*Preface: I realize that a lot of you who are proponents of Bitcoin have very good reasons for liking it, and you may consider this article to be FUD (Fear, Uncertainty, and Doubt). Yes, I will poke fun in this article and display (accurate) hyperbole, for the sake of emphasis. All I ask is that you keep an open mind. The best traders/investors in the world keep open minds, and always consider the both sides. The point is to make money, and keep it… not to gamble. Having a strong opinion without considering the opposite side will blind you to possible errors in your judgement, and increases your risk of failure. End preface.*
Bitcoin, Bitcoin, Bitcoin… it’s all the rage. I remember my nerdy friends talking to me about it back in 2011. I didn’t understand it in the slightest. I got that people were buying it, and it was popular amongst the tech-crowd. But it still made no sense to me.
Now with Bitcoin soaring to new high’s of around $7,000 USD, it’s caught my attention. But more importantly, it’s caught everyone’s attention… and that is not good for new potential buyers.
I wouldn’t describe myself as a Luddite. I’d say I’m pretty open-minded. However, with everyone (your grandma, your barber, you name it) talking about Bitcoin, with the lack of intrinsic value, with the lack of regulations and shady brokerage firms reminiscent of the penny stock “pump-and-dumps” in the 90’s… it has a few of the main markings of a bubble.
“There’s a sucker born every minute” – PT Barnum
Opinion: If you can convince enough people that marshmallows are valuable, you can create a similar currency to Bitcoin… with more physical and intrinsic value.
What Is Bitcoin?
Bitcoin is one of many cryptocurrencies, meaning that it’s a purely digital asset. Bitcoin is a decentralized digital currency, that can be transferred from one individual to another without the need to make transactions through banks.
Like gold, Bitcoin is mined, except Bitcoin is mined on the internet. Bitcoin Miners solve math problems and receive Bitcoin along the way. The catch is though that there are a finite amount of Bitcoins in existence (21 Million to be exact).
Here’s a video on how Bitcoin is mined. It’s essentially… well, I’ll let you draw your own conclusions.
Is It A Bubble? Maybe.
The thing about Bitcoin is that unlike a farm (for instance), it has no intrinsic value. A farm will produce and continue to produce real value such as food and whatnot through both Bull and Bear markets.
Take a simple piece of lumber for instance. You can burn it and use it for a fire. You can carve it down into a piece of art. You can create tools, bowls, and other useful household items. In other words, it will always have some intrinsic value to it, because of what you can do with it.
Utility companies and commodities are another example of things with intrinsic value. There’s an inherent value to them that are beyond whatever the current market price. 10 out of 10 times, you will pay/do whatever you have to get water and food.
In other words, one of the signs of a bubble would be a lack of intrinsic value, or at least an inflation of perceived value relative to actual value.
If you think back to the Tech Bubble, that was a period of time of heightened valuations of companies who hadn’t produced a single dollar of profit. The extreme rally in Stock prices at the time were based on perceived value of the companies that were, in reality, all hype with no real value. You know what happened next…
The consensus is built into the current price. The job of the successful trader/investor is to make judgements on whether or not the consensus is right, then go against the consensus if they are wrong.
So sure, the current consensus of Bitcoin at $6,000 is that it currently has some perceived value to it. People have bid it up from mere pennies a coin, so obviously people are willing to pay for it.
The question though is not whether or not people are willing to pay for it now, but whether or not they will be willing to pay for something (that has no real value, and is good as video game money) in the future?
The problem is that bubbles are difficult to time. If Bitcoin is indeed a bubble, it would be difficult to take advantage of it, because there aren’t many ways to short Bitcoin at the moment.
By the way, whenever I read opinion pieces where the author gives a middle of the road, “safe” answer it really bugs me. So, I’ll do you the favor and tell you that I think Bitcoin is a bubble.
If you’re getting into Bitcoin as an investment/trade right now, at $7,000 your trade location isn’t great.
Bitcoin Is Not Regulated
Bitcoin transactions are completely anonymous. There is no tracking or accounting between banks or institutions. Proponents of Bitcoin have argued that this one of the reasons that Bitcoin is a viable currency vehicle. The fact that currency doesn’t have to be transacted through banks means lower fees.
However, this also means that criminals have an easy way to fund their projects and move money without government authorities or police bodies having the ability to track their movements. I’m all for having Uncle Sam and the police minding their own business.
I don’t think the government should be constantly part of everyone’s personal affairs, but the fact that Bitcoin is completely anonymous severely hampers a government’s main function: protect the people.
