Bitcoin, the first crypto currency of the world, has come a long way. When I first heard about it, I thought it was a joke. A purely digital currency, really? Since bits are almost free these days, it seemed obvious that the value of such a currency would have to be zero.
It took me a while to understand that bitcoin was actually based on a genius new technology called the blockchain. This technology limits the amounts of bitcoins with mathematical certainty. More than that, it appears to be entirely libertarian. The whole purpose of bitcoin is to create a currency, that is as scarce as gold, and cannot be controlled by governments. But unlike gold, it also comes with a whole integrated, anarchic banking infrastructure. What an amazing idea.
Bitcoin could really be a great form of money. It has almost all the characteristics that we know money needs to have. Firstly, it is durable. So far, the software seems secure, and the bitcoins cannot be destroyed. Secondly, it is divisible. There are many bitcoins, which in itself can be divided into many subunits. Thirdly, it is fungible, meaning all bitcoins are interchangeable. It does not matter which bitcoin you own. And finally, bitcoin is convenient. It is easy to use. In fact it is probably more easy to use than anything else out there that tries to be money. All it needs is an internet connection and a very simple computer, and it can be transferred anywhere instantaneously.
There is however one problem with bitcoin. Unfortunately, it is lacking a characteristic that, according to the Austrian School of Economics, a potential currency needs to have. And that is an intrinsic value. For something to be money, it first needs to be used for something else but being money. Only then will enough people trust to keep their savings in that new currency, because only then they will have a guarantee that they can never fully lose their savings. The intrinsic value puts a floor into how far the currency can fall. It also spreads the usage of the commodity, and therefore establishes a market, before it is used as money. This is, so the argument, essential to give it the necessary trust, and acceptability to function as a currency.
Gold, for example, has been used as money for thousands of years. But it is also an extremely useful metal for other purposes. Even at current prices, it has a limited usage in the industry. If prices were to fall, it would immediately become attractive for all kinds of purposes. That puts an effective floor into the value of gold. It is this what we can call an intrinsic value.
Bitcoin however, does not seem to have an intrinsic value. It tries to jump this important first stage, and wants to be money straight away. The question is, is this possible? Or at least, is this possible on a free market. Sure, it is probably possible if a state forced people to use it. We have seen this happening with fiat currencies like the Euro. But will people voluntarily adopt something as money, that does not have an intrinsic value. With crypto currencies, we are currently in the process of finding out.
So far, one could make a strong argument that bitcoin proofs the austrians wrong. When I discovered bitcoin, the price was already around $30. Not bad for something without an intrinsic value. Ever since, the price has hugely fluctuated, but the tendency has been clearly up. As I am writing this, a single bitcoin sells for way north of $2000. It has more than doubled within a few month, and the chart seems to have turned parabolic.
But is this enough to proof that the Austrians were wrong? I thought about this a lot in the last few years. Since bitcoin already seemed to have a dollar price when I discovered it, I originally tended towards thinking that it indeed can be money without having an intrinsic value. However, I have since more and more changed my mind about this. I now think that bitcoin, or any other crypto currency, will not become a widely accepted currency. The idea that high bitcoin prices in dollars proof the opposite, seemed to have been a bit premature. It was literally wishful thinking on my part. I wanted it to be true.
I am sorry to say this, but I think what we are currently seeing is a classic speculative bubble. And far from being encouraging, this is going to kill crypto currencies in the end. That is because, as long as it is in a bubble, people are going to hoard it. This prevents it from being used in daily business transactions. And once the bubble pops, lots of people will get burned. For good reasons, humans don’t tend to forget painful experiences like that quickly. That means that when this is over, they will have likely learned to mistrust crypto currencies.
From very early on I realized that people who own Bitcoins were not all idealists. Yes, they kept telling me about the great technical functions this new currency had, and how it would create big problems for governments. But a scarily high number of people also told me, that they expected the price to skyrocket and consequently for bitcoin to make them rich.
These two things are not really compatible with each other. Sure there are currently a lot of traders in all kinds of established currencies. That means, the idea of making money on a currency is not unique to Bitcoin. What is unique however, is the scale of upwards volatility that people predicted in the crypto currencies, and also the high percentage of speculators.
Despite the fact that there are traders in all major currencies, the main function of these currencies is to facilitate everyday business activities. Most people use them that way. For that reason the volatility in these currencies is relatively low. It would be a major problem for any currency, if people started to abandon it for their everyday business. That is what we are seeing in a hyperinflation, which usually marks the end of a currency.
