From tulips to tech stocks and real estate, investors and speculators have seen their share of bubbles throughout history. So when an “investment” doubles in a month, and goes from $1,000 to $16,000 in less than 12 months, bubble talk is inevitable. But is Bitcoin in a bubble, or the future of money as some people contend? More on that in a minute.
First, let’s try to hash out what Bitcoin is and isn’t. Bitcoin is a peer-to-peer electronic cash system, aka a digital currency or cryptocurrency. It uses blockchain technology to create digital tokens and to track transactions, which makes counterfeiting very difficult. It is decentralized and anti-establishment, born in response to a financial crisis blamed on the financial sector. Black market participants (think drug dealers and purveyors of ransomware) seem to like it because of its anonymity. It’s also popular in countries like Venezuela and Argentina, where runaway inflation erodes savings. And even though it’s worldwide, the sum total of all Bitcoin in circulation is around $300 billion (as of this writing). Roughly 16 million Bitcoin have been created thus far and only 21 million can be created. (Here’s more about what happens when this 21 million number is reached.)
Here’s what it’s not…a currency you can hold in your hand or one that most traditional Wall Street custodians will allow you to own directly in your brokerage account. It’s not backed by a national government or central bank, recognized by most retailers, or something with an intrinsic value (it has value only to the extent that its users agree that it does). It’s not widely adopted as a form of payment; on any given day, around 400,000 people actually use Bitcoin, and most transactions are the mere trading of bitcoins. And security of Bitcoin vendors and exchanges continues to be an issue, as reports of hackings and hijackings are fairly common.
So what’s blockchain & mining?
The key idea behind Bitcoin is blockchain, a publicly visible but largely anonymous online ledger that records Bitcoin transactions. So-called miners detect new transaction requests from Bitcoin users, package them together, validate them, then add these to the blockchain. These miners utilize extremely high speed and costly computers in an attempt to process these transactions quicker than other miners. In exchange for performing these functions and for winning this digital race, a winning miner gets paid in Bitcoins (12.5 coins as of right now). Roughly 10,000 computers around the world help to maintain the Bitcoin network at the current time.
Enter Wall Street
Bitcoin futures started trading on the Chicago Board Options Exchange (CBOE) on December 10th with great fanfare (they surged as much as 26% on their first trading day). With a futures contract, players can bet on the price of Bitcoin going up or down without actually owning Bitcoins. Not to be outdone, the CME Group and Nasdaq also have plans to come out with futures tied to Bitcoin. All these new avenues will lead to new players coming into the market, not counting the roughly 100 cryptocurrency focused hedge funds that have launched already. Not everyone is onboard though, as JP Morgan’s CEO Jamie Dimon called Bitcoin a “fraud,” and Chinese regulators have cracked down on digital currencies.
At a minimum, there’s a financial Wild West component to Bitcoin, as well as a clear fear of missing out that has pushed prices dramatically higher in a short period of time. The advent of Bitcoin futures may help keep the exuberance from getting irrational (if it hasn’t already), or it may just provide a way for institutional investors to jump on the bandwagon. While this has all the classic signs of a bubble, this isn’t a classic investment and shouldn’t be called an investment at all. There are no underlying fundamentals, cash flows, or intrinsic value that a classic investment offers. And as Goldman Sachs CEO Lloyd Blankfein points out, “Something that moves up and down 20 percent in a day doesn’t feel like a currency, doesn’t feel like a store of value.” If you know how this movie ends, let us know. – Jon
We like to keep these articles for the P&A blog brief, so rather than delve into the nooks and crannies of Bitcoin and blockchain here, we encourage you to read these source articles if you’re interested in learning more:
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