Regulation Is Actually A Good Thing
Regulation is actually a good thing in reasonable quantities. Too much regulation, and you suffocate the market and it’s growth. Too little regulation and you have sharks and charlatans robbing innocent, unsuspecting people blind.
This is the reason that trading exchanges follow such strict rules and guidelines. A regulated exchange instills trust and confidence in the trader/investor that their funds are safe.
Take the Bitcoin exchange Mt. Gox for instance. The argument that Bitcoin is a safer asset to hold than money in a bank is erroneous, because Mt. Gox was hacked and had a bunch of Bitcoin stolen from it.
Participants of Mt. Gox had their funds frozen, and trading was suspended on the exchange while the firm figured out what was going on.
Bitcoin Is More Similar To Gold, Than The Dollar
People don’t quite realize this point. Bitcoin has a fixed supply. In the same way that the Earth only produces a certain amount of Gold, there will only ever be 21,000,000 Bitcoins. The US Dollar and other currencies are Fiat Currencies (which actually a really good thing). A Fiat Currency means that there is no physical backing to the currency.
Under the Bretton Woods System, the US Dollar was tied to the value of gold, but you couldn’t convert your dollar bills into gold like you could prior to the mid-1930’s.
In 1971, the U.S. terminated the Dollar’s tie to Gold, effectively making it a Fiat Currency (Again, a good thing. I’ll explain this in the next section).
Moreover, Gold hasn’t been the most stable investment… and neither has Bitcoin. These two “assets” (I hesitantly call Bitcoin an asset. It’s more a speculative bet.) are very volatile. Volatility is great for trading and speculating, but not so great for a method of exchange between governments, businesses, and billions of people.
The Dollar Used To Be Tied To Gold… Now We Have Monetary Policy
Monetary Policy is the saving grace of the whole Fiat Currency argument. Monetary Policy cannot exist with a Gold-Standard, nor can it exist with a form of currency that has its value tied to a fixed supply.
Monetary Policy is the ability for the Federal Reserve to adjust interest rates, and the supply of money (Read: Quantitative Easing) to dampen the effects of economic recessions/depressions and boost economic growth.
The ability for the Federal Reserve to print money, adjust interest rates, and lend money is what allows for businesses to get loans, and for you to buy a house and pay it off over 30 years.
Watch the video below by legendary investor Ray Dalio on his interpretation of how the economic machine (as he calls it) works. He will explain it much more clearly, concisely, and eloquently than I would.
Credit and lending is a good thing. Without it, I would not be surprised if there was an even larger wealth gap. Credit and lending is what allows the small business person with little capital to go out and secure a loan that will allow them to start a business. Credit and lending is what allows people the opportunity to buy their dream home.
Bitcoin, by its very nature, will never allow for credit and lending due to its fixed supply. The ideas that Dalio presents in his video support this claim.
The idea that Bitcoin will replace all other currencies is ludicrous. Will it join them? Maybe.
With A Fixed Supply It’s A Zero Sum Game
One man’s pain is another man’s profit. There is no growth with a fixed supply. Going off of the last point above, the lending and repayment of credit is what allows an economy to grow and progress (seriously, watch the Dalio video if you haven’t).
A fixed supply of Bitcoin cannot be lent with interest. I mean think about it. Say all the Bitcoins have been mined… how can someone be lent a Bitcoin, and repay it with interest?
You could say that the constantly cycle of commerce would allow for someone to render services in exchange for Bitcoin to pay the interest on their debt. In other words:
- You get load 10 Bitcoins with 10% interest
- You start a business on the 10 Bitcoins
- Your services are good enough to bring you 12 Bitcoins back
- You repay the 10 Bitcoins with 10% interest
- You’re left with 1 Bitcoin in profit
That’s all well and dandy. However if you talk to Occupy Wall Street, there’s plenty of hoarders out there. There will be a chokehold somewhere on the amount of Bitcoin in circulation, because of it’s fixed supply.
Now compare this to an economy based on a Fiat Currency that continually prints money, and there is plenty to go around.
What Is Bitcoin Backed By?
Nothing. Bitcoin is backed by absolutely nothing.
Okay, so we’ve established that the US Dollar is a Fiat Currency… meaning it’s backed by nothing. However, Bitcoin is also backed by nothing… which coincidentally makes it a Fiat Currency.
The disadvantage is that Bitcoin does not have the power of Monetary Policy on its side, whereas most regulated currencies do.
It’s Monetary Policy that the US Dollar has which allows for economy to be deleveraged smoothly and effectively without an all out panic during a market correction.