Despite the hype that we are witnessing at the moment, bitcoin currently is not used often as an actual currency. In fact, percentage wise, the number of people who use it as such seems to decrease rather than increase, as more and more speculators enter the market. So why are prices going up? Instead of seeing solid demand from real businesses for these currencies, the demand appears to come from people, who are betting on higher prices instead. I currently see a lot of media attention for bitcoin, hardly any of which is praising it as a currency. Pretty much all are promising new investors big fortunes. And that is even true for articles coming from the hardcore bitcoin community itself. But where exactly are these fortunes going to come from, if bitcoin is not used for real business?
And to my knowledge, there really is currently no major business out there that accepts bitcoins. I know, people will tell me that that is not true. Bitcoin can be spend in many shops. Yes, you can pay with them, but that does not mean that the business accepts bitcoin. I still have a euro account in Germany, with an attached VISA card. I can buy stuff with that card in pretty much any shop in the UK. That does not mean that euros are widely accepted in this country. The prices and all the accounting are still done in pounds. My euros are simply immediately exchanged into pounds at the time of the purchase. So what is really happening is that I have to sell my euros for pounds, and then pay the business in pounds. The technology simply enables me, to do all these things in only one step.
The same is happening when someone pays with bitcoins. However, at least for euros, there are many businesses outside of the UK which account in the European currency. But how many businesses are pricing and accounting in bitcoin at the moment? Hardly any, or maybe even none. For a legal business this is indeed close to impossible. Everyone has to pay their taxes in the local fiat currency. But also, it is impossible, because bitcoin is extremely volatile. This volatility makes business calculation and planing impossible.
A lot of people will argue that yes, currently the volatility is high and therefore bitcoin is not yet a currency. But the more people have it, the more it is going to be used as one. That way, over time, the volatility will go down and bitcoin will become a real currency.
There are two problems with this. Firstly, for the volatility to go down, people need to stop using it as a speculative asset. The speculators are driving volatility up, not down. First, they are driving prices up very quickly, which is what we are seeing at the moment. And then, when the time comes that enough people want to take their profits, they will drive down prices even more quickly. If bitcoin wants to become money, the speculators will have to go.
The problem is, they currently appear to be the only people who give the crypto currencies value and liquidity. That is because of bitcoin’s lack of an intrinsic value. At the moment, it is essentially just a Ponzi scheme. In other words, it is a zero sum game. For every winner there must be a loser. Winners are usually the early adopters, if they manage to get out in time. This puts a big incentive on these people to cash in their bitcoins for a more accepted currency. And as mostly in investing, the losers are the ones that come late to the party, which is often the majority of people. Those people will get burned.
That creates the second problem. Once these people got burned, the crypto currencies will gain a very negative reputation. While before anyone new about them, the reputation was at least neutral, after a major crash, the reputation will be bad. And that of course is not helping on the way to establish these currencies as trustworthy for business and savings.
So what we are seeing right now does not look like the breakthrough of crypto currencies. It looks more like the beginning of the end. It is a classic speculative bubble, in which people enter for no other reason but prices going up.
If you don’t believe that this is indeed the main reason for the current strong interest, then explain to me why are all of the crypto currencies going up simultaneously? If we were witnessing the breakthrough of a crypto currency, we would need to see one or two market leaders going up, but not all. The others would need to go down to zero. We cannot have all of these currencies establish themselves. That defeats the purpose of a currency, which needs to be as widely accepted as possible. The fact that there are so many appreciating crypto currencies out there, also proofs the critics right, who argue that, despite the blockchain technology, these currencies are not really scarce. Yes the internal number of units is limited, but there is no limit to the number of currencies itself. Anyone can easily create one.
I am sorry, but what we are seeing right now very much looks like a speculative bubble, a Ponzi scheme. Some people will make a fortune, while the majority will get burned. I am therefore fairly convinced that, although we are still in the middle of the party, the bitcoin experiment has failed. That is not to say that this party will necessarily end soon. But it does mean that bitcoin, or another crypto currency, will not become an actual currency. Before a crypto currency can take off, it will have to have a use in some other wide spread application.
None of this however means that the blockchain won’t be successful. We will almost certainly see this technology transforming the world in many, non money applications. And maybe one of these applications will get widely used, and eventually becomes a form of money. But as for bitcoin, it seems the austrian’s will be proven right again. At least on a free market, we will not see anything being adopted as money that does not have an intrinsic value first.