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Welcome back to Unhedged. If you have thoughts (and because today’s topic is bitcoin, many of you will), email me: [email protected].
Bitcoin is equity, not money
Years ago I was hired, with no experience in finance, as a trainee analyst at a hedge fund. I asked my soon-to-be boss how I should prepare. He said: “Get a financial calculator and learn to use the net present value keys. That’s really all there is to it.”
He was right. I have thought ever since in terms of streams of future cash flows, terminal values, and discount rates. Every other analytical tool I have acquired since has been secondary.
Which is why I am uneasy doing what I need to do today: write about bitcoin, an asset far beyond the comprehension of my HP-12c (millennials may now go look up what that is). The value of the stock of bitcoins fell by 29 per cent at one point today, a decline in value of $225bn. Here is the price of an individual bitcoin through the day on Wednesday (with the final tick on Tuesday included on the left) (data from Bloomberg):
Furthermore, bitcoin and the overall market trend seemed to be linked. From Refinitiv:
Something needs to be said. So what follows is this old-fashioned analyst’s best guess on what is going on. I look forward to your mail (I think?).
Bitcoin is best thought of as equity in a company whose only asset is a promising but unproven technology — this is not strictly true, but it is the right metaphor. A lot of people talk about it broadly in these terms. Here for example is Bill Miller, a very famous stock investor, in Barron’s a few weeks ago:
“Bitcoin is the solution to a problem that’s bedevilled economies since there were economies, which is government monopoly over the money supply and the banking systems, leading to serial defaults, confiscation with nationalisation, inflation . . . the best way to think about it is as digital gold. Gold is analogue, bitcoin is digital. It’s far superior to gold as a store of value . . . you can’t flee your country with millions of dollars worth of gold, as it’s bulky and hard to divide, whereas you can send bitcoin anywhere in a fraction of a second at very low cost, and it’s almost infinitely divisible.”
If the bitcoin technology works, that is to say, it will be a new form of money, and one that is superior in money’s particular function as a store of value: inflation safe, transferable without friction and out of the reach of government fiddling.
Here is Marc Andreessen, a very famous technology investor, writing some years ago, hitting similar points:
“The bitcoin ledger is a new kind of payment system. Anyone in the world can pay anyone else in the world any amount of value of bitcoin by simply transferring ownership of the corresponding slot in the ledger. Put value in, transfer it, the recipient gets value out, no authorisation required, and in many cases, no fees.”
And if bitcoin does become money, its value will rise a lot. Miller again:
“There’s about $10tn of gold value in the world, some in jewellery, some in central banks, some in things like ETFs. Bitcoin’s market cap is around $1.1tn. I’m highly confident that bitcoin can go up 10 times under certain reasonably assumed conditions — namely, it can be as valuable as gold.”
Rational people should agree, though, that bitcoin’s technology does not work yet. This should be obvious. Today’s price moves show bitcoin is too volatile to be money; for now, when the really bad stuff goes down, I’ll be fleeing across the border to Mexico with something other than bitcoins.
Just as importantly, transaction costs in bitcoin are generally high and slow, and it is only accepted in a few places. Bitcoin is not money, but the idea that it will one day become money is the source of its current value.
When the price of stock in a company whose only asset is an unproven technology fluctuates (and they do, a lot) that doesn’t matter. That’s just market noise, except when there is new information suggesting that the technology asset is more or less likely to succeed.
That is where a lot of bitcoin believers have made a mistake. They think when the price of bitcoin goes up, that is itself evidence that the technology is closer to working, and becoming money. It’s not! Lots of things, from baseball cards to cases of Château Lafite, go up in value. That does not make them money. It makes them assets. Assets are fine things, but the value of the said bitcoin comes from the possibility that it becomes a specific kind of asset, namely money.
Evidence that bitcoin is becoming money would involve people transacting in it more, in more places and more smoothly (whether there is any evidence of that is a topic for another day).
A final point. The nominal reason for the drop in bitcoin’s value on Wednesday was that the Bank of China said that it “should not and cannot be used as currency in the market”. Is that evidence that bitcoin technology will not work, and become money? Maybe, but remember that an essential part of bitcoin’s appeal is that the opinions of third parties and especially governments are not supposed to matter. Yet today’s volatility suggests they do.
There is an easy way to resolve that contradiction: by positing that much of the current value in bitcoin is pure, untethered speculation, with no connection whatsoever to the fundamental character of the technology.
One good read
If you have followed my writing in the FT, you know that I also wear a non-financial hat, writing a regular column on men’s style. I have always thought that my two kinds of writing were related, in that they require close thinking about human behaviour. I will not wear the style hat often in Unhedged, but once and a while I might slip it on.
So: last weekend in the New York Times style magazine, there was an absolutely outstanding example of style writing, Aatish Taseer’s piece on how eastern and western cultures have met in the recent history of perfume. If you have any interest in the history of fashion, read it.