The only thing that drives the price of Bitcoin is the perceived value around it, and whatever the next guy is willing to pay. It’s funny… Soros’s Theory of Reflexivity seems to be playing out as we speak.
As long as there is someone willing to buy it higher than what it’s currently trading for, the perceived value of Bitcoin will go higher. Remember what PT Barnum said?
I’m sorry, but what is so terrible about the Fiat Currencies we have now?
They cost some extra fee’s if you want to convert them, that’s true. But is that it? Is that the only argument you’ve got?
You know, there’s this thing in the human brain called the “Social Proof Bias” (Bias number 15).
Basically it means that if you see two restaurants across the street from each other, you will be more inclined to go to the restaurant that has the most amount of people inside. The line of (subconscious) logic is, “If everyone inside thinks it’s good, it must be good”.
Careful, careful precious lemming…
The Scarcity Trap of Bitcoin
“Get them now while they’re cheap!”
“Hurry! 50% off limited time only!”
There’s a lot of people hopping on the Bitcoin bandwagon because of FOMO (Fear of Missing Out). Since there is indeed a fixed supply of Bitcoin, it acts like a commodity.
In the way that the price of Gold Futures go up when supply is down and demand is up, so goes the price of Bitcoin. What happens when there is no demand, and the jig is up?
The “I want one too” mentality is not a valid criteria for entering an investment/trade. It is a valid criteria for blowing your money following the herd.
There’s plenty of opportunity in the market. Financial assets like Stocks, Futures, and Options are a much better trading/investing vehicle just by the fact that they are regulated and your funds are much safer.
Your choice… don’t be a lemming.
For A Speculative Trade, Have At It…
If you’re purely in Bitcoin to take advantage of the swings and volatility, have at it. I would caution against any extreme leverage, but I see no issue with taking speculative trades in a speculative instrument.
I’d also caution against using shady brokerage firms and exchanges that are not well capitalized. Your money is at risk with those firms, and it’s easy for an undercapitalized firm to go bust with your money in it.
The [Lack] Of Utility In Bitcoin
There’s two main requirements for a currency. 1) It needs to be a medium of exchange. 2) It needs to be a store of wealth/value. Bitcoin is way to volatile in it’s current price action for it to have much stability as a viable medium of exchange. So that (at the moment) rules out criteria number 1.
Concerning criteria number 2, many people argue that Bitcoin’s utility is a form of intrinsic value. Again, I’d go back to my main point that something is only worth what the next person is willing to pay for it.
A farm, for instance, is a store of wealth. A farm can produce food and resources for you to live. It is intrinsically valuable, but you can’t exactly trade a farm like you can other things, so it could never be a currency. It wouldn’t satisfy the first criteria (medium of exchange).
Gold is also a store of value/wealth, but only as long as people are willing to pay the current market price for it. I think we would both probably agree that a farm is more intrinsically valuable than gold, by the mere fact that it can help keep you alive. Gold is pretty to look at, but it won’t feed you.
Aside from Blockchain, where is the intrinsic value in Bitcoin itself?
There Could Be Future Value In Blockchain Technology
The intriguing thing about Bitcoin is that the story that pro-cryptocurrency people are selling is that it’s a way to transact value without any middleman. This is done with something called Blockchain.
Blockchain is essentially an open ledger that is broadcast to everyone across the internet to show the transaction history of every coin. It’s a way of keeping everyone “honest”, so to speak.
The major benefit here is that it provides complete transparency to the record of business, and hampers any tampering of the ledger because the information is available to everyone.
However, there is no way for any type of currency to be refunded. In other words, once a transaction is made on the Blockchain, it cannot be reversed like it can at a bank. Most banks are flexible and willing to serve their customers well if they are victims of fraud and whatnot.
Due to the nature of Blockchain, should you make a transaction where the counterparty is not honest you run the risk of losing your money to scams amongst other things.
That said, Blockchain doesn’t have to be (and probably won’t be in the future) restricted to trading currencies. Here’s a video that goes into more detail on Blockchain:
Yeah, I’m not a fan of Bitcoin. I think a lot of people are hopping onto the mania without thinking it through, and with too much FOMO. I do think it’s a bubble, but I could be wrong. I’m not afraid to admit that I might be wrong.
However, I think the perceived value of Bitcoin does not match its actual value. Does this mean that you personally should go out and sell your Bitcoin, or try to short it somehow?
Absolutely not. Whatever you do, make sure it’s your own informed decision, and remember that it is very difficult for the majority of people to time the bursting of a bubble.
That said, just be careful and don’t be a lemming.