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Bitcoin is all the rage, and it’s easy to understand why. A $1 investment in bitcoin in 2010 is worth over $5 million today. We not-so-boldly predict this performance will not be repeated over the next seven years, but that belies the question: Where is bitcoin’s price going?
Like all prices, it depends upon supply and demand. Bitcoin’s supply grows slowly and will be capped at 21 million bitcoins. It’s changing demand that causes price movements. So what determines demand?
Bitcoin is referred to as “digital currency,” but it’s not really money. Money is a commonly accepted medium of exchange that sellers accept from buyers as a means of payment. Bitcoin’s value can swing 20 percent in a day, which is way too volatile for most businesses or people to hold for transaction purposes. Bitcoin owners almost always exchange bitcoin into dollars to buy things.
Bitcoin is often called “digital gold,” but, unlike gold, it has no commodity value. Gold is valuable ultimately because it has ornamental and industrial uses. Not so for bitcoin.
Bitcoin is often compared to stocks and bonds, but that is woefully misleading. In return for an equity investment, a stockholder owns part of a corporation and has claim to future dividends. In return for a loan, a bondholder receives a legally binding promise of repayment and specified interest payments. Bitcoin promises nothing; it has no link to any money-making commercial enterprise or public tax base.
Bitcoin is called a “cryptocurrency.” This theoretically allows its owners to store value anonymously. Criminals want this to evade detection. But the authorities (FBI, IRS, etc.) are becoming increasingly skilled at using bitcoin’s blockchain to track and prosecute the bad guys. Smart criminals are already migrating away from bitcoin. And Bitcoin’s privacy feature is of limited value to most. Counting on other people’s paranoia is a weak foundation for an asset’s value: Why would the paranoid trust bitcoin?
So we are left with the following: Bitcoin is a speculative asset. People demand bitcoins today because they expect someone will pay a higher price tomorrow. We have seen this movie before. Can you say asset bubble, Ponzi scheme or “greater fool” theory? Expectations inevitably reverse and prices crash. That is, unless bitcoin emerges as our society’s money, but this is unlikely with hundreds of cryptocurrencies and central banks as competing money issuers.
So buy bitcoins at your own risk. Good luck. You’ll need it.•
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Bohanon and Curott are professors of economics at Ball State University. Send comments to ibjedit@ibj.com.
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