How should we think about Bitcoin?

Author: Eivind Pedersen. Source: Free Image

Back in 2014 I wrote a blog post entitled “Bitcoin is Impossible”. Every assessment I made at that time continues to be accurate: it takes longer and longer to complete transactions; mining is increasingly resource intensive; and major countries have clamped down on its use. Still, the digital medium continues to soar. As of right now, it’s priced at over $62,000 / unit, up over 177 times from when I first posted my story. Has Bitcoin’s time come?

Yesterday, Coinbase listed its stock publicly under the ticker COIN. Coinbase helps people buy, sell, and handle various cryptocurrencies. Coinbase makes money by charging fees for transactions, the same way major exchanges do for stocks and bonds. I hesitate to call these digital assets “currencies.” We buy currencies to buy something else. If I travel to Switzerland, I’ll buy Swiss Francs to transact business, maybe to buy a croissant after the plane lands. If I want to invest in Japan, I may need to buy Yen. That’s what a currency is for. Bitcoin, Ethereum, Litecoin, Ripple – and the thousands of other tokens – aren’t primarily used as for commercial purposes, even though Tesla now accepts Bitcoins as payment.

Digital token “heat map”. Source: Coin360.

These digital assets are primarily used for speculation, a digital version of gold – absent gold’s appeal for jewelry. Gold hasn’t been a medium of exchange for over 100 years. Think about it: when’s the last time you read a story about the price of the Indian Rupee? That’s a currency with over $8.7 trillion in circulation – significantly more than the $2.2 trillion for all the crypto-assets out there.

So what explains their appeal?

Part of their appeal is the age we live in. We’ve seen a massive transformation of many aspects of our lives, from work-at-home to software-eats-the-world to Amazon-selling-everything to all-streaming-all-the-time entertainment. Crypto seems to be one more step into a dematerializing economy. We use less and less “stuff” and more and more digital services. My own business used to require significant capital and physical ledgers. Now all I need is relationships and good software – with a good computer and bandwidth to access the software.

Part of their appeal is their mystery. No one knows who Satoshi Nokamoto is, even though he invented bitcoin by publishing the code and mining the “Genesis Bloc” (number 0).

First Bitcoin block. Author: Satoshi Yori. Source: Wikipedia. CC BY-SA 4.0.

The number theory behind the one-way hash-security is quite complex, and the anonymity of transactions adds to its sense of exclusivity.

It’s ironic, but part of Bitcoin’s appeal has been its durability. A digital asset that’s survived since 2009 – before Facebook went public, before the Euro crisis, before massive central bank asset purchases, dubbed “Quantitative Easing” – has some appeal. The asset has had its own internal crises: an internal verification bug in 2010, the fraud and bankruptcy of a major exchange, Mt. Gox, in 2013, Bitcoin’s “fork” in 2017. Many emerging trends would have collapsed in the face of challenges like these, but Bitcoin has endured.

Finally, we have to admit that a major appeal of Bitcoin is its recent price movement:

Source: Bloomberg.

In this, Bitcoin is similar to hot trends from the past: gold in the late ‘70s; AOL in the late ‘90s; Enron in the early ‘00s; FANG stocks more recently. People look at the most recent trend and wonder if they should jump on. After all, the price has jumped 6-fold in just the last few months.

As an investor, I have to respect the movement. But I’m also reminded of one of the most successful investments of all time: Amazon. In 1997 Amazon went public at $18 / share and proceeded to grow over five-fold in the few years during the dot-com boom. But then came the dot-com bust, and the shares fell 95%. They took over 7 years to reach their recent high, but then fell over 65% during the Financial Crisis and following recession. Even as recently as 2018 the shares declined by 37%. For long-term investors, the shares have contributed significantly to their performance, but it’s been a bumpy ride!

Source: Bloomberg.

But Amazon is a real company that employs 1.3 million people and provides concrete goods and services to customers around the world. We can model the value of its web-based services and “Prime” membership. There’s nothing similarly fundamental about Bitcoin other than the prospect of more digital transformation and blockchain-based transaction management. But despite the repeated promises of blockchain technology and the billions of dollars that have been spent researching “smart contracts” and bonded identity services and tokenized property, we haven’t seen much innovation from this. Just millions of dollars spent on non-fungible tokens, like crypto-kitties. For the life of me, these remind me of Beanie Babies from the ‘90s.

So, is Bitcoin impossible?

I’m not going to say that “Bitcoin is impossible” anymore. But I don’t think it’s probable. It’s subject to government regulations, including outright prohibition in some regimes. Mining is increasingly energy and carbon intensive. Transactions take a long time to clear; as ownership broadens, they will probably take longer. And Bitcoin’s anonymous nature ties it to criminal and other unsavory activities, like ransomware.

Bitcoin isn’t impossible. But its rising price makes it increasingly risky for investors. And not all risks result in returns.