Just to be clear, I do not particularly enjoy commenting on Bitcoin. It isn’t real, it’s going to zero, and it has legions of fanatical adherents that are prone to losing their minds when anyone endeavors to explain the folly of betting on something that is highly susceptible to government intervention.
But over the past week, it’s been difficult to stand idly by as the likes of Jamie Dimon (in characteristically abrasive fashion), Mohamed El-Erian (in a characteristically diplomatic fashion), and Marko Kolanovic (in characteristically Gandlaf-ish fashion) explained why cryptocurrencies aren’t likely to conquer the planet as so many of those riding the digital wave seem to believe they will.
The cacophony of derision comes as China steps up efforts to clamp down on the crypto-verse. Those efforts will likely show up in other countries in the not-so-distant future although they probably won’t be as overtly draconian as what Beijing is attempting to do.
Meanwhile, the B.I.S. was out over the weekend telegraphing the next move for central banks in a world gone crypto-crazy. Simply put: the world’s monetary authorities will simply adopt their own versions.
All of this has been met with a furious backlash from the crypto crowd and somewhat ironically given all the chatter about Bitcoin supplanting gold as a safe haven, their protestations sound a lot like what you often hear from the folks who keep physical gold stored next to their tinfoil hats in the basement. I penned an amusing piece on the similarities between Bitcoin proponents and gold hoarders on Monday which I can summarize with the following visual:
Well with all of that as the backdrop, consider the following piece by James Mackintosh for the Wall Street Journal and do spare a moment to keep James in your thoughts, because you can bet he’s gotten a lot of angry e-mail…
Behind every bubble is a good idea bursting to get out, and Bitcoin kind of looks like a good idea, at least if you squint a bit. A digital currency without borders that governments can’t control and that allows secret online transactions? I’m in. Bitcoin itself? Not so much.
So is a single Bitcoin worth $500,000, $5,000, $500 or $0? I’m inclined to say $0, especially if Bitcoin’s value depends on it being adopted as a global digital currency to replace dollars. There is no chance whatsoever that Bitcoin can displace the dollar, for the simple reason that it is badly designed. Bitcoin can handle a pathetically small number of transactions, and uses an inordinate amount of electricity to do so, making it entirely unsuitable to replace ordinary money.
Even if Bitcoin worked better, it is in a Catch-22 because of Gresham’s law, the nostrum that bad money drives out good. Given the choice of spending inflationary government-issued money or something which holds its value, everyone would spend the bad paper stuff and hoard the Bitcoin. You wouldn’t want to be the person who spent 10,000 Bitcoins on two pizzas in 2010, when a Bitcoin was worth a fraction of a cent. Those Bitcoins are now worth $40 million. But if no one spends Bitcoin, it will never get established as a currency.
There are two somewhat less ambitious claims for Bitcoin that could give it value. The first is that it is a limited form of money because of its usefulness for dealing illegal drugs and dodging capital controls. The second is that it is a form of digital gold: an insurance that will keep its value even if governments confiscate or inflate away the buying power of the currencies they issue.
Let us unpack the idea of Bitcoin being based on illegal transactions. Dan Davies, a banks analyst at Frontline Analysts in London, came up with a value thanks to Bitcoin’s built-in limit of 21 million in circulation.
In any currency, the money supply multiplied by how often it circulates equals the price level times the number of transactions. For Bitcoin we can estimate three of the four variables, Mr. Davies says. He observed that even hardened criminals don’t set prices in Bitcoin, but rather in dollars, and then immediately convert. Assume that all drug dealing moves online, that Bitcoins circulate as fast as ordinary currencies, and estimate a $120 billion-a-year market for illegal drugs, and the formula spits out an ultimate value of $571 for a single Bitcoin. The more drugs traded, the higher the value, and the more Bitcoin hoarded rather than spent, the higher the value.
Drug dealers might be willing to put up with the limitations of Bitcoin, notably the uncertain time taken to complete a purchase and the high transaction costs. Laundering dollars is more expensive. But studies cited by the United Nations Office on Drugs and Crime suggest that cryptocurrency-based online drug dealing remains relatively small, and focused on retail, meaning fewer and smaller transactions than Mr. Davies’ limiting assumption, so justifying a much lower Bitcoin price.
On this basis the current price of $3,950 is mostly speculation, and J.P. Morgan Chase & Co. Chief Executive James Dimon’s comparison to the 17th-century Dutch tulip mania is apt.
Bitcoin is “being driven all over the place by speculative portfolio flows,” says Mr. Davies.
