I initiated an online survey last week after the surge in Bitcoin’s price and the frequency of news reports and online comments/blog posts really started to make me think this thing is getting out of hand. I wanted to get a feel myself for how many people in my online world were involved with Bitcoin, or with any cryptocurrency for that matter.
I had over 150 responses to the survey and although it’s by no means scientific, I think it helps start an interesting discussion and analysis of the current state of play regarding the Bitcoin phenomenon.
Why do I love Bitcoin?
I love the concept of Bitcoin, or frankly any cryptocurrency which the world, or any society, country or eco-system collectively agrees can be used as a store of value and means of exchange. Governments have done this for us for centuries, and have failed time and time again to keep their currencies from becoming worthless. So the idea that we can have a digital and liquid store of value in place of, for example, gold, is appealing.
And we’ve been using different forms of virtual currency for years already in the form of credit card reward points and frequent flyer miles. We “earn” points, keep them in a kind of digital wallet and, at times, even spend them. The fact that many expire or have restrictions on how they are used is simply a technicality. So adding a new form of digital currency to my balance sheet is, in my opinion, entirely feasible.
Much of the world, and especially millennials, are longing for something which is modern, fair, stable and which can, in effect, “Uber-ize” the settlement of financial transactions and banking. Banks have become behemoths which are seen as self-serving market manipulators. Banks used to perform a service of accepting deposits and then loaning those deposits out to others in order to let them start a business or buy a house. But add leverage into the mix supplemented with QE-infinity and you get a potentially infinite money supply from governments and debased currencies. See the following chart of the supply of US dollars. Scary!
The creation of new and widely accepted currency(ies) will allow “the people” to take control of money, cut out the banks from things like holding deposits, making loans and facilitating payments, and allow the sharing economy to take over. Just like Airbnb is now the biggest hospitality business, with Bitcoin and other cryptocurrencies “the people” can stick it to the banks. Great idea – I say let’s do it!
Who is driving the price surge?
I’ve had a sense that this phenomenon has been limited to a rather small group of people and that perhaps even the meteoric rise in price has been driven by a small group of people, potentially just trading with themselves and bidding the price up. This happens in other markets, most notably with penny stocks (The Wolf of Wall Street), and those kind of big run-ups in prices almost always end in a crash, usually one which the stock/underlying company never recovers from.
But could this be different? My gut says it is, but why? I’ve set out to really come up with a conclusion here as to what my personal view on Bitcoin is. Many views I’ve heard and read tend to be lean to one extreme or another – either that Bitcoin is fraud and will go to zero or has changed the world and will in time be worth up to $1,000,000 per coin. And if someone isn’t a lover or a hater of Bitcoin, then they will simple say they don’t know what will happen with it. That’s a fair enough answer (and in reality is true for everyone as no one can know), but I want to actually look at what seems to be driving this frenzy and then actually draw my own conclusion. So I will conclude this piece by stating exactly how I am approaching Bitcoin from an investor standpoint, which is what many friends and others have been asking me in recent months.
Of course, I need to issue a disclaimer that what I’m writing here is only my personal opinion as me and me alone, and not as an advisor of any sorts, and this is not connected with any firm, regulated or otherwise, with which I am associated.
Also, for the sake of disclosure, at the time of this writing, I do own about $1,000 worth of cryptocurrencies, about half being Bitcoin, the others being Litecoin and Ether, all of which I bought a few months ago to understand the process and have an excuse to monitor what was going on. And for the sake of clarity, I will add that this amount does not represent a significant portion of my net worth, so I do not believe the fact that I own part of a Bitcoin impacts my ability to analyse this topic objectively.
Who is actually doing the buying and selling?
This is the question I set out to answer and in part my online survey has helped with painting the picture. But before getting to the survey, according to statistics from September published at howmuch.net,
As seen in the chart, only 3.47% of the total amount of the Bitcoins in existence are owned by 96% of the Bitcoin addresses (i.e., owners). This is a jaw-dropping statistic, which on the other side of the equation means that the remaining 96.53% of Bitcoins are owned by the remain 4% of owners.
It’s not clear how many people actually own this vast amount of Bitcoin, but Bloomberg says that there are about 1,000 “whales” who control 40% of the market. From other research I have read, this 4% is estimated to be only a few hundred people. Even if we don’t know, either way you do the math you end up with a lot of people with $100+ million portfolios of Bitcoin.
