Recently, I announced that bitcoin was the winner of the “Bubby,” an award I made up for the bubble of the year. I kind of like the idea—and will do it again—but it was certainly done at least a bit tongue in cheek to highlight the appreciation over the recent past. Sometimes, however, you get it right almost by accident. Events since then have made that post seem somewhat prescient.
Bitcoin in the news
The first event was when Jamie Dimon, chairman and CEO of J.P. Morgan, called out bitcoin as a fraud, and it lit up the Internet. Since then, I have seen many comments calling out both Dimon and J.P. Morgan as fraudsters, usually from people who are heavily invested personally or professionally in bitcoin. These remarks resemble those I saw as the dot-com boom was rolling over, heavily focused on attacking the heretic personally rather than responding to the analysis. That was not always the case, of course, but it did point out that many holders of bitcoin are more true believers than cold-blooded analysts. When an asset gets to that stage? It is usually a bad sign.
The second newsworthy event was the decision by the Chinese authorities to prohibit initial coin offerings and (depending on how you read the law) to outlaw cryptocurrencies, which include bitcoin. Although the initial impact was mixed, the decision by China’s second-largest digital currency exchange, BTCC, to shut down its Chinese exchange seems to have cemented the fear there. China has been a major source of both bitcoin creation and bitcoin demand, and the regulatory disruption seems to be having a sobering effect on the bitcoin market. Indeed, as of last night, bitcoin was down about 25 percent from its peak on September 2, placing it in a bear market.
This kind of correction does not mean the bitcoin ride is over. In July, bitcoin was down 35 percent, before bouncing back in August. Overall, it is still up sharply for the year. Extreme volatility seems to be normal, and this could be just one more instance of that.
The function of “money”
At the same time, these two occurrences highlight the very real risks that true believers may be missing. Specifically, anything used as money fills a few functions. First, it must act as a store of value. With bitcoin, is the general public going to be comfortable with a store of value that can vary that much, month to month? Second, to be usable, it must work within the existing system. Banks are certainly working on blockchain technology, but that is different from cryptocurrencies. Mr. Dimon is probably a good indicator of how senior executives are thinking in the global financial system, so the banking system is not on board—at least yet. Even more important, money ultimately has to be legally acceptable as a medium of value transfer, which—at least in China—is coming increasingly under doubt.
Would the U.S. outlaw bitcoin?
Can’t happen here? Not relevant in the U.S.? Maybe so. But the U.S. did outlaw private gold currency ownership in 1933, so we have done it in the past. China is already halfway toward outlawing cryptocurrencies entirely, with one stated reason being to stop money laundering. All it would take here, for example, would be for a major terrorist attack to be tied convincingly to bitcoin finance. Bitcoin already has a reputation as being the economic conduit for drugs and guns, so terrorism is a logical next step.
Price versus risk
When you put this all together, it is not to say that cryptocurrencies have no rationale or use. They do. But one may conclude that they have very real risks and concerns and that the true believers who may be driving the market right now are not necessarily taking those risks into account.
Here, a good comparison might be the Internet. In 1999, investors were convinced it would change the world. And they were right; it did. This did not mean, however, that all of the companies at the time were good investments. Bitcoin and other cryptocurrencies face that same risk.
Being a good company, or even a good idea that will change the world, does not necessarily mean something will be a good investment. It all depends on the price you pay.
If bitcoin is outlawed . . .
Those investors may turn out to be right. If the regulators act in a heavy-handed way, as they seem to be setting up to do in China, bitcoin could once again become what it was not that long ago: a fringe asset, used by very few. If the banking system, for whatever reason, decides to turn its collective back on bitcoin, perhaps in favor of a rival cryptocurrency it creates with governmental approval, then bitcoin could also drop in popularity.
If bitcoin is outlawed, whether formally by governments or practically by the banking system, only outlaws will want bitcoins. It may take us back to the not-so-distant past when much lower values prevailed. Keep that risk, and many others, in mind as you decide whether bitcoin is really an equivalent to other assets.
This post is intended for educational purposes only and is not a recommendation for or against cryptocurrency.