The Great Bitcoin Fever

The opposing statements from investors Charlie Munger and Bill Miller are representative of the battle fronts regarding bitcoin:

"Bitcoin is rat poison!"(Munger 2018)

"Bitcoin could be rat poison, and the rat could be cash." (Miller 2021)

One sees the cryptocurrency as poison not to be touched and the other merely as a cash killer and digital money of the future.

The many faces of bitcoin

Money generally has several functions: it serves as a means of exchange, a store of value, and a unit of account. For some, bitcoins are digital money, organized in a decentralized way via the blockchain, independent of governments and central banks. Bitcoins have existed for over ten years, but the cryptocurrency has not yet established itself as a broad means of payment. It is also not suitable as a store of value and a unit of account due to its high volatility.

Perhaps the Chinese regulator's assessment in 2013 was correct; it defined bitcoins as a virtual commodity. Digital gold, so to speak.

Bitcoins as a substitute for gold

With an estimated market capitalization of USD 10 trillion, gold is a store of value that has been around for 3,000 years. If you believe that bitcoins can be a store of value as well (a big "if" here), they offer advantages over gold: they are more convenient, scarcer, more transmittable and more divisible. However, there are also disadvantages: more hackable, easily misplaced, less insurable, and intangible versus physical.

As long as the number of people who believe that bitcoin can become gold 2.0 increases, the more buyers will come to the market. This is because the price depends on how much the next person is willing to pay for it. There is no intrinsic value of bitcoin.

The total amount was already fixed at 21 million bitcoins at the inception of the idea. Currently, there are already 18.6 million bitcoins. The scarcity arises from the fact that it is becoming increasingly difficult to "mine" new bitcoins. With the record price of $40,000 or 33,000 euros per bitcoin just achieved, we are currently talking about USD 740 billion (EUR 600 billion) of total capitalization.

It is impossible to say exactly how many people own bitcoins. However, a hundred million investors are a realistic estimate. Not everyone holds a whole bitcoin, but often only a fraction of it (the smallest possible fraction is called Satoshi, a hundred millionth of a bitcoin). At any rate, this scale warrants discussion. Although the size of the market is not a validation. Neither was it in the tulip fever of the 1630s.

Bitcoin in US Dollar

Source: FactSet. Past performance is not a reliable indicator of future results.

Digital store of value

For countries in the euro zone or in the USA, the need for an additional digital store of value may not be so great. In the short term, one's own bank account will suffice and in the longer term, real and productive assets are the obvious choice.

However, think of the vegetable farmer in Venezuela who sells corn on the cob with his wife at the wholesale market in Caracas. The bolivars taken are good for two seconds as a store of value. Then it already begins to burn in the pockets, quickly changed into dollars at the black market value. In many countries, the state prohibits exchange into foreign currency and prosecutes possession. The physical bills are a risk. In these countries, a digital form of storage has a very different appeal, not seen in the U.S. or Europe. Meanwhile, the black market serves not only in the demand for U.S. dollars, but also for bitcoins.

People, without bank accounts or credit cards, could still participate in the internet economy; assuming they are widely accepted at some point.  

Easy access and little regulation

It is getting easier and easier to buy bitcoins. I watched myself as my 19-year-old son opened an account at a crypto exchange in a few minutes and bought bitcoin fractions for a few hundred euros. No investor profile, no risk disclosure, no MiFID II directive.

What is scary is the possibility of speculating on credit on crypto exchanges. For example, one buys the equivalent of 100, but deposits only 20; a drop of 20 percent wipes out the equity. Therefore, no one knows what the total outstanding leverage in cryptocurrencies is and this can be a scary prospect.

Already now, trading bitcoins and other cryptocurrencies is not for free. If the different market participants eventually have to apply similar regulatory standards and anti-money laundering rules as banks, credit card networks and securities exchanges, the costs would also be comparable (high).

Blockchain instead of middleman

How do you create a trustworthy network of people who do not know each other? Blockchain, the technology behind bitcoins, solved the problem; a functioning network, even if there are some people on it who cannot be trusted.

Bitcoin wanted to make the "trusted middleman" unnecessary via the decentralized organization. However, almost everyone buys bitcoins and the other cryptocurrencies via electronic crypto exchanges and deposits them there. The trusted institution makes life easier and settlement faster. Admittedly, there are now offers of "decentralized exchanges".

Blockchain technology and its philosophy is creating many new applications, that is undisputed. In any case, banks are evaluating ways to use blockchain technology for themselves. It could also be attractive for investors not to wait two days for a stock transaction to settle. It could be recorded immediately in a decentralized database - in real time. After all, every value date of several days can carry risks.

Bitcoins and Esperanto

We already pay with digital versions of the euro, dollar and other established currencies, such as the pound, yen and renminbi. Will bitcoin become another great digital alternative, or will it end up as the Esperanto of currencies? If you live in Venezuela and hold all your money in dollars, that opens up other risks. After all, you are holding currency from a country where you have no rights. From that perspective, an independent digital currency has an appeal.

We all want a fast, secure and efficient payment system. If possible without the necessary, trustworthy institution as a toll bridge in the middle. Blockchain technology has been a beacon of hope for this for many years. However, another limiting factor is speed. Each block confirms a limited number of transactions. The blockchain currently processes about five transactions per second. By comparison, the Visa network processes 2,000 transactions every second and 24,000 transactions per second would be possible.

Got bitcoins Mr. Ponzi?

The system is organized in such a way that new bitcoins are created more and more slowly - at 21 million coins, the end is reached. If the value is in expecting the bitcoin price to rise due to scarcity combined with an ever-increasing number of interested parties, it is very reminiscent of a pyramid scheme. Played globally, the economic damage at the end of the journey could be devastating.

Pyramid scheme or not, bitcoins, like gold, are not a productive asset. Anyone who buys a kilogram of gold or a bitcoin today will still have a kilogram of gold or a bitcoin in twenty years.

I find productive assets much more attractive for long-term investments. What do you think? What lets investors have a good night’s sleep? Probably a stock portfolio with excellent business models or real estate in a prime location.

If you want to know more about the history of bitcoins, I recommend the book "Digital Gold" by Nathaniel Popper. It is informative and entertaining.

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