Meanwhile, it’s the remaining $10 billion worth of Bitcoin being traded by “the masses”. Such scarcity of coins is most certainly adding to what has been driving the the price up, while a few hundred “whales” sit by watching, many of whom I have to think are grinning from ear to ear at what they’ve created. These were, for the most part, early investors/backers of Bitcoin, and include Winklevoss twins of Facebook fame. They are, not surprisingly, some of the loudest cheerleaders for Bitcoin and the other day predicted the price of Bitcoin could increase up to 20 times! They got kicked out of Facebook early on and presumably lost out on much of could have been, but so far at least they are getting their own back through the growth of Bitcoin.
The survey results
Broadly speaking, the results of my survey, which over 160 people in my world responded to, confirmed my hypothesis that the ownership and/or trading of Bitcoin is not currently broad-based.
65% of respondents said that they do not own Bitcoin or any cryptocurrency. Moreover, I have a sense that the survey may actually have proved more enticing for those who do already own Bitcoin than for those that don’t, and if that is true then the 65% might well be understated. Of those who don’t own any cryptocurrencies, the majority (60%) did not know how or where to buy a currency if they wanted to. And of the 35% who do currently own Bitcoin, myself included, most do not trade frequently.
What I did not ask in the survey was how big a bet, i.e., what percentage of a person’s net worth or investable assets, did the owners make into cryptocurrencies, but my guess would be that virtually all would answer that, like me, their investments are either quite small as a percentage of their net worths, and/or are relatively small in absolute dollar terms.
Applying some basic math to the above ownership statistics, if we take the $10 billion of Bitcoins owned by the masses, and knowing that something like 25% of Bitcoin trading takes place on San Francisco’s Coinbase (where I bought my Bitcoin), who as of November had 13.3 million customers, apparently now more accounts than the traditional online brokerage Charles Schwab, we get an average account size of only $200. Rough math, but indicative I believe, and I’m quite sure that Charles Schwab’s average account size is significantly larger.
So what conclusions do I make from the survey?
If we are to assume that the rally in the Bitcoin price is not broad-based, and if those involved in it have allocated relatively small amounts of money, then there is room, even significant room, for further price growth as more people get involved and allocate more and more fiat money to it.
So my bottom line conclusion is, with all things held constant (which only generally ever happens in theory, I should add), there is room for the price of Bitcoin to increase, and significantly, at least in dollar terms.
Assuming that all other factors are held constant (e.g., none of the above-identified “whales” do any significant selling which could no doubt have a significant impact on the price), this leads to the one question that everyone keeps asking.
Is Bitcoin in a bubble?
Bubbles come in all shapes and sizes and can also stick around for a long long time. Most, however, are short-lived, especially ones which make headlines with the frequency that Bitcoin currently does.
In my professional lifetime I have experienced, and participated in, a number of bubbles.
The first was the Russian stock market in the mid-nineties. I remember day after day telling my then girlfriend (now wife) how much my investment had gone up, and it was pretty much going up every day, although with not nearly as much volatility as Bitcoin has shown of late. But the feeling of euphoria and sense that it would simply keep going up was palpable.
Later in the same decade I also experienced a bubble, albeit on a smaller scale, in Azerbaijan where the government was issuing privatization vouchers which, in theory, were to be used to buy State-owned enterprises like SOCAR, the government-owned oil company. One big investment fund, backed by a now international fugitive (with whom I even accidently ended up at dinner with one evening in Baku), pumped millions of dollars into the market for the vouchers. This drove the price up very quickly and sucked in lots of speculators, myself included, with hopes of big profits. The government then changed their minds on what the vouchers would be used for and the price crashed.
I was left holding paper but even if the voucher been built using Blockchain, a perfect application for them, my digital wallet would have been just as empty. It’s hard to know who exactly out-witted (scammed) who on this one, but end result was a nice shift in wealth from the investment fund, backed by some high-profile US investors, to the citizens, including government officials, of Azerbaijan. The made out like bandits!
We all saw multiple bubbles in the mid-2000’s leading up to the 2008 crash, the most notable for me being the price of oil reaching almost $150, before crashing to $34 in the course of five months. Then came silver in 2011, when aggressive buying drove the price up to almost $50 an ounce quickly, only to see the price then drop even faster, by about 30% in less than half a year.
Many have already made comparisons of Bitcoin to tulip mania so I won’t go there other than as an introduction to the following well-publicized diagram which sets out how bubbles typically form and then deflate.
But this time it’s different… right?
