Bitcoin is the elephant, we are the blind men gathered around it, each feeling a different part and none in agreement with ‘what it is’.
So far, this is what I’ve touched:
Bitcoin ain’t bling. “If you flashin it, you must not want it” – DMX
Regulating Cryptocurrencies–and Why It Matters
Bitcoin mining and fossil fuels. If you buy, sell or mine, YOU ARE THE PROBLEM
Bitcoin. Zimbabwe and the dollar
Bitcoin and Blockchain. The explainer…
Cash has no memory
From the denarii to bitcoin and cryptocurrencies…
Cashless. Gold, Barter and Bitcoin. New ways to cheat at Monopoly
Tackling more big questions. Let’s do a bit of bitcoin reverse engineering of its asset properties.
The first equation of asset pricing is price = expected present value of dividends. Bitcoin has no cash dividends, and never will.
If the price is greater than zero, either:
people see some “dividend,” some value in holding the asset, beyond its cash payments; equivalently they are willing to hold the asset despite a lower expected return going forward,
They think the price will keep going up forever, so that price appreciation alone provides a competitive return.
Bubble or yield?
Rational bubbles If prices goes up forever, the value of bitcoin will exceed all of world wealth. The “greater fool” has to break at some point, or rely on an irrational, and endless, belief in the “next fool”. But his can’t be it, rational bubbles does not account for the association of price surges with high volatility and high trading volume.
Convenience yield Dollar bills don’t pay interest, and they don’t pay dividends. By holding dollar bills, you are holding an asset whose fundamental value is zero, and whose expected return is lower than that of one-year treasuries. One year Treasuries are risk free, and over a year will give you about 1.5% more than holding dollar bills. This is arbitrage.
You hold (some) dollar bills, or their equivalent in non-interest-bearing accounts. They are more convenient when you want to buy things. Dollar bills have an obvious convenience yield that makes up for the 1.5% loss in financial rate of return.
Nobody holds dollar bills for a whole year. You minimize the use of dollar bills by going to fill up at the ATM occasionally. And the higher interest rates are, the less cash you hold and the more frequently you go to the ATM. So, already we have an “overpricing“, dollars are 1.5% higher priced than Treasury’s. This related to “short-term investors“ and lots of trading, high turnover, with more overpricing when there is more trading and higher turnover, just like bitcoin.
Good or bad is besides the point. The point is that there is a perfectly rational demand for bitcoin as it is an excellent way to avoid both the beneficial and destructive attempts of governments to control economic activity and to grab wealth…
…even if people holding it know that it’s a terrible long-term investment.
Speculative demand. Well, suppose you know or you think you know that bitcoin will go up some more before its inevitable crash. In order to speculate on bitcoin, you have to buy some bitcoin (I don’t know if you can short bitcoin, but if you wanted to you would have to borrow some bitcoin and sell it, and in the process you would have to hold some bitcoin) So, as we also see in high-priced stocks, high prices come with volatile prices and large trading volumes. Someone speculating on bitcoin over a week cares little about its fundamental value. Even if you told him or her that bitcoin would crash to zero for sure in three years, that would make essentially no dent in their trading profits, as you can make so much money in a volatile market over a week, if you get on the right side of volatility.
To support a high price, you need restricted supply as well as demand. The Achilles’ heel of bitcoin’s long term value is that there is nothing to stop people from creating bitcoin substitutes. There are already hundreds of other similar competitors…
…and there is nothing to stop people from creating private claims to bitcoin, bitcoin futures, to satisfy speculative demand. But all that takes time. And none of my demands were from people who want to hold bitcoin for very long. Ice cream is a fast-depreciating asset, but people hold it for a while. Bitcoin remains a terrible buy-and-hold asset, especially for an investor who plans to pay taxes.
What’s going on with Bitcoin is “normal”.
Intersect a convenience yield and speculative demand with a temporarily limited supply, plus temporarily limited supply of substitutes, and limits on short-selling, and you get a price surge. It helps if there is a lot of asymmetric information to spur trading.
Bitcoin is not a very good money. It is a pure fiat money and its only value comes from limited supply plus the demands I described.
My bet is that stable-value cryptocurrencies, offering one dollar per currency unit and low transactions costs, will prosper in the role of money. But this ain’t it