Whoa, Bitcoin… Settle Down!
A friend of mine decided it was high time that he jump aboard the Bitcoin rally earlier last month. Unfortunately, he got in when the digital currency was hurtling towards the $20,000 mark, and is sitting on a not so neat unrealised loss of nearly 30% as on date. Scepticism is starting to seep in. I consoled him with one of my more oft cited stories of how Thomas Edison lost a bundle of money in the South Sea Bubble, and if the genius inventor could - then we could too. My friend is a Dean's lister from an ivy league B School, in case you're wondering.
I'm not one of those vociferous opponents of cryptocurrencies, by the way. In the contrary, I'm quite enamoured by the concept of a blockchain based, borderless, trust less system of exchange that cannot be controlled centrally. Who knows, maybe cryptocurrencies are the future? Maybe they'll replace fiat currencies altogether someday? On that front, your guess is as good as mine.
My concern is with the obvious paradox that exists today, when it comes to how and why Bitcoin (and other crypto) prices are rising today. Think about it for a moment - is cryptocurrency really an "asset", financial or otherwise? Will your Bitcoin pay you dividends or interest? Does it have a balance sheet or a price to earnings ratio? Can you live in your Bitcoin? Can you melt your Bitcoin and convert it to jewellery for your daughter's wedding? No, I beg to differ - Cryptocurrency isn't an asset at all; rather, it's a medium of exchange, just like any other currency.
Which brings us to how we can actually assign a 'value' to a new, paradigm busting medium of exchange that's not linked to an underlying economy, and has no precedent to draw parallels from. My simple answer to that would be based on its acceptability as a medium of exchange. And yet - here's a disturbing fact: the acceptance of Bitcoin as a medium of exchange is falling, as it's price is rising. A recent Morgan Stanley research note concluded that Bitcoin's acceptance "is virtually zero", and that the acceptance of Bitcoin among the top 500 online retailers actually dropped in the last year! Big oops.
Based on today's prices, the overall float of 16.7 Million Bitcoins are worth 224 Billion US dollars, or 0.6% of the 37 Trillion worth of global M1 currency (read: dough that's easily convertible to cash) in circulation today. Is that a fair value? Is 0.6% of all global trade taking place using Bitcoin? And more importantly - will it ever? Once again - that's an answer that's open to speculation.
Back to reality. One of the basic features of a 'good' currency is its stability or 'solidity'. Imagine this: you buy an asset worth Rs. 100,000 USD using Bitcoin (roughly 7.5 Bitcoin in today's terms). Your asset appreciates 20% in one year, but when you go out to sell it (again, using Bitcoin), you find that the cryptocurrency's price has doubled to $ 26,000. You receive 4.61 Bitcoin from the sale - nearly 3 Bitcoin less that your purchase price. Which is fine, you say, because the price of the cryptocurrency has doubled too. But what if it tumbles 30% from there, in a month, right after you've made the sale? You'll be sitting on a heavy loss.
Whether or not the tidal wave of liquidity will push Bitcoin to dizzier heights is anybody's guess, really. It's the volatility that troubles me. If Bitcoin is indeed rising based on solid fundamentals related to its acceptance in the near or distant future, its extreme swings raise questions about whether or not enough end users or merchants will be using it anytime soon to trade a substantial quantum of goods, services or assets. In the meantime, is it that difficult to believe that a better, more advanced, more secure cryptocurrency won't come along and eat Bitcoin's lunch? Agreed, Bitcoin cannot be 'stopped' as it's not regulated by a central authority. But it sure needs to settle down before it can start to command any real utility. And if it does indeed settle down and stop rocketing ahead, of what use will it be to the hordes of speculators who got in to make a quick buck? None at all. And what'll they do? Start dumping them en masse. This paradox is a deep, deep concern - and one that's sure to play out quite quickly. In the meantime, if you're looking for me - I'll be sitting on the side lines.
