Which is the worse way to gamble away your money? Beanie Babies or Bitcoin? I’m leaning towards Bitcoin. At least when both hit bottom, your 1-year old can still have fun chewing up the plush toy. Bitcoin design by David McBee, CC0
On Saturday, the Washington Post ran a morally troubling article that discussed people in Kentucky rushing to buy Bitcoins in hopes of cashing in on cryptocurrency mania. I’ve ignored Bitcoin from the start and refused to buy into it. Don’t get me wrong, I agree that the blockchain technology is of value to society. But Bitcoin itself is a false prophet in all of its forms: as a form of currency, a place to store value, and as a place to invest.
What is an Investment, and Why is Bitcoin Not One?
Investing is the act of putting money into a business or venture that offers profitable returns and reasonable safety of the invested money. If you buy a share of Wal-Mart stock, you’re investing. Was-Mart is an established company that has proven that it can retail goods to customers and turn a profit. Investments produce goods or services, pay dividends, and leave both the investors as well as the customers better off. Investing is a positive-sum game. The players involved with investing end up with a greater value of goods and services and money than they started with. Even if Wal-Mart fails, the value of its real estate and unsold goods still have tangible value.
Bitcoin cannot say this. Bitcoin is not a company, it has no tangible goods or patents or property. It’s not even real. It’s simply electrons flowing through computers. Bitcoin is not backed by the taxing authority of a government. It does not have any intrinsic value. It offers no promise or even a hint of what its value will be tomorrow. A Bitcoin doesn’t produce anything of value – no tangible goods or services or dividends or anything. The only reason Bitcoin has value is because people are willing to pay money to buy the limited supply of them. Once people stop paying into the system, the value evaporates.
Bitcoin as a Negative-Sum Game
Bitcoin is a negative-sum game. A negative-sum game is a situation in which the total gains and losses are less than zero, meaning the players as a whole lose money.
Let’s look at a hypothetical three-person Bitcoin economy consisting of Person A, B, and C. If Person B wants to buy $100 worth of Bitcoin, he has to pay cash to a seller, Person A, to buy Person A’s coins. Afterwards, Person B has Bitcoin and Person A has cash. The first problem is that they had to go through an exchange to do the trade. Person B may end up with $99 worth of Bitcoin after the $1 trading fee. As the Washington Post article above points out, Person B in Kentucky is now hoping to sell his $99 worth of Bitcoin to Person C at a higher price and make a profit. But Person C is only willing to pay $80 for Person B’s Bitcoin. The trade occurs, Person B takes a $20 loss off his original $100 investment, and Person C now has $78 worth of Bitcoin after paying a $1 exchange fee. Person C also hopes to sell his Bitcoin for a profit. The three-person Bitcoin economy is worth less than it started with due to exchange fees. During the course of the economic activity, the Bitcoins produced no additional value or dividends or any other gains. But here comes the real trouble for all the person C’s in Kentucky.
Musical Chairs
Just like every other speculative investment frenzy that has come and gone, whether it be tulip bulbs, 1990’s tech stocks, Beanie Babies, or $800,000 condos in Nevada, the music eventually stops and someone is left without a chair. One only has to look at a supply and demand curve to see the problem.
Graph from Quora.
The reason Bitcoin will crash is that there are only a limited number of people willing to pay cash for cryptocurrency and an unlimited number of people willing to supply new cryptocurrencies. Gold maintains its value because of its limited supply and uses in electronics and jewelry. Bitcoin promises to limit the number of coins in circulation to keep the value from being inflated away. However, this won’t stop new cryptocurrency alchemists from entering the market.
As new currencies are endlessly invented by coders looking to cash in on the money train, the Person D’s out there that Person C is hoping to sell his $78 worth of Bitcoin to is leaving the Bitcoin economy, gambling his money on cheaper currencies elsewhere. As Person D’s leave Bitcoin in search of easier gambling elsewhere, the value of Person C’s Bitcoins slides towards zero. All this will occur even without government or financial market intervention, which is already battering Bitcoin’s value.
Get Out While You Can
In every speculative frenzy, there are some lucky early adopters who make out like bandits. But don’t be the Person D who enters late in the game and gets left without a chair when the music stops. If you want to play with a small sum of money that you can afford to lose, cool, do that if it is a fun hobby and learning experience. But don’t gamble your pension or your rent money on a sinking ship. At least if you spend thousands of dollars on a Beanie Baby, a stitched, cute animal-shaped bag of pellets, your kid can still enjoy it when you realize it’s value is zero.
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