Valuing Bitcoin: Millennials Fake Gold or "Something Else Entirely"?

Originally posted on the Contrarian Edge.

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?

I can understand gold bugs and the original Bitcoin aficionados. The global economy is living beyond its means and financing its lifestyle by issuing a lot of debt. Normally this behavior would cause higher interest rates and inflation. But not when you have central banks. Our local central bankers simply bought this newly issued debt and brought global interest rates down to near-zero levels (and in many cases to what would have been previously unthinkable negative levels). If you think investing today is difficult, being a parent is even more difficult. I tried to explain the above to my sixteen-year-old son, Jonah. I saw the same puzzled look in his eyes as when he found out where babies come from. I also felt embarrassed, for my inability to explain how governments can buy the debt they just issued. The concept of negative interest rates goes against every logical fiber in my body and is as confusing to this forty-four-year-old parent as it is to my sixteen-year-old.

The logical inconsistencies and internal sickness of the global economy have manifested themselves into a digital creature: Bitcoin. The core argument for Bitcoin is not much different from the argument for gold: Central banks cannot print it. However, the shininess of gold has less appeal to millennials than Bitcoin does. They are not into jewelry as much as previous generations; they don’t wear watches (unless they track your heartbeat and steps). Unlike with gold, where transporting a million dollars requires an armored track and a few body builders, a nearly weightless thumb drive will store a dollar or a billion dollars of Bitcoin. Gold bugs would of course argue that gold has a tradition that goes back centuries. To which digital millennials would probably say, gold is analog and Bitcoin is digital. And they’d add, in today’s world the past is not a predictor of the future – Sears was around for 125 years and now it is almost dead.

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 strategists have already figured out how to model and value this creature. Their models sound 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. You can let your imagination run wild with X’s and Y’s, but the simple truth is this: Bitcoin is un-valuable.

In 1997, when Coke’s valuation started to rival some dotcoms, 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 ounce 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.

If you cannot value an asset you cannot be rational. With Bitcoin at $11,000 today, 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 like a clock 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 in time 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 other suckers like you who bought it at what – in hindsight – turned out to be the all-time high and who got sucked into the potential for future riches. 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. The X times Y = Z math will be reapplied by Wall Street as it moves on to something else.

People who are buying Bitcoin today are doing it for one simple reason: FOMO – fear of missing out. Yes, this behavior is so predominant in our society that we even have an acronym for it. Bitcoin is priced today at $11,000 because the fool who bought it for $11,000 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 dotcoms in the late 1990s – that round ended in tears, too. And now millennials and millennial-wannabes are playing it with Bitcoin and few hundred other competing cryptocurrencies.

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 (mostly) unconsciously bought into. (I highly encourage you to read my favorite book of 2015: Sapiens, by Yuval Harari.) Of course, society and, even more importantly, 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 US 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 – this is how they can overpromise and underdeliver. No less important, the anonymity of cryptocurrencies makes them a heaven for tax avoiders – governments don’t like that. The Chinese government outlawed cryptocurrencies in September 2017. Western governments are most likely not far behind. If you think outlawing a competitor can happen only in a dictatorial regime like China’s, think again. This can and did happen in a democracy like the US. With Executive Order 6102 in 1933, US President Franklin D. Roosevelt made it illegal for the US 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.

Vitaliy Katsenelson

Mish Comments

Katsenelson's re-send was quite timely.

Moments ago, I reported Kodak Soars 77% on News it Will Launch "KodakCoin" Cryptocurrency.

I found the announcement amusing. Kodak issued this statement: "For photographers who’ve long struggled to assert control over their work and how it’s used, these buzzwords are the keys to solving what felt like an unsolvable problem."

Really?

What does the KodakCoin have to do with the unsolvable problem of photographers "who’ve long struggled to assert control over their work"?

Absolutely nothing!

It's a digital coin stupid. It's possible that blockchain technology will be of some use in regards to the stated mission, but the coin is pure nonsense.

