Is Bitcoin a Massive Opportunity or a Massive Bubble?

It is imprudent to allow your emotions and politics dictate your investment choices.

Discussions about Bitcoin — or crypto-"currencies" in general — are frequently fraught with strong emotions. That fact alone is reason for my skepticism. Strong emotions almost usually work against you when it comes to investing. And when it comes to Bitcoin, it's about more than feelings. At times, one gets the impression that arguments are being stated with almost holy zeal. There does not appear to be much opportunity for nuance or critical analysis. Nonetheless, allow me to attempt.

Bitcoin proponents frequently express strong opposition to today's dominant monetary system, which they describe to as "paper money" or "fiat money." When they refer to fiat money, they are referring to a medium of exchange (currency) that lacks intrinsic value and is not connected to the price of a commodity, such as gold. That criticism of fiat money has become an issue at all today is a result of the practices pursued by state-sponsored central banks worldwide, which have grown increasingly reckless in recent years, particularly since the financial crisis.

Since 2009, the money supply has been dramatically extended through the printing of increasing amounts of money. Numerous government bonds, such as those issued by the German government, have negative interest rates, which means that investors, rather than gaining money by lending to the government, are actually paying for the privilege when they purchase bonds.

Critics fear that this will result in increased inflation, if not hyperinflation. While inflation has increased modestly in recent months, the high inflation predicted by opponents since 2008 has not materialized. Rather than that, all asset classes have increased in value, particularly government bonds and real estate, but also securities. Critics of expansionary central bank policies are justified in their fear that this would never end nicely. As a result, some have resorted to gold as a hedge against the possibility of another financial crisis.

However, you may be wondering what this has to do with Bitcoin and other crypto-"currencies"? The critique of fiat currency is not new. Almost half a century ago, economist and Nobel laureate Friedrich August von Hayek criticized the paper money system and urged for the removal of the government's monopoly on money in his 1975 speech "Choice in Currency." He contended that everyone should be allowed to give commodities that others may wish to demand in exchange for money. He reasoned that it should no longer be the exclusive province of the state to generate money, but that everyone should be permitted to offer their own kind of money. And, as is customary in a free market economy, he was certain that the best currency will prevail via the natural process of competition.

Bitcoin and kindred crypto-"currencies" are viewed by proponents as the practical realization of Hayek's principles of private money. However, is Bitcoin truly a "currency?" Money and individual currencies perform a range of tasks, the most important of which are to act as a store of value and a medium of exchange. Bitcoin is incompatible with both. Given Bitcoin's enormous price volatility, it is absolutely unsuited as a store of value. And Bitcoin is only accepted as a form of payment in extremely rare circumstances. It may have a place in organized crime, but not in everyday commerce. Elon Musk recently claimed that he will accept Bitcoin payments for Tesla vehicles, however it is unclear whether this will ever happen. Thus, the phrase "crypto-currency" is technically incorrect and should be preceded by inverted commas, as it is not a currency.

To the majority of crypto-"currency" investors, crypto-"currencies" are just speculative. They purchase a crypto-"currency" in the assumption that prices will climb and they would earn a healthy profit, which was previously feasible. Investors who entered at the proper time gained multiples of their initial investment. However, the chance of making a large profit does not define a crypto-"currency" as a "investment" in and of itself. It is also feasible to rake it in at a casino, but no one would ever refer to a casino wager as a "investment."

Bitcoin critics point out that the last few centuries have been rife with speculative bubbles—all of which eventually burst. They are reminiscent of the 1630s Dutch "tulip frenzy," during which the bulbs of specific varieties of tulip were objects of speculation. In certain situations, the prices of single bulbs were comparable to those paid for Amsterdam's most expensive homes. As is the case with all bubbles, the tulip bubble eventually burst—exactly what Bitcoin opponents are now fearful of.

However, even historically solid or well-established financial assets, such as stocks or real estate, can turn speculative. I'm sure we all recall the rising prices paid for houses in the early 2000s in the United States and certain cities and regions of Europe—at least until the bubble burst. Another recent example is the stock market's Dotcom Bubble in the mid- to late-1990s. The development of a bubble around a particular asset does not, however, imply that the item itself is fundamentally flawed.

Nonetheless, I am always dubious when anything becomes "fashionable" and suddenly, everyone is urging you that you must invest immediately. That truly throws off my alarm bells. I did not become wealthy by engaging in "fashionable" activities—I have always invested in assets that left others scratching their heads. Later, when investing in these assets became fashionable—for example, real estate in my hometown of Berlin—I sold.

In terms of crypto-"currencies," German financial market specialist Gerd Kommer makes an excellent point: "Numerous private investors have failed to grasp the fact that crypto-currencies can be used as a method of payment or as a medium of exchange, but not both at the same time. If crypto-currencies do become what they were intended to be but have not yet achieved, namely real currencies that can be used for more than a handful of transactions rather than being used for speculation and gambling, as they have been, their expected inflation-adjusted return will fall to near zero, as is the case with all currencies."

Unlike equities and real estate, which normally earn dividends or rental yields, bitcoin does not create any income. As a result, calculating the intrinsic worth of Bitcoin with any degree of accuracy is difficult. Bitcoin proponents dispute to this claim, pointing out that this is a quality shared by Bitcoin and gold, which similarly produces no income. While this is accurate, the parallel is flawed: Bitcoin has been existing for twelve years, but the first indication of gold being used as a means of payment dates all the way back to the tablets carrying the Babylonian ruler Hammurabi's code of laws, 1,870 years before Christ's birth. Gold was used as money in China 1,100 years before Christ's birth, in the shape of little cubes.

And such traditions are significant: One of the most significant insights provided by the aforementioned economist von Hayek is the recognition that well-functioning institutions arise "not through contrivance or design, but through the survival of the successful," with the selection process operating "through imitation of successful institutions and habits." For thousands of years, gold has passed this test. It remains to be seen whether any of the existing crypto-"currencies" will ever survive and grow through this process of "imitation."

I've saved the most critical piece of advice for last: if you're considering an investment, you should rid yourself of your ideological views, just as you would before handing in your coat at a cloakroom. Personally, I've been interested in politics my entire life and have extremely strong political views. For instance, I am attracted to a variety of libertarian positions—but I put these sympathies aside when weighing the advantages and cons of a particular investment.

Nonetheless, I frequently engage in discussions with others who share my political values and who base their financial methods on those beliefs. They make several compelling arguments against paper money (fiat money) and then recommend that you invest in crypto-"currencies." The majority of people who believe this way have strong political views but have never made a lot of money as investors. Political convictions are frequently inextricably related to powerful emotions—and it is precisely these strong emotions that have no place in the investment world.

** Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. You should do your own thorough research before making any investment decisions. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of USA GAG nor its advertisers. The author will not be held responsible for information that is found at the end of links posted on this page.

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