Digital gold might be more appealing for Bitcoin’s true believers, who would surely prefer to avoid basing a currency on illegal activity. Gold is hopeless if you want to pay the mortgage or buy bread, but is useful insurance because we can be confident that if a government currency collapses the shiny metal will roughly hold its value. It helps that history holds plenty of examples of currencies losing all their value to hyperinflation while gold could still be bartered for food and shelter.
Gold has a value far above what is justified by its uses in electronics and jewelry only because (almost) everyone agrees that it has value. That “network effect” is what Bitcoin needs to establish itself, and the more attention it garners, the more likely it is to become established. Yet, gold has had thousands of years and a history of being used to back money to support its position. Technological disruption may be overturning many societal norms, but securing society-wide recognition as a safe asset takes more than the backing of tech evangelists and a bunch of get-rich-quick stock promoters.
Still, the potential to replace gold gives us some figures to work with. Thomson Reuters GFMS estimates there were 2,155 metric tons of gold held in exchange-traded funds. Switch all of that into Bitcoin and it would justify a price of about $5,500 for the 17 million Bitcoins currently outstanding.
We could be more optimistic and think Bitcoin might replace gold coins and bars. Leave aside that the gold is better than Bitcoin because gold doesn’t depend on having an electricity supply, and the 24,000 metric tons GFMS estimates have been bought for investment in the past half-century would justify a price of $61,000 for every Bitcoin.
If we assume that Bitcoin will either succeed completely in displacing gold or fail and be worth zero, it helps explain why the digital token has been so incredibly volatile, with a 40% loss in two weeks, and a 33% rebound since Friday’s low. Based on the simple choice between total success and failure, we can very roughly say that Bitcoin at 70% of the gold ETF-derived price suggests a 70% chance of displacing so-called paper gold as society’s chosen emergency store of value, and a 6% chance of displacing physical gold. Even digital dreamers should accept that is far too high.
Being “badly designed” and small potatoes in the larger realm of currencies may be the only two things that keep it from being flung on the trash heap by those with real power..the nation states that this illusion of financial privacy and integrity is lightly butting up against.
Bitcoin exists solely at the discretion of the powers that be…any number of knock out punches can be thrown at it…many virtually impossible to defend against..money laundering..conspiracy to commit tax fraud..etc. Please remember that it is IRRELEVANT if any of those are true or true for more than a few of those using a cryptocurrency. A lever is a lever..and property seizures are…well..part of every Godzillas repertoire…Just ask Jeff Sessions.
It could go to zero. Of course I was buying oil stocks in the late 90’s. Held them too.
I kept telling myself back in January to buy one, just one. It was around $1,000.00. I didn’t.
Rode in a cab in Maui with a couple who’s son had invested everything he had a few years ago in Bitcoin.
That was right before the correction off $3k.
I can see it going either way. I don’t know. This could change society.
Kinda like betting on the Cubs to win it all. Who would’ve thought.
Just a hedge
Bitcoin will be zero
anybody thinking that post FOMC we get another bounce in S&P’s and smack down in Vol…BUT perhaps as soon as Friday it could be a good time to to go long Vol? (again)
I know month end/quarter end next week but maybe that mark-up is happening now as opposed to next week?
A great article with a strong analytical/quantitative basis for more realistic Bitcoin valuation projections. An approach totally avoided by cryptocurrency promoters.
In comparing cryptocurrency to gold as collapse hedge – there is no comparison and for a lot of reasons. Primarily, cryptocurrency depends on the electric grid and the internet remaining intact and fully operational. This is not a rational assumption in a global economy of “domino” national currencies, geo-poltical feuds, critical resource wars, and with the top major economies interlinked and dependent on each other. Any collapse of the big three economies US, Europe, and China – perhaps just the US or China will bring the global international monetary system down. In doing so it will also bring down the cash flows necessary to operate the internet and other critical commerce functions – including the electric grids with it. Cryptocurrencies are the epitome of the fragility of the internet and electrical grids and the economies that depend on them.
“It helps that history holds plenty of examples of currencies losing all their value to hyperinflation while gold could still be bartered for food and shelter.” This is the view of some one who has not well studied either historic national collapses and or used the extensions of them to project a global collapse realities. Paper gold ceases to exist along with cryptocurrencies once national currencies collapse because the infrastructure necessary to exchange them – ceases to exist.