In most bubbles, many people, usually those who are long the bubbling asset, come up with all kinds of reasons why this time it’s different and this is NOT a bubble, but rather a movement to a new norm. And time and again they are proved wrong when the bubble deflates.
So with Bitcoin, is this time really any different?
Yes, in my opinion this time it is different. And I’d say it is VERY different. The main difference is that, from what I can tell, it has essentially been the public, not the institutions who have been driving the recent price increases. I have been amazed at the lack of knowledge about Bitcoin (or even Blockchain) shown by the likes of senior hosts/commentators on CNBC and Bloomberg, as well as how Jamie Dimon simply dismissed Bitcoin as a fraud. The institutions have not been in it. Bitcoin enthusiasts tout this as an argument to why Bitcoin will really take off, claiming that the institutions will drive the price to $50,000 or more when they finally get involved.
So either this time we have either skipped the institutional phase or we assume that we’re still in the “smart money” phase, meaning that 35% of my network, based on my survey, can be classified as smart money guys?
Personally, I believe we are in the “public” phase (i.e., technology and the sharing economy have allowed us to skip the “institutional investors” stage) and that, in the case of Bitcoin, the institutions as we know them simply won’t get involved in any meaningful way.
First of all, the institutions are controlled by old guys who don’t want to accept this new technology or, in some cases, even bother to try to understand it. The status quo has served them well to date.
But secondly, they actually aren’t stupid and they know that there are essentially two types of Bitcoin owners: the original “whales”, and minnows like me. The institutions getting involved now will only serve to make the current two holder groups richer. And let’s be honest, the Wall Street fat cats don’t exactly have a reputation for allowing others to make out like bandits at their expense. Historically, it’s always been the big finance guys who have taken the rest of the world for a ride.
This time around what is different is that the institutions aren’t in the game – but it’s a bridge too far, in my view, to assume they will get involved and that they’ll get hoodwinked by the people (as much as I’d like to see that happen).
This leaves it to the public to perpetuate the price growth (or not), until what will no doubt be an eventual correction.
So, to answer the bubble question, yes, I believe Bitcoin is a bubble. But it’s one which might still have room to run if more people in my network, and their friends, etc, get involved and/or significantly increase their paltry allocations to Bitcoin.
I’ll even take my view one step further and say that if the bubble grows exponentially from today’s price before falling dramatically, Bitcoin’s reputation could be so tarnished that it becomes completely irrelevant (i.e., it will be the MySpace of the Internet version 1.0).
But what about fundamentals?
The value of Bitcoin is not based on any fundamentals. This is an argument which I have heard and read often enough, yet it is an argument I disagree with. The value of Bitcoin is absolutely based on fundamentals.
I have a history of working in the extractive industries of mining and oil and gas (i.e., raping the planet). It is an economic given that the marginal cost of production for a given commodity serves as a fundamental basis for the price of the commodity. We see this now in the US with the production of shale oil where the marginal cost to produce one barrel is something around $50, meaning that as long as the last barrel of oil required (demanded) by the market can be produced for say $50, and sold for a profit, then the floor price for the commodity will be about that, give or take fluctuations for short-term supply/demand and inefficiencies. Thus, the price of oil is based on a fundamental of the cost of its production. The price for gold, in general, works the same way and is why the price of gold can be said to keep up with inflation, since the price to produce it will increase with the general cost of materials, labour, etc.
The basis on which Bitcoin is produced, or mined, can therefore be tied to its price, at least as a floor, as the cost of its production. Because Bitcoin is mined by computers processing complex equations, the cost of the processors and the cost of the electricity and labour involved in the mining represents the fundamental base price of a Bitcoin. Each new Bitcoin takes longer to mine, and thus costs more to produce, so a form of inflation (due to the increased cost) and increasing scarcity is built into the system. Then there’s the fact that, according to the developer, there will never be more than 21 million Bitcoins ever mined.
I have tried to get a reasonable estimate of what it costs to produce a Bitcoin currently, but it seems to be a bit of a mystery of late, perhaps because most new Bitcoin is currently mined in China thanks to dodgy or simply sweetheart deals server farms have been able to strike with electricity producers. That said, it seems that not that long ago Bitcoins could be produced for something in the range of $500 each. Even allowing for an increased processing time and cost, it seems a stretch to say that the fundamental cost of producing a Bitcoin could be much more than $1,000. This is just a guess, but in some ways it may not even matter as fewer and fewer new Bitcoins are being produced now anyway. Therefore, the new supply from coins being mined going forward will not have a huge impact on the supply.
