Bitcoin Is Dangerous – and Worthless

Articles

by senior futurist Richard Worzel, C.F.A.

Bitcoin was the first crypto-currency, and still the most widely known. It has been making headlines in large part because some of the people who have bought it have made fortunes, at least in theory. In turn, this has seduced other people to pile in, which has pushed up the value of Bitcoin, which has made more money for more people, which has encouraged even newer people to buy it, which has pushed up the value – and so on.

Sort of like a Ponzi scheme.

Bitcoin is not a Ponzi scheme, but neither is it a currency. In fact, I suspect that very few people know just what Bitcoin is, and that lack of understanding makes its current popularity dangerous. To see why, let me describe what a currency is, and hence, what money is.

Wikipedia defines a currency as “a system of money (monetary units) in common use, especially in a nation.”[1]

The definition of “money” is incredibly complicated, far more than you might think. There are big, fat textbooks written on the subject, and economists have been known to get into fistfights over the issue, so I will merely tip-toe around it. However, I will say that Bitcoin is not money – and that’s part of the problem.

A distinct group of financial writers, typically gold bugs and people who rail against governments printing paper money that isn’t backed by something of real value (like gold) like to say that government currency isn’t worth the paper it’s printed on. They are wrong.

Take the currency of Canada, for instance. What a Canadian dollar represents is a claim by someone holding that dollar on a small portion of the goods, services, and assets produced or held in Canada, or by Canadians. Hence, the entire stock of (physical and electronic) Canadian currency – all of Canadian money, in other words – represents all of the claims, both foreign and domestic, on the goods, services, and assets of Canada.

If the Bank of Canada, its central bank, prints money faster than Canadians produce more goods and services, then Canada experiences inflation, and the value of the Canadian dollar declines. If Canadians produce things faster than the Bank of Canada produces money, then the value of the Canadian dollar increases.

This is a horrendous oversimplification, but is fundamentally correct, even though most economists would want to start a fistfight with me over what I’ve just said, and many others will want to quibble.

So, the so-called paper money (even though most of it is electronic) of a nation is backed by real things, being the goods, services, and assets of that nation.

What is Bitcoin backed by, and by whom?

Bitcoin is independent of any nation, which is a large part of its attraction. The inventor(s) of Bitcoin is/are unknown. The inventor was supposedly someone called Satoshi Nakamoto, but the name is accepted to be a pseudonym for the person or persons who came up with Bitcoin.

Bitcoins are produced by a process called “mining”. Mining implies work, but in fact, the only work that is done is by computers, and this work produces nothing of value. Instead, the calculations performed result in a difficult mathematical, but meaningless, outcome. It literally has no purpose except to demonstrate in a verifiable way that a calculation relating to Bitcoin has been performed.

So, the mining process produces nothing of value in the real world. Bitcoin is backed by nothing, and no one stands behind it. It is not money.

A Store of Value

Bitcoin proponents will vehemently disagree with me. They say that the mining process does produce something of value, which is the verification of the computing chain that verifies that Bitcoin computations have been made. I would interpret this as meaning: Bitcoins verify that each Bitcoin is produced in a verifiable way. This is a logical tautology, and says nothing about its underlying value.

A lot is made of how Bitcoin is independent of any country or government, so individuals or organizations can transfer value between each other without reference to, reliance on, or the knowledge of a national government. I accept that Bitcoin could be a worthwhile vehicle for transferring value from one entity to another – if there were a way of determining the value being transmitted.

So, what is the value of Bitcoin? Well, the technical definition of any market value is: that price at which a willing seller will sell, and a willing buyer will buy. But there is no external or independent reference to guide buyers and sellers as to the value that should be placed on Bitcoin, the way there is for a bushel of wheat, or a pound of copper, or a restaurant meal. The value of Bitcoin is whatever the market says it is. That means it could be really high today, and really low tomorrow. There’s no way to measure it independently.