In his article, Katsenelson stated "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."

Katsenelson hit that nail squarely on the head. However, I disagree with Katsenelson that Bitcoin is the Millennial's gold. And I rather doubt any central bank is truly scared over Bitcoin.

Days to Download the Blockchain

The notion that bitcoin will ever be a widespread currency is downright potty.

It takes days to download the blockchain!

And every transaction that gets added to the chain increases the length of time it take.

"It usually takes me about 4-6 days to complete the blockchain download in full (in a datacenter on a quad core i3)." said one person on Reddit. That was in 2015.

Scalability

Wikipedia has some interesting Scalability Issues to consider.

• In contrast to Visa's peak of 24,000 transactions per second, the bitcoin network's theoretical maximum capacity sits between 3.3 to 7 transactions per second.
• The bitcoin scalability problem is a consequence of the fact that blocks in the blockchain are limited to one megabyte in size.
• Bitcoin miner fees for processing bitcoin transactions rose to above $25 per transaction in December 2017, making small payments uneconomical.

There are other cryptocurrencies with larger blocksizes, but as a consequence of perpetually adding every transaction to the chain, any cryptos using that method are all going to eventually blow up.

No Barriers to Entry

There are no barriers to entry regarding blockchain. Proof of the lack of barriers is the fact there are now thousands of competing cryptocurrencies.

Some purport to handle scalability issues, and perhaps they will for a while.

CryptoKitties

On December 3, I noted People Spent $1M on Totally Useless Ethereum "CryptoKitties".

To breed CryptoKitties, you first have to buy them. Then you have to find a greater fool willing to spend more for your crypto-offspring than you paid to buy the parents.

True Believers

The true believers say digital currencies will bring down a central bank.

The notion is silly.

Crypto Bubble is Obvious

An amazing amount of energy has been spent by the true believers in an attempt to persuade people there is no crypto-bubble.

Certainly there was a fortune to be made. Hindsight is crystal clear on that. But now?

The way to make $1 million on bitcoin now involves plunking down $100,000 on bitcoins and hoping your money rises 10-fold on top of the 10,000-fold increase in hand.

It is going to take some serious risk now to make $1,000,000 in Bitcoin.

People see that, so they have flocked to crypto-kitties and hundreds of other totally useless coins because they are "cheap".

Not a Bubble

The latest nonsensical reason bitcoin is not a bubble comes from Liberty Blitzkrieg's Mike Krieger who says Bitcoin Isn't The Bubble - The Global Financial System Is.

For one thing, bubbles don’t do what bitcoin has done since its inception in 2009. During my 10-year tenure on Wall Street, I saw several bubbles grow and then burst, and one thing you learn is that an actual bubble rises like crazy and then totally pops. It doesn’t come right back a couple of years later and soar again to a new price 10 times greater than the previous bubble's high, which is what bitcoin has done after each one of its three or four previous “bubbles” burst. That’s not a bubble, but something else entirely.

"Something Else Entirely!"

No, Mike Krieger, Bitcoin is a bubble and an obvious one.

Bitcoin is a symptom of the global financial bubble. Curiously, the global financial bubble has the exact same characteristics that Krieger says proves Bitcoin is not a bubble.

The Fed blew a bubble in 2000, it popped. It blew a bigger bubble in 2007, and that popped too. And now for the third time the central banks blew an even bigger bubble.

By Krieger's own logic, the global financial system cannot be a bubble because it keeps soaring to new highs.

Something Else Not!

At the peak of every bubble there is some greater fool shouting "It's different this time".

The top may be in. I do not know, nor does anyone else.

Meanwhile, the speculative mania regarding Bitcoin as well as the creative rationale used to justify it are amusing sights to behold.

Greater Fools

I understand the desire of Libertarians and others to mock central banks and adopt something the bankers can't touch.

Unfortunately, the faith is misplaced.

The entire crypto-currency movement is nothing more than the biggest greater-fools game in the history of mankind.