Does the value of Bitcoin even matter?
As my very smart friend, blogger and former colleague, Gagik Yeghiazarian, pointed out recently, we may be missing the point with all the questions about the price and “value” of Bitcoin. True Bitcoin enthusiasts will not actually care about the coin’s value versus any fiat currency like the US dollar. A true believer in a non government regulated currency would not care about simply getting rich off of Bitcoin, or any altcoin or ICO. Instead, they would see the coin as a store of value and as an eventual means to acquire goods or services that he or she wants or needs. I noticed this when speaking with an experienced Bitcoin trader and early investor who, when I asked him the value of his current Bitcoin holdings, had to think and compute the value in USD. He “thinks” in Bitcoin, not US dollars.
In theory, Bitcoin could, and maybe will, be a great mechanism for making payments, as it can be split up into pieces and transferred peer-to-peer much easier than large amounts of cash can (it’s bulky) or the centuries-old store of value – gold. Financial advisors I’m associated with advise clients to hold some portion of their investable assets (usually something around 5-10%) in physical gold. Some go so far as to say one should have multiple denominations of gold bars and coins so that, in a time of chaos or crisis, one can use smaller gold quantities to buy bread and other basic necessities (slicing up a 400-ounce gold bar, valued now at about $500,000 per bar, could prove annoying if one just needed to pay for dinner).
When will I be able to use Bitcoin as a currency?
Bitcoin can’t currently be used reliably to pay for things, except for maybe dinner in some odd-ball locations, primarily because of its volatility. Even places like Expedia or Amazon which accept Bitcoin must, I’m quite sure, immediately convert the Bitcoin to a currency. For a currency to have broad-based utility as a means of payment and store of value it must be stable in value. So long as it’s value is volatile, even if it’s going up, it will be viewed as a speculative asset held for profit. Thus, as my 17-year old son pointed out, Bitcoin is a digital asset, not a digital currency. His generation gets this stuff – pay attention.
Even the CEO of Coinbase, Brian Armstrong, said recently about the phenomenon, “It’s probably a little bit too focused on the price or people trying to make money.” He is passionate about digital currencies as a way to give the world an open financial system, not simply to make a quick buck (and can you see the irony in talking about making “a buck” on an asset class which meant to serve as a reliable alternative or even replacement to fiat money?). In short, greed has set in.
If and when the price of Bitcoin settles down, then maybe it can be used as a means of payment, but by then it will have lost its sex appeal. Bitcoin will, at that point, have been relegated to being a boring currency which can be used to buy bread, movie tickets or a house. There is a long way from here to there, largely in terms of the need for infrastructure, but most importantly for broad-based acceptance of the cryptocurrency as an accepted means of payment. I can absolutely see this happening, and sooner than later, but there are many other currencies out there now other than Bitcoin – and from what little research I’ve done, many are much more efficient than Bitcoin in terms of actually utility. Ultimately, it will be the one “boring” currency that sticks and manages to be used to settle transactions on a big scale which will survive.
So the message to those of us who really want to see cryptocurrencies replace fiat currencies would do better to work earnestly to find more and more ways to actually use the currencies. Once I can buy a Big Mac (not that I would) with a cryptocurrency which I don’t expect or worry will change in value significantly tomorrow, then I’ve got something in my crypto-wallet which I can actually use.
So what’s my bottom line in terms of a conclusion on Bitcoin?
First of all, let me be clear on my position – yes, it is a bubble. Although it could well have much much further to run, if you’ve made money on it, sell enough to get your original money back and then do whatever you want with what’s left – trade it, hold it, whatever.
Second, if you plan to buy Bitcoin, only buy an amount you’re ok to lose in full, because it might end up in the same place as my Azerbaijan privatization vouchers did.
Finally, there’s probably more money to be made actively trading Bitcoin than than just buying and holding it – plus a trader should be able, in theory, to get out in time when the crash comes (assuming the broker allows you to sell and/or doesn’t crash – in my experience, this is an issue). I am currently directing some money to a professionally-managed Bitcoin trading strategy, but under the principle of “it could all be lost”.
That’s my bottom line on Bitcoin. There are other coins out there which, I believe, warrant looking at in terms of their potential utility for actually making payments. That’s a different topic, but I will be putting some money to that space just to keep engaged and see how this takes hold. I do believe we are in the very early stages of a massive revolution in how the world thinks about money. Bitcoin has caught our attention but isn’t by any means the revolution.
Thanks to those who participated in my survey, and for taking the time to read this.