Bitcoin continues its slide, with prices now around $8,000. This is down from $12,000 just five days ago, and down from its historic high of almost $20,000 in December.
For some time now, I have privately and publicly shared my assessment of Bitcoin. In a LinkedIn post a month ago, I called cryptocurrencies «bubbles with fundamental values close to zero». And in a tweet two months ago, I said that «a similarly sad demise [bursting of the bubble] awaits #bitcoin«.
I have therefore as a fundamental investor avoided cryptocurrencies.
A year before the tulip #bubble burst, tulips were traded on formal exchanges around the Netherlands. There were even #futures markets for speculators. I am now in little doubt that a similarly sad demise awaits #bitcoin, but it’s difficult saying when.
— Gordon Lee (@GordonKJLee) 18 December 2017
Bitcoin’s intrinsic value
Thinking of Bitcoin (or cryptocurrencies in general) in terms of supply and demand leads to the conclusion that its intrinsic long term value is close to zero. I foresee long-term demand for any single cryptocurrency to be low, and the supply of cryptocurrencies in general to be high.
Demand-side analysis: What is Bitcoin good for?
In the longer term, it may be the case that traditional state-issued fiat currency incorporates technology now associated with cryptocurrencies. In particular, blockchain technology can help prevent fraud and potentially reduce transaction costs.
The benefits of private crypotocurrencies over this alternative is highly limited. You could possibly point to a higher degree of anonymity — but this is only of value to a small group engaging in illicit activities or who are highly protective of their privacy. And this anonymity is going to be eroded by Government regulation as has happened in Korea.
Supply-side analysis: Competing cryptocurrencies
The supply of Bitcoin is limited. Only 21 million will ever be created algorithmically (‘mined’).
But it is this limited supply that has contributed to Bitcoin’s rising price. Consequently, as in any market, the high price spurs competition. We now have Litecoin, Ethereum, Zcash, Dash, Ripple, Monero, and a whole host of cryptocurrencies. And many more cryptocurrencies are still being released through Initial Coin Offferings (ICOs).
Therefore in the longer term, the supply of cryptocurrencies can increase hugely in response to price rises (high price elasticity). The value of any single cryptocurrency is unlikely to be sustainably high.
But aren’t cryptocurrencies the future?
In the 1840s, enthralled by the new technology and captivated by the rise in prices of related stocks, speculators poured huge sums of money into new and existing railway companies. In a familiar story, new railway companies were being set up, funds were raised, and along the way some companies turned out to be fraudulent. Railways were indeed the future. But the economics of supply and demand still meant that their high prices during that period now known as Railway Mania were not justifiable or sustainable.
In the late 1990s, as the benefits of internet-based businesses became more apparent, speculators eagerly invested and drove prices up high and fast. Internet retail and other online businesses were indeed the future. But again as we know, the economics of supply and demand meant the dot-com bubble had to burst.
Cryptocurrencies may indeed be the future, but a reference to supply and demand analysis covered in the previous section would suggest that their prices are way above their fundamental values.
I am an adherent of fundamental investing. Before buying an asset, I aim to determine its intrinsic value in the belief that its price would tend towards its underlying value over the long term. Based on this principle, I expect the price of Bitcoin and other cyptocurrencies to fall close to zero. However, it is less obvious when this will happen. The recent collapse may be the beginning of the end, or perhaps just a short-term blip and the bubble may yet continue to grow.
By contrast, and to put it simply, others are speculators (who make instinctive or news-driven bets about prices) or technical investors (who study historic price patterns and trends to predict prices in the immediate future). It is possible to make money from cryptocurrencies through these methods — they are just simply not my style.
If you consider yourself a fundamental investor, and if you are tempted by Bitcoin and other cryptocurrencies because you think their long term outlook is favourable, stop and think again!
The opinions expressed are for information purposes only and do not constitute investment advice. Independent advice should be sought from a duly licensed professional where appropriate.