“Is Bitcoin the Paris Hilton of the Currency World?”
Bitcoin soared to just over $11,000. Then tanked 20% in a matter of hours.
Here’s today’s chart from Bloomberg showing the price action…
Here’s a chart from Bloomberg showing its run since 2016 (compared to the price of gold)…
As you can see, Bitcoin has gone from about a $1,000 to over $11,000 in less than a year.
What goes up, must come down.
A lot of people have been asking me about Bitcoin.
Emails, LinkedIn messages, holiday parties, you name it.
The bottom line is that the real innovation here is the blockchain. Not Bitcoin itself.
The Federal Reserve Bank of Boston published a paper about Bitcoin in 2014. The authors wrote:
Bitcoin’s lasting legacy will be the innovations it has spurred to payment technology, although the payment system will remain dominated by large processors because of economies of scale… The revolution in payments technology pioneered by Bitcoin helps to accelerate the development of better technologies for making payments and transfers cheaper, faster, and more secure.
The technology could revolutionize trade and commerce around the world.
Even something like buying a home. Or anything that involves contracts for that matter.
There’s even potential it could make our personal information more secure.
Bitcoin’s price and value is another story.
It’s not a business. You can’t analyze the products and services it sells. The management. The assets. Or the debt.
You could say it’s a form of money.
Some say it isn’t an investment and has no yield. (Some gold critics would say that about gold too. But gold has been around as a store of wealth for thousands of years.)
You could say it’s a chaos or inflation hedge.
There was a study done by Briere, Oosterlinck, and Szafarz that found Bitcoin returns had a weak but significant correlation with gold and inflation-linked bonds. (Which just means that some investors see Bitcoin as an inflation hedge.)
Right now, that doesn’t seem to be the case. If so, the price of gold would be soaring with Bitcoin. As you can see from the chart above, gold has been going the opposite direction of Bitcoin since September.
You could say it is a commodity.
Goldman Sachs searched all the commodities throughout history and found that U.S. natural gas in 1910 is the only thing that’s ever grown by a factor of four in ten years.
Jeff Currie, global head of commodities research for Goldman Sachs, says Bitcoin is a commodity that’s “not much different than gold.” Like gold, Bitcoin doesn’t have a liability attached it. In other words, there’s no counter party so there’s no counter party risk.
A paper published in 2016 titled, Is Bitcoin The “Paris Hilton” of the Currency World, looked at whether investors should include Bitcoin in their portfolios.
In short, the authors found that it doesn’t add value to portfolios. The portfolios with only the traditional asset classes (stocks, bonds, currencies, commodities, and real estate) had superior performance.
Their conclusion “challenged the growing belief that adding Bitcoin to an investor’s traditional portfolio will lead to better performance.”
A lot of the perceived value comes from the technology behind it that I mentioned earlier.
But the price estimates you see in the media are pure speculation.
One way analysts value it is by its market value or monetary base. In other words, they estimate its transactional demand for buying goods and services.
For example, think of it like demand for a currency which people want to use to buy things. Like dollars or euros. People use dollars and euros to buy things all over the world.
Right now, the total U.S. currency in circulation is close to $1.6 trillion. Bitcoin’s market value today is close to $170 billion.
The number of Bitcoins created will never exceed 21 million. (It’s projected to hit that total by the year 2140.) It’s estimated that there will be close to 20 million in circulation by 2024.
Let’s say you think Bitcoin is worth the $1.6 trillion market value. You get a value close to $80,000 (1.6 trillion divided by 20 million). Close to eight times the value it is today.
Sounds like a great deal if you believe that.
It could also go to zero with a stroke of the pen from the government.
Nobel prize winning economist Joseph Stiglitz thinks the government should ban it “because of its potential for circumvention, lack of oversight.”
There’s also the attention it gets because of its use in illicit dealings.
Then there’s the tax questions. The IRS could shut an exchange down to investigate claims of tax evasion. A lot of people have made a lot money in Bitcoin.
Remember the Liberty Dollar case several years ago?
Bernard von NotHaus produced and sold pure silver coins he called “Liberty Dollars.” In 2009, the Feds arrested and charged him with violating federal law which prohibits making coins “intended for use as current money.”
The government said it has the exclusive power to produce currency. The Feds seized gold, silver and other property from him valued around seven million dollars.
Based on Joseph Stiglitz opinion, Bitcoin doesn’t seem much different. Remember, some say it’s a form of money.
Now, I’m not trying to compare Bitcoin to the Liberty Dollar. It’s just something to think about. Like any potential risk.
You never know.
No one even knows who created Bitcoin. We know the name. Satoshi Nakamoto. But that could be a person or several people.
Maybe governments around the world will soon issue their own “Bitcoins.” Then outlaw Bitcoin.
Then you have the battle of the billionaire investors.
When billionaires make moves, other investors tend to follow.
Except it’s mixed when it comes to Bitcoin. There are billionaires investing in Bitcoin and billionaires who think it’s in a bubble.
Again, we’re back to square one. Like I said, it’s pure speculation.
It’s difficult to determine the price and value of a Bitcoin. There’s also a lot of other unknowns that I explained above.
The same paper I quoted earlier by The Federal Reserve Bank of Boston also says,
The Bitcoin network as originally designed, and especially its associated digital currency, will probably not survive in the long run. Some serious design flaws of the current Bitcoin system have been identified, and some of them may eventually prove fatal.
If you want to speculate in risky stocks, bonds, currencies, real estate, commodities or Bitcoin, you need to understand two things…
First, understand that you are speculating. For example, that you have no idea whether the price will triple in six months. Or go to zero in two months.
Second, you should only speculate with money you could take outside right now and light on fire. Like the money you take on your annual Las Vegas trip.
In other words, money that you don’t need to pay your bills, save and invest for retirement or to save for your kid’s college fund etc.
Lastly, consider diversifying. For example, an investor could buy one each of the top five coins by market capitalization.
As of today, that is (in order) Bitcoin, Ethereum, Bitcoin Cash, Ripple and IOTA.
Bitcoin is the highest priced coin at just over $11,000. You would need around $14,000 to buy one of each.
If you have less than that, you could pass on Bitcoin and buy the next five. You would only need about $3,000 to do that if you bought one of each.
Also, you can buy less than one Bitcoin. Meaning you can buy fractions of Bitcoin instead of spending thousands of dollars for one coin.
The bottom line, if you want to buy Bitcoin or any other coin, know that you’re speculating and consider diversifying.