Bitcoin

I posted about this on FB in January 2018. Almost 2 years have passed, during which bitcoin has fluctuated in price, but it continues to have a large market value.

In case anyone has been living under a rock, bitcoin (BTC) is a privately-created, purely electronic currency, which you can easily transfer securely, and you can use it to buy various things online (and I guess at some physical stores?). E.g., you can use it to buy stuff on Overstock.com (https://help.overstock.com/help/s/article/Bitcoin).

Anyway, here's what I said about it in 2018 (with minor edits today):

Is bitcoin overvalued or undervalued? Below are the arguments of Bitcoin Skeptics (“BTC is overvalued”) versus Bitcoin Enthusiasts (“BTC is undervalued”), as I see it:

Bitcoin Skeptics

I. No Intrinsic Value

“Intrinsic value” = The value people place on a good for reasons independent of the expectation that other people value it; value independent of the market price. E.g., orange juice has intrinsic value, because (some) people like to drink it, independent of whether others value it. In the case of a stock, intrinsic value is based on the company’s assets and future income stream (as opposed to the price of the stock).

Skeptic claim: BTC has 0 intrinsic value. Therefore, its current price can only be a speculative bubble.

Enthusiast reply: BTC isn’t a security; it’s a currency. Currencies, such as the dollar, typically have zero intrinsic value. This does not mean they have zero value period.

Skeptic: But the dollar’s exchange value was established first by having it backed by gold. Only once it was in widespread use was its backing removed. BTC can’t get established to begin with without some backing.

Enthusiast: That is an empirical, causal claim, which is being empirically tested right now. The empirical evidence is that it's false. In 2010, a pair of pizzas was sold for 10,000 BTC. Today (12/2019), one BTC is worth over $7,000. Its market value appears to have been established. (https://www.bitcoin2040.com/bitcoin-price-history/)

II. No Rational Valuation

Skeptic: We have no objective method of figuring out how much a bitcoin is worth. It doesn’t pay dividends, there’s no established interest rate for bitcoin loans, and it doesn’t have any intrinsic value. (http://www.businessinsider.com/morgan-stanley-on-bitcoin-value-2017-12) Since we have no rational way to assign a value to BTC, its current price is based only on risky speculation.

Enthusiast: The value of a currency is determined by the value of transactions conducted using the currency, per unit time, and the number of units of the currency in circulation. This is based on the economic principle that the total value of goods and services exchanged using the currency (in a given time period) must equal the total value of the currency that is exchanged in that time period.

So there is a rational basis; it is not purely a matter of predicting other people’s feelings.

III. BTC Is Rarely Used

Skeptic: Very few vendors are accepting BTC. Therefore, based on the above, it is worth very little. (http://www.businessinsider.com/morgan-stanley-on-bitcoin-value-2017-12) Almost everyone buying BTC is doing so for purposes of speculation, not to use it as a currency.

Enthusiast: Correction to earlier statement: The value of any asset is affected by its anticipated future value. Thus, if BTC *will* be widely used in the future, and this can be rationally anticipated, then it *now* has great value. If it *might* be widely used in the future, then it has some present value based on the probability that this will happen.

IV. Price Increases Look Bubble-like

Skeptic: In 2017, BTC’s price in dollars rose by 1400%. This could not plausibly correspond to any actual change in its objective value. So it must be a speculative bubble.

Enthusiast: Price changes need not be justified by a change in the objective value of an asset. They could instead be justified by a *recognition* of facts previously neglected. The rise in BTC’s price may reflect the fact that it suddenly came to the attention of many investors who previously took no notice of it. They then recognized its enormous potential value.

Skeptic: But this posits a huge market inefficiency before the price increase. Markets are not usually hugely inefficient.

Enthusiast: That is true for well-established assets and asset-classes. But huge mis-valuings, especially undervaluings, could be expected for a totally new asset.

V. Dogecoin Isn't Worth a Billion Dollars

Skeptic: There are >1300 cryptocurrencies [now almost 3,000, in 12/2019]. The top 100 are all valued by the market at over $180 million [now $35 million, in 12/2019; see https://coinmarketcap.com/all/views/all/]. Dogecoin, for instance, has a market capitalization close to a billion dollars [now <$300 million, 12/2019]. But all these crypto’s are obviously not going to become widely used. So their value is pure speculative bubble.

Enthusiast: True, but that doesn’t mean BTC is a bubble.

Skeptic: But the forces driving up the price of Dogecoin are presumably also affecting the price of BTC.

Enthusiast: True, but that still doesn’t mean BTC is overvalued. It could be that irrational forces are putting upward pressure on the price and that it is still worth more than its current price. This is not implausible. There can be multiple errors in the market.

