Bitcoin’s Price Crashes, Many Now Say The Cryptocurrency Has No Value

Bitcoin’s price has been on a wild ride since its inception. 2017 alone saw massive gains, starting the year at under $1,000 and, at its peak, it hit $19,000.

Yesterday it Plunged down to $11,000

I’ve been watching this bitcoin situation for a few years, assuming it would just blow over.

But a collective insanity has sprouted around the new field of “cryptocurrencies”, causing an irrational gold rush worldwide. It has gotten to the point where a large number of financial stories – and questions in my inbox – ask whether or not to “invest” in BitCoin.

Let’s start with the answer: no. You should not invest in Bitcoin.

The reason why is that it’s not an investment; just as gold, tulip bulbs, Beanie Babies, and rare baseball cards are also not investments.

These are all things that people have bought in the past, driving them to absurd prices, not because they did anything useful or produced money or had social value, but solely because people thought they could sell them on to someone else for more money in the future.

When you make this kind of purchase – which you should never do – you are speculating. This is not a useful activity. You’re playing a psychological, win-lose battle against other humans with money as the sole objective. Even if you win money through dumb luck, you have lost time and energy, which means you have lost.

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Investing means buying an asset that actually creates products, services or cashflow, such as a profitable business or a rentable piece of real estate, for an extended period of time. An investment is something that has intrinsic value – that is, it would be worth owning from a financial perspective, even if you could never sell it.

To answer why bitcoin has become so big, we need to separate the usefulness of the underlying technology called “blockchain” from the mania of people turning bitcoin into a big dumb lottery. Blockchain is simply a nifty software invention (which is open-source and free for anyone to use), whereas bitcoin is just one well-known way to use it.

A bitcoin is not an investment, just as gold, tulip bulbs, Beanie Babies, and rare baseball cards are also not investments.
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A bitcoin is not an investment, just as gold, tulip bulbs, Beanie Babies, and rare baseball cards are also not investments.

Blockchain is a computer protocol that allows two people (or machines) to do transactions (sometimes anonymously) even if they don’t trust each other or the network between them. It can have monetary applications or in sharing files, but it’s not some instant trillionaire magic.

As a real-world comparison for blockchain and bitcoin, take this example from the blogger The Unassuming Banker:

Imagine that someone had found a cure for cancer and posted the step-by-step instructions on how to make it online, freely available for anyone to use.

Now imagine that the same person also created a product called Cancer-Pill using their own instructions, trade marked it, and started selling it to the highest bidders.

I think we can all agree a cure for cancer is immensely valuable to society (blockchain may or may not be, we still have to see), however, how much is a Cancer-Pill worth?

Our banker goes on to explain that the first Cancer-Pill (bitcoin) might initially see some great sales. Prices would rise, especially if supply was limited (just as an artificial supply limit is built into the bitcoin algorithm).

Bitcoin has become a bubble with the forces of human herd behavior, greed, and fear of missing out amplifying it
But since the formula is open and free, other companies quickly come out with their own cancer pills. Cancer-Away, CancerBgone, CancEthereum, and any other number of competitors would spring up. Anybody can make a pill, and it costs only a few cents per dose.

Yet imagine everybody starts bidding up Cancer-Pills to the point that they cost $17,000 each and fluctuate widely in price, seemingly for no reason. Newspapers start reporting on prices daily, triggering so many tales of instant riches that even your barber and your massage therapist are offering tips on how to invest in this new “asset class”.

Instead of seeing how ridiculous this is, more people start bidding up every new variety of pill (cryptocurrencies), until they are some of the most “valuable” things on the planet.

People who think that there’s even a tiny chance bitcoin could become a world currency say it is severely undervalued.

You could make the same argument about my fingernail clippings: they may have no intrinsic value, but they’re in limited supply so let’s use them as the new world currency.

Let’s get this straight: in order for bitcoin to be a real currency, it needs several things:

Easy and frictionless trading between people.
To be widely accepted as legal tender for all debts, public and private.
A stable value that does not fluctuate (otherwise it’s impossible to set prices).
Bitcoin has none of these things, and even safely storing it is difficult. Bitcoin exchanges such as Mt Gox in Japan, Bitfinex and various other wallets and exchanges have been hacked.

The second point is crucial. Bitcoin is only valuable if it truly becomes a critical world currency. In other words, if you truly need it to buy stuff, and thus you need to buy coins from some other person in order to conduct important bits of world commerce that you can’t do any other way. Right now, speculators are the only people driving up the price.

A speculative cult currency like bitcoin is only valuable when you cash it out to a real currency, like the US dollar, and use it to buy something useful like a nice house or a business. When the supply of foolish speculators dries up the value evaporates – often very quickly.

A currency should also not be artificially sparse. It needs to expand with the supply of goods and services in the world, otherwise we end up with deflation and hoarding. It helps to have the Federal Reserve system and other central banks guiding the system.

