Michael J. Casey is chairman of CoinDesk’s advisory board and a senior advisor of blockchain research at MIT’s Digital Currency Initiative.
In this opinion piece, part of a weekly series of columns, Casey suggests that bitcoin’s price might be in a bubble and that curtailing the mania around it would be good for the technology’s future.
This is not “normal.”
Of course, not being normal is part of bitcoin’s appeal. Bitcoin has redefined money and created the hitherto non-existent concept of a scarce digital asset. It’s hard to hold it to the standards of “normal” assets.
But as someone who spent decades watching financial markets go through repeated patterns of exuberance and retrenchment, I’m quite uneasy with bitcoin’s latest runup. A 20% gain over the weekend left it up 60% over two weeks and up an eye-popping 900% year-to-date.
Record-breaking gains are irrelevant in isolation. The important question is “compared to what?” And the search for an apples-to-apples comparison is especially tricky for an asset class whose binary set of outcomes might lie in an all-or-nothing range of $0 to $1 million.
Cryptocurrencies don’t have any real precedent from which to establish benchmarks. That makes them hard to value.
But being hard to value doesn’t get us off the hook. Investors must at least try to assign numbers to the assets they buy. And any rational assessment of something’s value must, by definition, compare it to the value of something else. Value is an inherently relative concept.
Tulips… there, I said it
Here’s a value comparison worth thinking about.
Three long weeks ago, when bitcoin was only worth $7,000, Convoy Investments pointed out that, throughout history, the only other price performance for an asset class that exceeded bitcoin’s was the Netherlands’ infamous Tulip Mania of 1619-1622.
As most students of finance know, that one didn’t end so well.
Bitcoin compared to other bubbles. There is only one which surpasses it: the Dutch tulip mania.
The chart is from a newsletter from my long time friends at Convoy investments. If you’d like to subscribe, email them at firstname.lastname@example.org pic.twitter.com/ZdLSFXcvLn
— The Long View (@HayekAndKeynes) November 8, 2017
While it’s true that resorting to the Tulip Bubble analogy has been a somewhat hackneyed, knee-jerk tool for many bitcoin critics, I think the instinct among many bitcoin bulls to mock them for resorting to it is often similarly simplistic.
William Mallers did it last week in an impassioned rebuttal of financial blogger John Lothian’s criticism of the CME Group’s plan to introduce bitcoin futures.
The problem is that such rebuttals often resort to strawman portrayals of the critic as someone who misunderstands bitcoin’s far-reaching societal potential, as an ignoramus who thinks it’s as worthless as a tulip bulb. This misses the point.
The problem with the tulip bubble wasn’t that the tulip bulbs were worth nothing, it was that a cycle of mania, speculation and FOMO (fear of missing out) pushed their price far out of line with their realizable value. It’s not unreasonable to argue that a similar phenomenon is pushing bitcoin’s price far beyond what’s justified by its unproven potential, conceivably powerful as that might be.
In one of my very first articles on bitcoin four years ago, I too evoked the Tulip Bubble comparison as the BTC price was then topping $1,200. It turned out to be prescient, as the price shortly thereafter fell to around $200 and then took three years to regain the lost ground. But by then I didn’t care. Writing that column led me to explore cryptocurrencies more deeply.
I became a convert, wrote a book about bitcoin, and ultimately left The Wall Street Journal to join the Digital Currency Initiative at MIT’s Media Lab.
The point is that I’m not alluding to tulips out of Jamie Dimon-like ignorance. I believe, strongly, in cryptocurrency technology, and just as importantly, in its core promise of a superior, more robust and universally acceptable form of money.
It’s just that I also think it’s healthy to separate that inherently hard-to-quantify aspect of its fundamental value to humanity from the particular, fleeting, quantitative expression it finds in the market.
What worries me most is the cult-like mindset of the investor community, with its “to the moon” rallying cries and simplistic justifications for price performance.
The notion, for example, that bitcoin’s in-built scarcity will drive its price higher ad infinitum assumes it operates in some kind of detached vacuum. The ever-present prospect of software forks, while not technically adding to the supply of bitcoin core, points to a wide set of options for investors in the future.
If they find those options more appealing – and who’s to say a better idea won’t come along? – it will matter nothing that only 21 million coins will ever be produced. (For a brutal breakdown of other pro-BTC arguments, read this critique by the economist Constantin Gurgdiev, who, like me, is a believer in the underlying power of cryptocurrency technology.)
The problem I have with the immaturity of bitcoin’s investing culture is not that it’s setting the market up for a correction. It’s that it constrains progress toward attaining the technology’s more fundamental social value.
Speculation is unavoidable, even useful in bootstrapping innovation. But if bitcoin is to change billions of lives, it needs to become a more mainstream asset class, one that’s connected to the real world that those people occupy. As much as we might all love this quirky, abnormal “honeybadger of money,” bitcoin needs to become more normal.
It needs more stability. It needs a two-way market.
That two-way market is coming. And it will be brought to us by financial professionals, hordes of whom will be showing up at CoinDesk’s inaugural Consensus: Invest conference Tuesday. At the same time that venture capitalists and hedge funds are creating investment vehicles to take positive bets on bitcoin and other crypto assets, investment banks and exchanges are creating facilities that will allow other institutions to bet against it.
Futures in bitcoin’s future
The bitcoin bulls who’ve welcomed the CME Group’s plans to introduce bitcoin futures contracts before year-end as an easier way for institutional investors to invest in the sector might want to be more careful what they wish for.
The quarterly-ROI-obsessed fund managers who will trade these contracts share none of quasi-religious mindset of bitcoin HODLers. And now they have a tool, in the futures contracts themselves, with which to short the market.
If it makes sense to do so, they will gladly take actions that drive the price lower. Wall Street is pragmatic, self-interested and obsessed with its short-term bottom line. It doesn’t HODL.
To be sure, it’s not clear how much of an immediate impact futures trading will have on the spot market for bitcoin – the CME’s contracts will be cash-settled, which means that neither counterparty to a trade takes physical ownership of the underlying asset. Investors will merely treat the underlying bitcoin market as a reference.
But as the futures market gains liquidity, and as cross-market hedging strategies become more sophisticated, the futures price on the CME may well become a driver of spot market prices. With such an imbalance between the sizes of the institutional and retail markets, the tail could start wagging the dog.
Here’s the thing: This rite of passage is welcome. By lowering volatility, two-way institutional engagement will increase the impact that bitcoin can have on the world.
It’s an important step in fulfilling bitcoin’s purpose. But it also means the moon might have to wait.
Peter Pan image via Shutterstock
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