Another Bitcoin Bubble?

Bitcoin and other cryptocurrencies are back in the news this month as prices have doubled. Regular people should be wary of another Bitcoin bubble.

Bitcoin is Not Digital Gold

Many in the crypto community have latched onto the Bitcoin is a Digital Store of Value argument, something I first heard about from famed investor and Bitcoin bull Michael Novogratz. This is likely because there is yet to be an actual use case for blockchain technology at scale. Despite having filed the most patents of any US Bank, Bank of America CTO Cathy Bessant recently stated:

“I haven’t seen one [use case] that even scales beyond an individual or a small set of transactions,” Bessant said. “All of the big tech companies will come and say ‘blockchain, blockchain, blockchain.’ I say, ‘Show me the use case. You bring me the use case and I’ll try it’.”

Cathy Bessant, chief operations and technology officer for Bank of America Corp.

Let’s go over some of the features and arguments for crypto to determine if we are in another Bitcoin bubble.

Security

Proponents claim that Bitcoin is secure. I get that the algorithms underlying it are secure to an arbitrary level of security. But everything digital is subject to a hack somehow. We all thought WhatsApp encryption was impenetrable. As it turns out, if you lock all of your doors, bad people will simply come in through the pipes. In the case of WhatsApp, spyware was installed on people’s phones without their knowledge that let hackers spy on their phone’s activity, including Whatsapp.

Bitcoin bulls will say that gold can also be stolen, which is correct. However, unless you forget where you store it or don’t care to check on it from time to time, you are 100% assured of always being able to find out if it is still there. Unless you can rank with the finest developers in the world, you may not even know when your digital assets have been hacked. If you want to learn more, Bitcoin Exchange Guide has published a list of all of the Bitcoin hacks and scams out there.

Borderless & Unconfiscatable

Nothing is beyond confiscation or borderless. As long as you live in the physical world, as long as you interact with other humans, as long as you have families and friends, a power greater than you (usually governments) will have more firepower than you. You may be the only person to hold onto your private key, but when the cavalry shows up at your door, I am willing to bet you turn it over. Ok, so maybe you move from your home country to another one? Virtually every country in the world is now connected to each other. Or you can go into hiding from big bad governments everywhere? Would you like to go live in Venezuela, where anti-American sentiment is high? Is that a solution at scale? If you have a family, go ask them what they think about that plan.

Investment in the Space is Growing

Pitchbook, via Retuters, recently published data on corporate and venture capital investment in blockchain and crypto technology. The numbers are impressive and growing.

Interestingly, much of that investment is in infrastructure, so-called crypto “plumbing”. That’s an important distinction. Principles of crypto can be applied to upgrade and secure the core cloud infrastructure of the internet. It can be applied to fundamentally rethink business models in lower trust-intensive arenas like gaming, media, and parts of financial services. Just like the world has been changed by the intersection of mobile, social, and cloud technologies, crypto has the opportunity to help shape the next wave of innovation, perhaps in conjunction with Artificial Intelligence and AR/VR.

But this is very different from saying that bitcoin will become the new default global currency or even a true store of value.

The fundamental premise of a store of value is that human beings cannot make more of it. No matter the so-called rules of a cryptocurrency asset, some individual or group can always change the rules. For example, even if you corner the market on gold or silver, you cannot make more it. You cannot change the currently known laws of physics. If you corner a cryptocurrency, you can always change the code to issue more.

A Good Mental Model: Who is Involved

When you’ve seen a few market cycles in your adult life (currently requiring that you are about 40+), you develop a few mental models. One that I like to rely on is to assess who is involved. No question, top-tier companies, investors, and individuals are working on legitimate blockchain/crypto projects and businesses. However, the bitcoin world is also littered with con artists, promoters, and C players. Their preferred methods are reminiscent of the pump and dump penny stock operators. I am willing to bet most of them couldn’t explain to you the building blocks of crypto, namely Cryptography, Distributed Computing, and Mechanism Design.

Recently, one of the leading personalities in the crypto investing space, someone with a legitimate background in tech product development, posted the following tweet:

Amazon went public 22 years ago today. A $1k investment would be worth $1.2M today. Bitcoin is only 10 years old. A $1k investment would be worth $2.6 BILLION today.

The tweet, sent to this person’s >200k audience was retweeted over 2,000 times, liked over 6,000 times, and elicited over 200 comments. The absurdity of it hasn’t ceased to amaze me. It’s a classic apples v. oranges comparison to make a point that is not true. The right comparison is when one could reasonably invest in Amazon, their seed round (not it’s IPO), and when one could reasonably invest in Bitcoin (when Mt. Gox came online).

• A $1k investment in the seed round of Amazon would be worth well above $140M today
• A $1k investment from July 17, 2010, when the well known Mt. Gox exchange came online, would be worth well over $160M today, per https://dqydj.com/.

Both of those are amazing outcomes. But a far cry from the 2166x return differential implied by this tweet. As they say, never let the facts get in the way of a good story. Feels like a Bitcoin bubble to me!

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Any opinions or forecasts contained herein reflect the personal and subjective judgments and assumptions of the author only. There can be no assurance that developments will transpire as forecasted and actual results will be different. The accuracy of data is not guaranteed but represents the author’s best judgment and can be derived from a variety of sources. The information is subject to change at any time without notice.