This article was originally published on Kiplinger – https://www.kiplinger.com
If Bitcoin is at $10,000 today it’s because the fool who bought it for $10,000 is hoping another greater fool will pay $12,000 for it tomorrow. But what do you get for your money? What’s it worth? That’s the problem.
I’ve been asked about Bitcoin a lot lately. I haven’t written anything about it because I find myself in an uncomfortable place in agreeing with the mainstream media: It’s a bubble. Bitcoin started out as what I’d call “Millennial gold” — the young (digital) generation looked at it as their gold substitute.
Bitcoin is really two things: a blockchain technology and a (perceived) currency. The blockchain element of Bitcoin may have enormous future applications: It may be used for electronic contracts, voting, money transfers — and the list goes on. But there is a very important misconception about Bitcoin. Ownership of Bitcoin doesn’t give you ownership of the technology. I, without owning a single bitcoin, own as much Bitcoin technology as someone who owns a million bitcoins; that is, exactly none. It’s just like when you have $1,000 on a Visa debit card: That $1,000 doesn’t give you part ownership of the Visa network unless you actually own some Visa stock.
Owning Bitcoin gives you a right to … what, actually? Digital bits?
Wall Street’s Wrong about What It’s Worth
A client jokingly told me that his biggest gripe with me in 2016 and 2017 was that I didn’t buy him any Bitcoin. I told him not so jokingly that if I bought him Bitcoin, he’d be right to fire me. Maybe I’m a dinosaur; but, like gold, Bitcoin is impossible to value. What is it worth? It has no cash flows. Is a coin worth $2, $200 or $20,000? But Wall Street’s price model sounds like this: “If only X percent of the global population buys Y amount of Bitcoin, then due to its scarcity, it will be worth Z.” On the surface, these types of models bring apparent rationality and an almost businesslike valuation to an asset that has no inherent value. But the simple truth is this: Bitcoin is un-valuable.
In 1997, when Coke’s valuation started to rival some dot-coms, bulls used this math: “The average consumer of Coke in developed markets drinks 296 ounces of Coke a year. These markets represent only 20% of the global population.” And then the punchline: “Can you imagine what Coke’s sales would be if only X% of the rest of the world consumed 296 ounces of Coke a year?” Somehow, the rest of the world still doesn’t consume 296 ounces of Coke. Twenty years later, Coke’s stock price is not far from where it was then — but on the way it declined 60% and stayed there for a decade. Coke, however, was a real company with a real product, real sales, a real brand and real tangible, dividend-producing cash flows.
The Foolish Reason People Buy Bitcoin
If investors cannot value an asset, they cannot be rational. With Bitcoin at over $10,000 today — at its highest, in December it was almost $20,000 — it is crystal clear to me, with the benefit of hindsight, that I should have bought Bitcoin at 28 cents. But you only get hindsight in hindsight.
Let’s mentally (only mentally) buy Bitcoin today at $11,000. If it goes up 5% a day and gets to $110,000 — you don’t need rationality. Just buy and gloat. But what do you do if the price goes down to $8,000? You’ll probably say, “No big deal, I believe in cryptocurrencies.” What if it then goes to $5,500? Half of your hard-earned money is gone. Do you buy more? Trust me, at that point the celebratory articles you are reading today will have vanished. The awesome stories of a plumber becoming an overnight millionaire with the help of Bitcoin will not be gracing the social media. The moral support — which is really peer pressure — that drives you to own Bitcoin will be gone, too.
Then you’ll be reading stories about suckers who bought it at what — in hindsight — turned out to be the all-time high. And then Bitcoin will tumble to $2,000 and then to $100. Since you have no idea what this crypto thing is worth, there is no center of gravity to guide you or anyone else to make rational decisions. With Coke or another real business that generates actual cash flows, we can at least have an intelligent conversation about what the company is worth. We can’t have one with Bitcoin.
People who are buying Bitcoin today are doing it for one simple reason: FOMO — fear of missing out. Bitcoin is priced today at $10,000 because the fool who bought it for $10,000 is hoping that there is another greater fool who will pay $12,000 for it tomorrow. This game of greater fools is not new. The Dutch played it with tulips in the 1600s. It did not end well. Americans took the game to a new level with dot-coms in the late 1990s. And now Millennials and Millennial-wannabes are playing it with Bitcoin and few hundred other competing cryptocurrencies.
See Also: Can You Save Too Much in Your 401(k)?
But What Makes Dollars or Other Currencies Real?
The counterargument to everything I have said so far is that those dollar bills you have in your wallet or that digitally reside in your bank account are as fictional as Bitcoin. True. Currencies, like most things in our lives, are stories that we all have bought into. Of course, society and, even more important, governments have agreed that these fiat currencies are going to be the means of exchange. Also, taxation by the government turns the dollar bill “story” into a very physical reality: If you don’t pay taxes in dollars, you go to jail. (The U.S. government will not accept Bitcoins, gold, chunks of granite or even British pounds.)
And finally, governments tend to look at Bitcoin and other cryptocurrencies as a threat to their existence. First, governments are very particular about their monopolistic right to control and print currencies. No less important, the anonymity of cryptocurrencies makes them a heaven for tax avoiders — and governments don’t like that. The Chinese government outlawed cryptocurrencies in September 2017. Western governments might not be far behind.
If you think outlawing a competitor currency can happen only in a dictatorial regime, think again. This can and did happen in a democracy like the U.S. With Executive Order 6102 in 1933, President Franklin D. Roosevelt made it illegal for the U.S. population to hoard gold coin, gold bullion or gold certificates.
However, nothing I have written above will matter until it does. Bitcoin may go up to $110,000 by the end of the 2018 before it comes down to … earth. That is how bubbles work. Just because I called it a bubble doesn’t mean it will automatically pop.
See Also: What Will the Stock Market Do Next?
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