Imagine that I offered you what I said was a new, independent currency, called Tolkens. Each Tolken is minted when an independent, incorruptible judge agreed that I, or anyone else, had twiddled their thumbs 1,000 times while in a place where the judge could attest this had been done. And suppose the Tolkens could not be counterfeited, and could be transferred electronically with absolute safety. What would the value of a Tolken be?

Maybe you can tell what that would be, but I can’t.

That’s my interpretation of Bitcoin’s value.

Is there something worthwhile in being able to transmit value in an untraceable, unstoppable manner from A to B? Yes.

Is there something worthwhile in being able to verify that something specific has been done in an incorruptible way? Yes, there is.

But what is that value? I have no idea – and I contend that nobody else does, either.

Why All the Shouting?

So, given what I’ve said, why is Bitcoin being bid up to astronomical heights? The simple answer is that it’s going up because it’s going up. We’ve seen that movie before, and it doesn’t end well.

In the early 1600s in Holland, tulips became fashionable, and particularly rare or beautiful varieties were bought and sold at high premiums. As more and more people started trading tulips, the prices went up even further. And as the prices went up, more and more people made money by buying tulips. And as new people bought tulips, the prices went up further – and so on, in a self-stoking cycle that became known as tulpenmanie, or tulip mania. It eventually stopped in February of 1637, when the prices of tulips came crashing down. They went from a high of an estimated 2,500 Dutch florins for a single tulip bulb, a Viceroy, to less than 10 florins[2].

Crashes of this nature were described in a classic book, well-known to people who work on Wall Street, called Extraordinary Popular Delusions and the Madness of Crowds, published in 1841 by a Scottish journalist named Charles Mackay. And they happen whenever the conditions are right, especially when something of ambiguous value is involved.

Sometimes a mania or madness relates to things that do have value, such as stocks. The tech bubble of the late 1990s and 2000 involved many companies that did, and still do, have value, such as Amazon (now one of the most valuable companies in the world) as well as others that don’t, such as a company called Nortel (now bankrupt). Bubbles grow on investor psychology, when people become panicked about missing out on an opportunity to get rich.

That’s what I see happening with Bitcoin. There may, or may not, be value in Bitcoin as a verifiable means of transmitting value, but any real value has long been eclipsed by the maniacal conviction that if I just buy it, I can get rich.

There’s a cliché to describe this phenomenon. It’s called the Greater Fool Theory. The Greater Fool Theory says that it doesn’t matter how much you pay for Bitcoin; some greater fool will pay more. Therefore, you should buy it no matter what the price is, because the price will always go up – which it will. Until it doesn’t.

Why Is This Dangerous?

But, so what? Some people will lose money, sooner or later, but that’s not a big deal (although it’s dangerous for them).

The problem comes when the mania becomes widespread. Supposed, for instance, that the CFO of a major company decides to take a flyer in Bitcoin with the company’s temporary, excess cash reserves. This could happen for many reasons. The CFO might believe the stories, for instance, and decide that the company should try to benefit. Or the CFO might decide that if he invests in Bitcoin with the company’s funds, and the company makes a fortune, his bonus will be appropriately fortunate.

Now suppose he’s one of the last to the party – and the company suffers a severe financial setback because of it, possibly pushing it into insolvency. (By the way, just this kind of thing happened with subprime mortgages in 2008 – which was one of the reasons why the stock market tanked.) If that company’s insolvency comes as a surprise to investors, and if they start to wonder how many other CFOs have been so tempted, then a collapse in Bitcoin could lead to a run on the stock market, precipitating a bear market collapse.

It’s never a good thing for people to chase an item which has a price running through the roof, and that has a story they don’t fully understand. It’s dangerous, both to them, and the fallout may be dangerous to a lot of unsuspecting bystanders as well.

And Bitcoin is just such an item.

© Copyright, IF Research, February 2018.


[1] https://en.wikipedia.org/wiki/Currency

[2] https://en.wikipedia.org/wiki/Tulip_mania