“Stock market bubbles don't grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception.”
-George Soros
Bitcoin is on a rip by anyone’s definition. At last sighting, it was soaring past $16,000. It has risen by over a third in just the last two days. Not long ago, we were talking about the months it takes for Bitcoin to hit the next hundred-dollar mark. Now we’re talking about the hours it takes for Bitcoin to hit the next thousand-dollar mark
Volume is surging as well. By all indications, retail is driving this buying spree more than institutions. This is the proverbial shoeshine boy… or Uber driver, or Youtube vlogger, or essential-oil salesperson. Bitcoin’s market cap (at $300 billion) now exceeds that of JPMorgan. So is Jamie Dimon an idiot for calling it a “fraud” (even while he’s figuring out how to make money off it whichever way it goes)?
Maybe not.
Back to the Global Macro Grind…
Let’s go back to basics and remind ourselves why Bitcoin is supposed to be worth anything at all. Bitcoin derives its value from the expectation that it will, in the near future, become a legitimate currency. Everyone agrees on this much.
OK, so is that expectation reasonable? No, I don’t think it is, and for a number of reasons. Let me recap a few of them here:
- Bitcoin doesn’t fit anywhere in the currency spectrum. Throughout history, across the full range of market economies at every stage of development, all currencies have been backed either by some tangible asset (as in a barter system evolving into the gold standard) or by regulatory decree (as in certificates of debt, usually public debts, evolving into a “fiat” currency).Bitcoin checks neither box.
- Bitcoin cannot guarantee scarcity. Enthusiasts argue that even if Bitcoin isn’t a commodity, that’s OK because (like gold) there is limit on its ultimate availability: Only 21 million will ever be mined. The word “mined” reveals how much Bitcoiners love this analogy. But it doesn’t really work. We’ve had thousands of years to get comfortable with the scarcity of gold—and we know now you can’t create more of this element except by basically vaporizing the solar system in a supernova. We have no such comfort with Bitcoin. The 21-million coin limit gets raised every time miners band together and implement a “hard fork”--digital currency’s equivalent of a 2-for-1 stock split. This dilution threat (one that could encourage collusion among miners—Nakamoto himself discusses it in his seminal essay) will always hang over Bitcoin.
- Bitcoin cannot guarantee desirability. More seriously, there are hundreds, even thousands, of other digital currencies out there. If people decide that there’s another one that’s better (faster, cheaper, more secure, less trackable), Bitcoin may suddenly become useless. And unlike gold, I mean useless, as in falling literally to zero.
- Bitcoin is dizzyingly volatile. “Store of value” and “unit of account” are two of the three classic attributes of any successful currency. Neither attribute attaches to a currency whose worth can swing hundreds of percent from one year to the next. Imagine taking out a mortgage in Bitcoin. You soon could be envying those Poles who took out mortgages in Swiss Francs. Will futures markets cure this volatility? Unlikely. Untethered by a thing or a law, Bitcoin has literally no value referent, either on the upside or the downside. Its volatility is existential.
- Large transactions: At your own risk. Total privacy makes Bitcoin a terrible choice for storing lots of money since it can be so easily stolen. When you “buy Bitcoin,” all you are doing is sweeping numbers into a random address that is linked to you by means of a secret digital key (typically in a “digital wallet” on your mobile phone). The problem: If that key is stolen, your ownership disappears—and is virtually impossible to reclaim—because there is no public record that it was yours to begin with. There is no paper trail you can grab hold of, and no court you can turn to. Alarmingly, close to a million Bitcoins have been stolen since 2011.
- Small transactions don’t make much sense, either. A good test of a currency’s utility as a “means of exchange” (the third classic attribute) is its ability to handle small transactions. But Bitcoin is a fail here too. Unfortunately, Bitcoin possesses negative economies of scale: The bigger it is, the less well it works. Bitcoin’s blocks have a fixed capacity of just one megabyte, and only one is fabricated every 10 minutes—which naturally leads to longer transaction confirmation times and higher fees with increased adoption. These problems are already cropping up: Since the beginning of 2017, the average Bitcoin merchant transaction fee has jumped from 35 cents to more than $7. While some of this is pure “rent” flowing to miners, the rest is accounted for by the brute physical cost of solving Bitcoin’s ever-more difficult cryptographic puzzles (“valid hashes”). Bitcoin’s global mining network currently consumes roughly 30 terawatts of electricity per year—more than all of Ireland. If users ultimately bail from Bitcoin, this could be issue that does it.
- Where Bitcoin absolutely excels: Illicit activity. For all the reasons mentioned above, very few people use Bitcoin for legitimate real-world transactions. There is, however, one area in which Bitcoin has an unrivaled comparative advantage over any other type of money, and that’s the world of illicit activity. The dirty little secret about Bitcoin? Most of the people using it as an actual means of exchange have dirty little secrets to conceal. We’re talking about a burgeoning dark web selling everything from fake IDs and stolen passwords to child porn and opioids. And this is just the tip of the iceberg. We could add in Chinese investors who are trying to get around export controls. Or rogue states like North Korea and Iran, who are widely assumed to be making large Bitcoin transactions to evade global sanctions. And then consider some $20 trillion in global tax-evading assets. When I run the numbers, I estimate that other-than-legal transactions constitute the large majority of Bitcoin’s means-of-exchange transactions—that is, transactions other than speculation. Governments around the world are winding up for some heavy crackdowns.
People sometimes tell me that Bitcoin is inevitable because Millennials like it. And it’s true, they do. Surveys show that Americans under 30 are more likely than older Americans to know about Bitcoin and to own some. On the surface, Bitcoin seems like a good fit for young people who like the idea of a democratized, algorithm-driven currency. It’s techie and geeky and most Boomers can’t understand it. Having said that, Bitcoin-loving Millennials remain in a small minority. Most Millennials are very unlikely to embrace Bitcoin for two basic reasons. First, Millennials are by and large a risk-averse generation that figures even getting a credit card is too risky. And second, as a generation that values social trust, they are unlikely to underwrite a system that epitomizes social distrust. Most Millennials will be fully aligned behind government efforts to make all financial instruments, including currencies, transparent, accountable, regulated, and safe. Everything that Bitcoin today is not.
People also tell me that Bitcoin represents the cutting-edge of a really cool “distributed ledger” technology that will in time change the way the world works. Here, I largely agree. The potential benefits will someday be enormous—and they will go way beyond new currencies. In this respect, Bitcoin is really behind the curve. Look, for example, at Ethereum (at $42 billion, number two in digital market cap), which combines transactions with “smart contracts” in ways that can allow entire dispersed groups to “self organize” around agreed-upon rules. Or look at Iota (at $12 billion, number four in digital market cap), a new block-free and infinitely scalable digital currency designed to enable devices to talk to each other and “make deals” with each other.
These are great ideas. But the operative word here is “someday.” (See Soros quote above.) None of them are helped much by Bitcoin’s stratospheric ascent. Indeed, the last 24 hours have pretty much sucked all the oxygen out of the room for the other digital currencies, which mostly declined. Someday sooner than “someday,” Bitcoin will crash—and that won’t be very good for them, either.
Best of luck out there today,
Neil Howe
Demography Sector Head
