid apps by the end of 2011 than there were in May, so the same calculation for 2010 revenue to developers gives us: $2.1 total sector revenue X 75% apple’s market share X 70% developer share gives us $1.1025B / 244,720 paid apps = $4505 per app in 2010.
I’ve calculated both 2010 and 2011 revenue per app because the only data I have on total paid apps is from May.
So total revenue per app now is roughly between $4K and $8K per year based on my back of the envelope calculations.
While app store revenue is increasing, so is the number of developers in the app store, exponentially:
Lets say you create a startup producing Apple App Store apps. You manage to completely dominate the app store in 2011 and capture 1% of the total 2011 app store revenue of around $2 billion that Apple will pay out to developers.  That’s $20 million in annual revenue. Remember, you’ve just owned 85,560 other unique developers and a quarter million other paid apps, which is not impossible.
To put this in perspective, here is the 2010 annual revenue from a collection of well known software companies, leaving out the eye watering revenue from companies like Oracle, Microsoft, Apple, Google and the like.
Sources:

Food for thought.

We are centrally planned and we are vulnerable

John Robb writes an excellent post arguing that the concentration of wealth in the United States has resulted in a centrally planned economy. I wanted to expand on his writing.

After World War II, there was a widely held view that Nazi Germany was the result of failed capitalism. Economists and political scientists in the UK and across much of western Europe thought that Capitalism was a bad thing and the answer was socialism.

A now famous economist called Fredreich von Hayek argued in The Road to Serfdom, published in the early 1940′s, that Nazi Germany was actually the result of central planning. He suggested that a centrally planned government is destined to become fragile and is easily seized and taken over by those that might not play by the rules.

Hayek was based in England, but his book was far more popular in the United States and it may be the reason we ended up with a free market economy post WWII.

John Robb’s idea is a new and useful lens to examine our political and economic decline: Through capitalism gone wild, we may have ended up with all the trappings of socialism after all.

 

 

The world is now paying the US government more to store their money.

I ran across this page on the Treasury’s website via Marc Cuban’s blog. It shows the yield on US government treasury bonds, adjusted for inflation. If the yield on a bond is 3% and inflation is 2.5%, the real yield is 0.5%.

So in inflation adjusted terms, anyone buying 5yr treasuries today is paying the US government 1.02% per year to store their money.

Curiously, after the downgrade, the world is paying the US government even more to store their money.

 

Treasury real yield curve

What does the S&P’s AAA to AA+ downgrade for the United States mean?

If you haven’t heard the news, S&P just downgraded us from AAA to AA+ and gave us a negative outlook to add insult to injury. But it’s not like we didn’t deserve it. In a democracy, people deserve the government they get. Remember that “We the people…” document? Well we the people just got a AA+.

It’s the first time the US has been downgraded since we received a triple-A rating from Moody’s in 1917 and a AAA from S&P in 1941.

Obama says “S&P’s analysis of the United States economy is deeply flawed.”. I think his chances of reelection just got deeply f***ed.

Keep an eye on treasury bond yields on Monday morning. There’s a tension between interest rates going up since they’re now technically more risky and the reflex flight to risk causing treasury buying that drives their rates down. It’ll be interesting to see whether fear or common sense prevail.

So what will happen going forward?

  • Interest rates in this country are bound to rise long term because, what the government pays on debt is the base of all other interest rates in the country.
  • Mortgage rates rising won’t help the housing market “recovery”. Less people will buy houses with the cost of borrowing becoming more expensive.
  • With asset prices falling a few more banks will fail. Their debt to asset ratio will not meet the minimum requirements and the FDIC will show up on Friday afternoon and seize them.
  • Expect to hear about the FDIC fund running short on cash and there to be a vocal debate about how to replenish it. Technically it’s an insurance policy that the banks fund and in normal times the government might just top it up. But what will probably happen as the fund gets depleted is that they will need to raise the rates they charge banks, which may make banking in this country more expensive for consumers and businesses.
  • The latest budget debate made it very clear there will be no more trillion dollar bailouts. The good news is that at least this kills moral hazard (when bankers and execs are irresponsible because they know they’ll get bailed out.
  • It gives us a reasonable facsimile of a free market. Even if you’re going to have to dodge the falling bodies on Wall St….
  • The dollar will fall as foreign investors move to countries like the UK, Germany, France and Canada who all still have their AAA rating intact.
  • Companies that rely on cheap foreign labor or resources will have to radically restructure their supply chains to survive and some might not be able to pull it off.
So where are the opportunities? Well I’ve said it before and I’ll say it again: “Gold prices will hit $1800 in September/October and $2200 or more by year end.
  • Companies that export US goods or services will earn more as the dollar falls.
  • Technology companies who are nimble, efficient and export services will do well.
  • New innovators will replace incumbents who can’t readjust.
  • We might get a new political party in the next half decade.
And for a laugh.. the Federal Reserve just announced that risk weightings for US government securities (how risky the government thinks it is) will remain unchanged:
For risk-based capital purposes, the risk weights for Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities will not change. The treatment of Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities under other federal banking agency regulations, including, for example, the Federal Reserve Board’s Regulation W, will also be unaffected.

And finally, lets hope that 500 point drop in the DOW this week was a leak that has now been fully priced into the market, or we’re in for an even bigger drop on Monday.

How sovereign debt becomes leverage – a lesson from history

"America Looks at its Neighbors" (political cartoon, 1932).

"America Looks at its Neighbors" (political cartoon, 1932).

I grew up in South Africa and for a time my birth country was the only worthwhile stop on the long sea journey that spice traders would make from Europe to India and back. South Africa was colonized by Europeans for this reason. A guy called Jan Van Riebeeck was ordered to set up camp there by the Dutch East India Company.

In November, 1869 the 10 year construction project on The Highway to India, aka the Suez Canal, was completed and South Africa became just another colony. Since then the Suez has had a colorful history, but there’s one specific teachable moment in the history of the Suez the United States could learn from…

In July 1956 the president of Egypt, Gamal Nasser decided to nationalize the Suez Canal. This irked a few stakeholders and on October 29, 1956, Israel invaded Egypt. The next day Britain and France threw their hats into the ring and started bombing Cairo.

At this point in history, Britain was suffering under a mountain of debt. Here’s a historical graph of Britains debt to GDP ratio to give you some perspective:

British Public Debt from 1900 to 2010

British Public Debt from 1900 to 2010

The United States held much of the debt that Britain was in. Some of the bonds were owed to the US as part of Britains World War II debt to the US government, corporations and individuals and some of them were part of the Marshall Plan to help rebuild Europe post WWII.

The US used this debt to put tremendous pressure on Britain to halt the invasion. Eisenhower ordered Humphrey, secretary of the treasury to prepare to sell part of the US governments sterling bond holdings. His British counterpart advised his prime minister, Anthony Eden, that if the US did sell their bonds, the British pound would devalue to such an extent that they would no longer be able to import what they needed to sustain the islands. Eden announced a cease fire on November 6th.

The US is now at around 90% debt to GDP ratio with a total debt of just over 14 trillion. Around 4 trillion of that is held by other countries, China being our biggest “investor”.

Lets put it this way: It’s hard to not take the call when your single largest investor needs a favor.