Bitcoin: Price Versus Value

Posted by Brad McMillan, CFA, CAIA, MAI

This entry was posted on Nov 30, 2017 3:28:50 PM

and tagged In the News

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bitcoinAll of the coverage on bitcoin has centered on its radical appreciation this year. But I believe something is getting lost in the discussion. While much has been said about the price of bitcoin, there has been little mentioned of its value. What I mean by this is that the value of bitcoin, at this point, is purely speculative. People are buying it in the hope that it will become an asset class of its own or just because it has risen so much—not because of what it is intrinsically worth.

What the bulls are saying

You can see this in the arguments made by the bitcoin bulls. It will change the world, they say, and everyone will own it. It will replace fiat currencies, since the supply is limited. It is digital gold and should be priced accordingly. All of the arguments depend on the hope that bitcoin will become widely accepted and used. Even if that happens—even if all of the bull cases come true—does that necessarily mean that bitcoin will be worth what investors are paying today?

The dot-com boom

I think it is instructive to look at the last time an investment boom was based on the hope that the world would change. I am referring to the dot-com boom, of course. Back then, investors pushed money into Internet companies with the expectation that the Internet would reinvent everything, that there was a new economy.

If you look around, those expectations have all been fulfilled (and then some). With Amazon, Google, Facebook, and Netflix, the way we shop, search, communicate, and consume media has been completely reinvented. All of the dreams came true (and then some). As I mention those companies, betting on bitcoin looks like a pretty good idea.

This is called survivor bias. The companies I mentioned are the ones that did well. Not mentioned are Pets.com, Yahoo.com, and Myspace.com. Most of these were among the earliest entrants. They were later superseded by other entrants, with better technologies or simply better marketing. The people who started Yahoo or Myspace were just as excited about the future as those who started Google and Facebook, and so were their investors. But they haven’t been good investments. Even for the winners, there have been substantial pullbacks when the frenzy of the boom subsided.

The cost of the hot asset

Buying bitcoin right now is equivalent to buying a tech stock in 1999 or 2000. You are paying premium prices for the hot asset. Even if bitcoin does end up as the default cryptocurrency—and there are hundreds of competitors, many based on second-generation blockchain technologies that are reportedly better—that does not mean the current price is justified.

Amazon is an instructive example. Remember, this is the poster child for Internet success over the past 20 years. The price reached $106.69 on December 10, 1999, only to drop to $5.97 on September 28, 2001, a decline of almost 95 percent. If you had bought at the peak and held on, of course, you would now be very happy indeed. If you had bought at the bottom, however, you would be much happier. Even if the value plays out, the initial price matters.

Price still matters

Twenty years later, the value of Amazon is clear. I suspect the same will be true of bitcoin’s underlying technology, the blockchain, in another 20 years. Anyone buying bitcoin at today’s prices, though, is making a bet that not only will bitcoin be the ultimate winner in the cryptocurrency space—against hundreds of competitors—but also that this is the best price at which they can buy. Even if the value is there, which is not at all clear, the price still matters. Right now? The price is very extended.

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