With the Con That's Bitcoin, There's No There There

With the Con That's Bitcoin, There's No There There
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Bitcoin is down 67% from its $19,871 high on December 17, 2017. How low can it go? Much, much lower, maybe all the way to zero since bitcoins have absolutely no investment value and may fall out of favor as a surreptitious currency. As an investment, bitcoins are a bitcon.

The fundamental value of an investment is the amount you would be willing to pay to hold it forever, and be satisfied by the cash it generates. Businesses that make profits have investment value. Bitcoins generate no cash and have no investment value. No sane person would buy bitcoins and say, “This is a great investment. I will never sell my bitcoins, because I am happy just owning them.”

Instead, bitcoin speculators count on selling their bitcoins for higher prices than they paid for them. When bitcoin prices are rising rapidly, this is a tempting assumption. When bitcoin prices are falling, there is no longer any reason to “invest” in bitcoins. Real investments are different. When prices fall, they become more attractive.

The Bitcoin Bubble will long be remembered as an example of what Charles Mackay called “Extraordinary Popular Delusions and the Madness of Crowds,” along with the Tulip Bulb Bubble, the South Sea Bubble, and (more recently) the Dot-Com Bubble. Although more people lost more money in the dot-com bubble than in the Bitcoin Bubble, the Bitcoin Bubble was more remarkable. Many dot-com stocks at least offered the hope that they might someday be profitable companies that could distribute cash to their shareholders. Some dot-com companies have done exactly that. Bitcoins and other cryptocurrencies offer no such hope. Bitcoins are pure speculation, bought by fools with the hope that they can soon be sold to even bigger fools.

Bitcoins are like some of the scams that occurred during the South Sea Bubble. In 1720, the British government gave the South Sea Company exclusive trading privileges with Spain’s American colonies. None of the company’s directors had ever been to America, nor had they any concrete plans to trade anything. Nonetheless, encouraged by the company’s inventive bookkeeping, English citizens rushed to invest in this exotic venture. As the price of the South Sea Company’s stock soared from £120 on January 28 to £400 on May 19, £800 on June 4, and £1,000 on June 22, some became rich and thousands rushed to join their ranks. It was said that you could buy South Sea stock as you entered Garraway’s coffeehouse and sell it for a profit on the way out. (Doesn’t that sound like the delusions embraced by Bitcoin buyers when bitcoin prices were rising?)

Soon, South Sea conmen were offering stock in even more grandiose schemes and were deluged by frantic investors not wanting to be left out. (Doesn’t that sound like the proliferation of other cryptocurrencies?) It scarcely mattered what a South Sea scheme was. One promised to build a wheel for perpetual motion. Another was formed “for carrying on an undertaking of great advantage, but nobody is to know what it is.” (Doesn’t that sound like blockchain technology, which almost nobody understands?) The shares for this mysterious offering were priced at £100 each, with a promised annual return of £100. After selling all of the stock in less than five hours, the promoter left England and never returned.

Another stock offer was for the “nitvender” or selling of nothing. Yet, nitwits bought nitvenders. When the South Sea bubble burst, fortunes and dreams disappeared. (Doesn’t that sound like the air going out of the Bitcoin Bubble?)

As with all speculative bubbles, there were many believers in the Greater Fool Theory during the South Sea Bubble. While some suspected that prices were unreasonable, the market was dominated by people believing that prices would continue to rise, at least until they could sell to the next fool in line. In the spring of 1720, Sir Isaac Newton said, “I can calculate the motions of the heavenly bodies, but not the madness of people” and sold his South Sea shares for a £7,000 profit. But later that year, he bought shares again, just before the bubble burst, and lost £20,000. When a banker invested £500 in the third offering of South Sea stock, he explained that, “When the rest of the world are mad, we must imitate them in some measure.” After James Milner, a member of the British Parliament, was bankrupted by the South Sea Bubble, he explained that, “I said, indeed, that ruin must soon come upon us but . . . it came two months sooner than I expected.” (Doesn’t that sound like bitcoin holders who wished they had sold at $19,000?)

Bitcoins are a modern-day nitvender. The price of bitcoins is no more related to economic fundamentals than was the price of the South Sea nitvender. There is no there there.

It is a mathematical fact that when the price of bitcoins goes to zero, this zero-sum game will have completed its circle. Every dollar of profit that anyone made trading bitcoins will be matched by the losses of other bitcoin traders.

We can laugh about the South Sea nitvender now, but it will be a long time before the gullible people who lose money on the bitcoin nitvender will laugh about their losses.

Gary Smith is a professor of economics at Pomona College, and the author of Money Machine: The Surprisingly Simple Power of Value Investing (AMACOM, 2017).  

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