This column has been updated from Sep. 16 to discuss Bitcoin's October rally.
It's hard to think of an investment that's been as deeply polarizing as Bitcoin has become as of late. And that polarization probably has much to do with the cryptocurrency's recent volatility. After a September selloff during which prices fell over 30%, Bitcoin has now risen over 50% to new highs, and is up more than 700% over the past 12 months.
The debate over Bitcoin is noteworthy not just in terms of how many passionate bulls and bears it has produced, but in terms of how many very smart people can be found in both camps. Among the bulls, one can find big-name fund managers such as Bill Gross, Mike Novogratz and Kyle Bass, as well as quite a few venture capitalists. Bears include Jamie Dimon, Howard Marks and Mohamed El-Erian, among many others.
What makes the debate so unique and head-scratching is that Bitcoin's value, unlike that of stocks, bonds, commodities or traditional currencies, isn't linked to measurable financial or economic phenomena. Stocks are valued on a company's existing assets and expected future cash flows; commodity prices are driven by supply and demand for the underlying commodity; currency values are driven by by money supply and demand changes, which in turn are impacted by things like GDP growth, interest rates and trade balances.
But Bitcoin? Outside of some limited use as a means to buy goods and services, Bitcoin's $61 billion market cap is linked to the perception of value. That is, Bitcoin is bid up out of a belief that others think it's worth something too, or will be in the future, even if (unlike traditional currencies) there isn't much demand for using it to buy things.
As others have pointed out, Bitcoin -- and for that matter other cryptocurrencies -- in this respect has much in common with precious metals such as gold and silver. But aside from the fact that precious metals also have industrial and jewelry use cases, the big difference is that gold and silver have been established for thousands of years as stores of value across numerous civilizations. Bitcoin is fighting for that same status, and depending on how confident one is in its ability to achieve it, it can look like a giant bubble or (even now) very underpriced. In that sense, Bitcoin isn't as much like precious metals as it is a bet that something will be looked upon like a precious metal in the coming years.
And certainly, the bet could still have a big long-term payoff. If millions of people were to wake up tomorrow and decide that Bitcoin is just as worthwhile a place to park their money as gold (estimated $7.5 trillion in circulation), its price would skyrocket. Analyst Thomas Lee, who this summer predicted Bitcoin (currently priced around $5,200) could be worth $20,000 to $55,000 by 2022 as cryptocurrencies "[cannibalize] demand for gold," seems to be expecting such a phenomenon to play out over a lengthier period of time. And so do a lot of other bulls, with many of them arguing that Bitcoin's security, global accessibility and fixed supply growth make it a better store of value than gold.
On the other hand, if Bitcoin fails to obtain many new converts and a lot of existing supporters lose faith, prices would nosedive. A lot of skeptics see just this scenario playing out. Marks, who deems Bitcoin "an unfounded fad (or perhaps even a pyramid scheme), based on a willingness to ascribe value to something that has little or none beyond what people will pay for it," is one good example. Likewise, NYU finance professor Aswath Damodaran suggests that unless Bitcoin becomes widely used to conduct transactions, it's just "a lucrative, but dangerous, pricing game with no good ending."
Dimon, who sees little need to use Bitcoin to buy/sell items in countries with stable, well-supported currencies and thus thinks the current frenzy is like the Dutch tulip bubble, is thinking along the same lines. He also cites the potential for fresh government crackdowns as cryptocurrencies are used more for illicit activities. Bitcoin was hammered in September after the Chinese government moved to ban initial coin offerings (ICOs), and Chinese regulators are reportedly planning to shut down local cryptocurrency exchanges.
Hey Dimon, Kiss Legend Gene Simmons digs Bitcoin.
Since Bitcoin's future prices depend so much on future perceptions rather than anything more concrete -- like, say, iPhone X sales or Chinese oil demand -- I'm hesitant to declare with strong certainy exactly where Bitcoin is headed. But I do think that much of what's going on in the cryptocurrency realm right now has a lot in common with past speculative frenzies, and should give pause to anyone thinking about getting in.
Perhaps the biggest red flag: It's not just one or two cryptocurrencies that have soared, but a legion of them. There are now nine different cryptocurrencies with $1 billion-plus market caps, and several more with $500 million-plus market caps. And altogether, there are 50 cryptocurrencies, including ones with names such as Byteball, Stellar Lumens and MaidSafeCoin, with $100 million-plus market caps.
This brings to mind how nearly any company with a dotcom at the end of its name blasted off during the 1999-2000 tech bubble. Even if one believes Bitcoin and No. 2 cryptocurrency Ethereum have bright futures, it's hard to see a dozen being looked upon as stores of value.
Also worrying: The billions that have been raised in ICOs, in which companies raise money by selling "tokens" (paid for using Bitcoin or Ethereum) in brand-new cryptocurrencies. The tokens don't give "investors" any shares, merely access to goods and services (often of the digital variety) that the new cryptocurrency supports. Though some have focused on the rise of ICO scams, many of the legal deals, which provide tokens that can be used for things such as in-game purchases and online betting, are worrisome in their own right.
Then there's the anecdotal evidence suggesting much of the recent mania is driven by speculation from latecomers who aren't exactly well0versed in the nuances of blockchains and distributed ledgers. One only has to look at the degree to which activity on Reddit threads and Facebook groups related to Bitcoin and other cryptocurrencies has swelled to get some idea.
None of this means Bitcoin won't live up to the hopes of bulls in time. If Bitcoin is eventually viewed on a large scale as "digital gold," then buying today might very be like buying Amazon in the midst of the dotcom bubble, when shares (though having soared) were still generally trading at less than one-tenth of current levels.
Nonetheless, those who bought Amazon back then and saw shares drop over 90% during the bubble's bursting probably wish that they waited a little longer.
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