VI. BTC Is Evil

Skeptic: BTC can be used for black market transactions and money laundering. Also, libertarians like it. It’s evil because it’s not under the control of the state. (https://www.huffingtonpost.com/entry/the-bitcoin-hoax_us_5a3fd6dce4b025f99e17bb2f)

Enthusiast: That is irrelevant to the present question, which is the fair market valuation of the asset.

VII. BTC Is Vulnerable to Hackers

Skeptic: BTC is not a safe store of value. There are multiple cases of hackers stealing large amounts of bitcoin. (https://www.theguardian.com/technology/2014/mar/18/history-of-bitcoin-hacks-alternative-currency)

Enthusiast: Hopefully people will be more careful about security in the future.

VIII. Bitcoin Is Just a Means of Transmitting Money

Warren Buffett says: “Bitcoin is a mirage. It's a method of transmitting money. It's a very effective way of transmitting money and you can do it anonymously and all that. A check is a way of transmitting money, too. Are checks worth a whole lot of money just because they can transmit money?” (https://www.cnbc.com/2014/03/14/buffett-blasts-bitcoin-as-mirage-stay-away.html)

Enthusiast: *A bitcoin* is not a method of transmitting money. It is itself a bit of money. *Sending bitcoin* is, of course, a method of transmitting money. It does not follow from this that the money that is sent has no value. On determining the value of a unit of money, see (II) above.

IX. Bitcoin Isn’t Scarce Enough

Skeptic: A bitcoin is just a number. But there are infinitely many numbers. So bitcoin isn’t scarce at all. So it must have minimal value. (I am not making this up! This guy actually said that: https://www.forbes.com/sites/jayadkisson/2017/12/28/the-great-bitcoin-scam/2/)

Enthusiast: Um, a bitcoin isn’t a number.

Smarter Skeptic: Okay, but it’s possible to create any quantity of any number of other cryptocurrencies. Therefore, cryptocurrency in general is not scarce.

Enthusiast: It is also possible to create any quantity of any number of fiat currencies. That doesn’t mean that, say, the dollar has minimal value. Example: the supply of Venezuelan Bolivars has increased massively in recent years, leading to runaway inflation in Venezuela. But that doesn’t cause inflation in the U.S., or destroy the value of the U.S. dollar, because people who use dollars don’t have to use Bolivars. Similarly, the existence of other cryptocurrencies would not lower the value of BTC, unless these other currencies were widely used as substitutes for BTC.

X. The Government Will Shut it Down

Skeptic: The U.S. government may try to shut down bitcoin, e.g., making bitcoin transactions illegal. They would do this because BTC is useful for money laundering, black market transactions, and tax evasion.

Enthusiast: This was a more plausible worry in the Silk Road days. Now it is becoming increasingly unlikely that they will do this. The total market capitalization of all cryptocurrencies is over $600 billion (https://coinmarketcap.com/) [now ~$200 billion, 12/2019]. Regardless of whether you think those prices are justified, it is highly unlikely that the government will try to eliminate a whole asset class valued by the market at [>$200 billion].

XI. BTC Is Inconvenient

Skeptic: BTC transactions take too long and cost too much. Large numbers of people are not going to put up with that.

Enthusiast: The bitcoin community will probably fix those things.

Bitcoin Enthusiasts

I. Large Potential Use as Currency

The value of BTC depends on the value of transactions that will be conducted with it in the future. It has presently reached only a tiny portion of its potential, and it is increasing. The number of businesses accepting BTC increased steadily throughout 2017 (from ~8200 to ~11,000) (https://cointelegraph.com/news/bitcoin-adoption-by-businesses-in-2017). Given all the recent media attention, the number will probably increase even more in 2018 and thereafter.

II. Future Investors

The current price of BTC is driven by a relatively tiny (compared to the class of people who reasonably could invest) number of bitcoin enthusiasts. Only a tiny portion of investors have yet accepted it as a reasonable thing to invest in. This is partly because it is new and unfamiliar, partly because they don’t see enough other people doing it, partly because of the high volatility, and partly because of uncertainty as to whether it is a ‘real currency’.

All those factors will subside in the next several years. As they do, the number of people investing in it can hardly do anything but increase. That means the price will almost inevitably go up, a lot.

III. Sentiment Is Not Excessive Enough

Many are saying that bitcoin is “a bubble”. In an actual asset bubble, the peak price occurs when sentiment is at the maximum. If bitcoin is a bubble, it is nowhere near its peak. We can know this because there are so many skeptics declaring it to be a bubble. If it’s a bubble, the time to get out will be when almost all the skeptics are gone and almost everyone is touting BTC as a great investment.