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Finally, nothing becomes a good investment just because “it’s been going up in price lately”.

The world’s governments are not going to let everyone start trading money anonymously and evading taxes using bitcoin. If cryptocurrency does take off, it will be in a government-backed form, like a new “Fedcoin”. Full anonymity and government evasion will not be one of its features.

The cryptocurrency bubble is really a repetition of the past. This is a known bug in our operating system, and we have designed some parts of our society to protect us against it.

These days, stocks in the US are regulated by the Securities and Exchange Commission, precisely, because in the olden days, there were many stocks issued that were much like bitcoin, marketed to unsophisticated investors as a get-rich-quick scheme. The very definition of this investor is: “Being more willing to buy something the more its price goes up.”

Don’t be one of these fools.

Scarcity and utility
In economics, something has value if it checks the following two boxes: scarcity and utility. Scarcity just means that something has a finite supply. In the case of bitcoin, the cryptocurrency has a set cap of 21 million bitcoins.

Many analysts note that this set cap makes bitcoin more desirable than other assets, even gold. That’s because unlike with gold, there’s no need to worry about a digital Gold Rush. A treasure trove of bitcoin won’t ever be “discovered,” causing the crypto’s price to crash with an influx in supply.

“There are potentially millions of times more gold underground than actually has been extracted,” said Tom Lee, head of research at Fundstrat Global Advisors. Lee was chief equity strategist at J.P. Morgan before co-founding Fundstrat in 2014.

Ben Yu, a blockchain expert living in San Francisco, says technological advances are also making gold easier to mine.

“Today we mine gold at four times the rate that we did just 100 years ago,” Yu said.

So if bitcoin has scarcity, what about its utility?

Many believe the cryptocurrency’s utility lies in its potential to be a more efficient commodity than we already have. Proponents of bitcoin like it for a number of reasons.

First, bitcoin is decentralized, meaning no government, bank or single person has control over it; it can’t be toppled by corruption at the top. It’s also trivially divisible, meaning you can buy a small item like a doughnut with it as easily as you can buy a house or even a mansion. And finally, the code it’s built on is open source, meaning that it’s available for anyone to look at, scrutinize and even modify. This means bitcoin is constantly evolving and improving.

None of those uses is intrinsic, however. And that’s a point bitcoin skeptics often make. Gold, for example, is thought to have intrinsic value because of its applications in industries like dentistry and electronics. Some people even argue that dollar bills have intrinsic value, since they can be used as kindling or to write on.

But as you break down either of those claims, it becomes clear that gold and paper money don’t have that much intrinsic value either.

According to the World Gold Council, in 2016, only 15 percent of gold was used in industries. The majority went toward making jewelry and gold bars and coins — items that have value mainly because they’re trusted to be valuable.

With paper money, the Federal Reserve says it costs about 16 cents to create a $100 bill.

So the rest of that hundred bucks — the remaining $99.84 — comes from the trust people place in it.

It can be hard to see the digital currency as having value because you can’t hold it in your hand like you can a dollar bill or gold.

As a solution, Lee said to think of bitcoin as a digital business.

“If you ask a baby boomer, ‘Can you justify the value of anything that’s a digital business?’ they probably don’t accept that Facebook, Google, Netflix, Amazon, Apple, these are the largest companies in the S&P 500 and they’re primarily digital businesses built almost purely on digital trust,” said Lee.

“Anyone who thinks digital gold isn’t a store value is overlooking the fact that most businesses today are built around digital trust, including the financial system.”

Valuing the cryptocurrency
It’s clear that some people believe bitcoin has value. And if it has value, it’s hard not to wonder how much a single bitcoin could end up being worth.

There are two main theories being used to calculate the potential value of one bitcoin.

The first theorizes that bitcoin, which some perceive to be a better asset than gold, could end up replacing either a portion of gold or gold entirely.

If it were to replace gold entirely, one bitcoin could be worth $357,000. That’s calculated by taking the total value of all the gold ever mined in the world, which is about $7.5 trillion, and dividing that number by 21 million — the total bitcoins that can ever exist.

Lee told CNBC it’s more realistic to assume bitcoin will replace 5 percent of gold within five years, making a single coin worth $25,000.

Another theory of Lee’s is based on Metcalfe’s law, which says that the value of a network is proportional to the square of the number of users on the network.

For example, one phone is useless because you can’t call anyone else with it. But the value increases exponentially as other people get phones.

Studies have shown that Metcalfe’s law holds true for Facebook using 10 years of data. It also holds true for Tencent, China’s largest social media company.

Fundstrat looked at users on the bitcoin network and found that the square of this value explained 94 percent of the variation in bitcoin prices since 2014.

Many people think that bitcoin is a bubble, and that’s predicted on the concept that bitcoin has no value. But there’s reason to believe that that just isn’t true.

By definition, bitcoin is scarce. And the cryptocurrency may have utility as a superior way to store and exchange wealth.

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