Physical gold only serves as a barter item as long as their are sufficient critical resources to barter. In the past when nations were isolated and one went down, the other nations surrounding it remained functional and sources of critical resources and so bartering with gold did indeed work. When critical resources (food, water, shelter, medicine, energy, security, etc.) become in short supply globally, no amount of gold will replace them. Consider that most if not all developed country’s citizens today live with less than a ten day supply of food on hand. The national food and material warehousing systems that serve their local stores have only a few months of stocks. Pandemics and economic collapses threaten an abrupt supply chain end to our national life support and distribution systems. Worse as major components of our supply distributions supply systems go down, they have a domino effect disrupting others. We have yet to experience a global economic/supply chain collapse. It could happen far quicker than most of us realize.
In a global collapse barter exchange priority is solely based on critical resources and their extensions. Consequently, there is no priority to barter for gold as a barter currency, because as Buffett says – “Gold has no utility.” In a true collapse considering the civil breakdown and chaos that follows – there would be extremely limited opportunity to barter safely. Security of some kind of “market” place is necessary for even basic barter to occur practically. Until some level of civil security is resumed after a major collapse, barter will be difficult to impossible.
Once barter does return and there are ample levels of critical resources, history says physical gold may once again be attractive enough for barter – though it will still have no more utility than it ever did. Even then more utilitarian pragmatic small units of critical resources are likely to have a higher priority for most barter activity than gold. Units of food, bullets and or other portable life support resources are projected to be the post collapse coinage. As many “Preppers” project it will be a “beans and bullets” based barter economy for some period of time – from many months to many years – before people can not only barter for gold, but before they can secure, store and defend it.
All in all I find that when it comes to economic security and or collapse hedging – both cryptocurrency and gold hedging proponents share several things in common. A general lack of both historic and present economic knowledge, a real understanding of how fragile and necessary a functional technology/electronic/digitally based “market” economy is for a market economy and finally the realization and implications of the total lack of real utility value for both cryptocurrency and gold as a substitute for critical resources.
The reichsmark collapse didn’t result in complete social collapse. The dollar collapse won’t result in the end of electricity and the internet. Complete social collapse is not worth planning for, it’s practically impossible outside of the realm of billionaires. Disaster planning should be for maybe a few weeks without power and water at most and neither gold nor crypto serve that purpose, you need to have the goods on hand in a disaster prior to the disaster.
Crypto if a hedge for anything is a hedge against a sovereign currency collapse such as the Yuan or USD. The reason it is likely to survive that scenario is how many of the wealthy will find it very useful in that scenario as the poor and middle class will catch on later when it’s value is much higher. The government needn’t police it at all aside from normal taxation purposes such as other FOREX trading income and whatever digital USD 2.0 is launched to replace the dollar can be freely exchanged to from crypto after the fact. There is no scenario where the government loses, but there are ones where crypto coexists. Gold isn’t banned and it isn’t valueless yet it does compete with the dollar as a store of value just like land and fine art but most people don’t bother.
I would be very surprised if post Yuan collapse China doesn’t open back up the exchanges and allow the wealthy in China to bring back their wealth. The trouble is always in letting the masses participate.
Real Money, a term of art I define on the BetterMoney blog (and which, of course, encompasses all government-issued currencies), entails an Issuer for which all Base Money issued and outstanding constitutes a liability, against which earmarked assets are held giving it the wherewithal to buy back all the money.
With unbacked play money, such as Bitcoin, Ripple or Ethereum, there is no such issuer and no concept of monetary liability. As a result, with a drop in demand, as with a panic situation, no entity can commit to make an orderly market for exchange as, for instance, a Primary Dealer could (in certain settings that I detail). With Real Money, a drop in demand for that particular brand has little or no impact on its exchange rate (depending on whether mechanisms for on-demand redemption exist). With unbacked play money, a drop in demand can only be adjusted for via a drop in exchange rates, with no floor but zero.
Granted, the current situation with central banks unable to significantly shrink their balance sheets impedes such adjustment. [A particularly weird case is the Bundesbank, with over 50% of its assets in the form of TARGET2 obligations owed by other Eurosystem NCBs – an asset for which no market exists].
In relation to this topic of Bitcoin valuation, a NYT Dealbook piece today recycles the particularly sloppy meme that governments are no different, describing them as creating money “out of thin air”. But this is not an accurate or useful characterization. Governments create money out of valuable assets (via OMO), most of which – such as government securities – trade on highly liquid markets. Only the discretionary nature of their policies could be likened to thin air.
So nobody is going to explain use in Japan, the place
It makes the most sense. Brian Kelly’s thesis blows anything here away.