Bitcoin: Nothing More Than A Fad. Not A Currency, Only A Speculative Investment
Bitcoin has surged from around $100 when the Winklevoss twins started investing in it a few years ago, with some of the proceeds from their suit against Mark Zuckerberg alleging he stole their idea to start up Facebook. Many, including myself, found ludicrous the idea of Bitcoin, a blockchain algorithm with a maximum number of bitcoins allowable, being a store of value and an alternative to gold. To my astonishment, Bitcoin’s price has since skyrocketed to about $50,000 recently. As a speculative investment, Bitcoin has certainly been spectacular since its inception. But, that does not exclude the possibility that Bitcoin is just a fad, that its price will eventually fall dramatically, and that it will even completely cease to exist in any meaningful way.
For the moment, however, even sophisticated investors are piling in, including some central banks. The idea is that Bitcoin will not only replace gold as a store of value, it will even become a global currency. Some businesses have announced that they will accept payment in Bitcoin.
But Bitcoin cannot be a currency since its value/price is so volatile. A currency is a medium of exchange. The dollar, the euro, the yen, and the pound are currencies, because they function well as a medium of commercial exchange, having a steady value, at least in the short term. Gold is not a currency, because its value can change substantially in the short term. Bitcoin is much more volatile, its price often swinging wildly over just a few days, therefore it does not have the essential attribute of currencies. Just like gold, Bitcoin needs to be referenced to and convertible into a currency, precisely since it is not a currency.
(Currencies are not, and are not meant to be, stores of value, contrary to traditional thought. Investments, not currencies, are meant to be stores of value. The essential function of currencies is to be a medium of commercial exchange, nothing more. Shackling them to gold, wanting them to be stores of value, inhibits economic growth. What counts over time is not zero inflation, but real economic growth. In the 1930’s, a misguided economic policy of fiscal austerity -fixated on budget deficits, federal debt, and inflation fears- resulted in the Great Depression. The same would have happened with the 2008 financial crisis and the 2020 COVID crisis had the Federal Reserve not understood we needed QE, in total disregard of fallacious mainstream economic theories regarding budget deficits, federal debt, and inflation. QE will turn out to be a major advance in economic theory and policy. The current fears that the QE of the past 10 years will cause rampant inflation are based on a flawed understanding of economics. Fortunately, former Fed Chairman Ben Bernanke and former Fed Chairwoman Janet Yellen understood, and current Fed Chairman Powell understands, otherwise we’d be mired in another Great Depression.)
Bitcoin, like gold, is simply an investment, just like a stock. Its value measured in dollars (or another currency) can go up and down. The difference is that a stock represents a share of an ongoing business which it is hoped will make profits, even increased profits over time. Gold, instead, is just a commodity, while Bitcoin is just like a collector’s limited edition or rare postage stamp whose value fluctuates according to its popularity among stamp collectors.
As for the idea that gold is the best store of value, the best protection against inflation, one must carefully view statistical history. Gold was around $330 an ounce in 1985, and reached around $1,700 in 2020, for an increase of about 5X over 35 years, an appreciation of about 400% over 35 years, an average annual rate of 11.5%. In contrast, the Dow Jones was around 1,500 and the NASDAQ around 330 in 1985, and in 2020 they reached 30,000 and 11,000, for an increase of around 20X and 33X, an appreciation of 1900% and 3200%, an average annual increase of 54% and 91% respectively, far outperforming gold’s average annual increase of 11.5%. During the same 35-year period, the average single family home in the United States increased from about $100,000 to $350,000, an increase of 3.5X, an appreciation of 250% since 1985, an average annual rate of around 7.2%. So the best protection against inflation, the best store of value by far over the past 35 years, have been the Dow Jones and the NASDAQ index funds, followed way behind by single family homes, and even more behind by gold. 10-year Treasury bond yields have averaged around 6% and inflation around 4% during that same 35-year period (1985–2020).
(To take 1970 as a starting point for gold is illogical, since its price had been fixed at $35 an ounce for decades by the U.S. government, until Nixon deregulated it in 1971, whereupon its price shot up overnight to $100, and to $200 in 1975. During the energy crisis of 1979–80, when oil surged from $15 a barrel to about $40 causing a sharp rise in inflation, gold spiked to $800 an ounce, and subsequently fell back to a range of $300–400 after the energy crisis ended in 1981 and inflation started falling. So, taking 1985 as a starting point for comparing gold’s performance is logical, as it excludes the artificially low price of gold in 1970, held down by the government’s decades long price control, as well as the temporary price spike in 1980.)
While gold, a commodity, has a market value/price underpinned by 1) its global use in jewelry, 2) its use as a hedge against inflation, 3) its cost of production of around $800 an ounce, and 4) its limited supply since new gold mines are rare, Bitcoin’s market value/price has no underpinning except for its use as a speculative investment based on an algorithm. Bitcoin does have a cost of production (computing power and energy costs), but that can vary as the price of energy and computing power declines. And while Bitcoin has a production ceiling due to its algorithm, competitive crypto-currencies already exist and can potentially multiply, drawing investors away from Bitcoin. Finally, who is to say that Bitcoin will never be hacked, severely impairing investor holdings, no matter how impregnable blockchain appears to be.
The bottom line for Bitcoin is that it will never become a currency; it has no intrinsic value; it is simply based on an algorithm; its high price depends on the continuing conviction of increasing numbers of speculators who believe it is a better hedge against inflation than gold or stocks or real estate; its high price also depends on the absence of strong crypto-currency competitors, its being perceived as impervious to hacking, and to speculators playing a “greater fool” game.
Bitcoin’s parallel is a collector’s limited edition or rare postage stamp. As long as there are stamp collectors believing rare or limited edition stamps are a good investment, these will retain their value. To date, Bitcoin has been an exceptional investment. But for the future Bitcoin is not a sure bet. It may well end up being just a fad, where the early investors make enormous profits, and late investors get wiped out, as happened with the tulip bulb mania in 17th Century Holland.
© Edward Sonnino 2021
February 25, 2021