Today I saw a smart young man in a brand new VW Golf. ‘I mine bitcoins for profit – let me show you how’ said the sticker on the side.
Bitcoin is everywhere. There’s no escaping it: there are adverts on my mobile phone, on my computer, in magazines, and even flyers in my post-box. Everyone’s getting rich on bitcoins, except me it seems.
Recently, we presented the basics of personal finance to Grade 7 pupils at a local primary school. In each of the four classes we were asked about bitcoin during the Q&A session. These 12- and 13-year-old children had no doubt learned of the riches to be made around the family braai or dinner table, but it’s hardly surprising that the topic had filtered all the way through to them: the return from trough to peak last year was a staggering 1 750%, a mythical ten-bagger.
It is a truism that by the time an investment is widely discussed in suburbia most of the return has already been made. We buy anyway because the price is still going up and we want some of the action that everyone else is enjoying.
The fear of missing out is mixed with a touch of greed and a sprinkle of excitement – the perfect recipe for speculation.
What is bitcoin? It is a cryptocurrency, a virtual currency that exists within a secure, very complex, numerical framework. Bitcoins may be purchased for cash on various trading platforms. Owners possess an encrypted security code or key in a virtual wallet on their computer or mobile phone. Transferring ownership of the key between virtual wallets also transfers the value of the bitcoin. The key is sufficiently complex for it to be, for all intents and purposes, not decodable by a third party. Bitcoin is a secure, anonymous, global, and unregulated means of facilitating trade.
There are drawbacks. It takes more than ten minutes for a transaction to be processed, so it’s not convenient for buying groceries, and a transaction is irreversible once confirmed, so you won’t get your money back if your purchase disappoints. Your bitcoin key can also be stolen if your virtual wallet is hacked via some phishing trickery or if you fall foul of one of many sophisticated fraudulent online trading or exchange scams.
The one thing that bitcoin is really good for is illicit trade and money laundering. It provides anonymity for nefarious activities across political borders. Although it has been around since 2008, bitcoin came to general public awareness only in 2013, when the FBI closed down Silk Road, an internet platform where guns, illegal drugs, and stolen credit card details could be bought without consequence. The currency of choice in this dark web was bitcoin.
Perhaps the strongest argument for caution is that although bitcoin purports to be a currency, it trades like an investment. Its volatility is emphatic evidence of this. A currency is a stable means of facilitating the buying and selling of goods and services, and its value should not vary unpredictably between the time of sale and the time that the seller uses the proceeds to buy something else.
But bitcoin is not an investment, either. It has no measurable fundamental value, no dividend, no inherent intellectual property, no earnings, and no tangible assets.
There are no financial metrics to reference its value against. There is no management, no governance, and no regulatory oversight.
The only case that could possibly be made for buying bitcoin is that it is a scarce, tradable entity supported by an underlying demand for illegal activity. There are nearly 17 million bitcoins in circulation now, and a maximum of 21 million will be available by the year 2040. However, several other virtual currencies are emerging to compete with bitcoin, so scarcity may not be one of its long-term features.
The total value of available bitcoins is US$200 billion at a unit price of US$12 000. This is the size of Coca-Cola, Toyota, or Verizon. It is significant, but it is not huge. Global equity markets have a capitalisation of around US$100 trillion, so bitcoin may be seen as a 0.2% holding within this investable universe.
Unless you want to purchase an AK47 or a few ounces of cocaine online, you are probably buying a bitcoin because you believe that you will be able to sell it to someone else for more than you paid for it. The Economist calls this The Greater Fool Theory.
This is not investing, it is gambling. As long as you understand the difference, then you can have fun trading bitcoins, but remember that, just as you wouldn’t take your pension savings to the casino, don’t bet money you can’t afford to lose on bitcoin. Remember, also, that its continued attraction relies on the evangelical efforts of people such as my young man in his new car.
Bitcoin is a faith-based currency.