With the economy robust and the stock market soaring, the question of which I have received most frequently recently is... "should I invest in bitcoin?"!
The fact that this question is on the minds of so many people is, in and of itself, a big red flag. How many of them even understand what Bitcoin is, or how it works? I personally think that Bitcoin is headed towards a tremendous crash. My answers to these people are "No! Only if you want to play with and lose money."
Photo by Satheesh Sankaran, Creative Commons License
Bitcoin is not (yet) really a currency. Drug dealers love it. Virgin Galactic accepts it for rides into space. Bitcoin has natural advantages for all sorts of black market commerce. But Amazon does not accept it. My local grocery store does not accept it. No gas stations nor restaurants nor the huge majority of websites accept bitcoin. For something to work as a currency, crypto or otherwise, it must be accepted by almost everyone, and Bitcoin comes nowhere close.
Most of us sit on the fence, waiting to see which crypto-currency, if any, gains acceptance in the marketplace. Hundreds of them exist, of which bitcoin is simply the first and best known (but no longer the largest). So many kinks in the payments system, in record keeping and tax reporting, must be worked out, that I think it will be years before any crypto-currency gains wide acceptance.
Therefore, for the time being, bitcoin has no practical value. It is nothing more than an instrument of speculation. And I think we are experiencing a speculative bubble of similar magnitude to the Dutch tulip bulb craze of 1637. In that bubble, at its peak, otherwise sane individuals paid prices equivalent to the value of a large estate for one tulip bulb. They did so with the confident intent of selling it later and at a much higher price to an even greater fool than they. Bubbles like this develop a self-sustaining momentum of their own, and can reach absurd heights due to herd behavior, until one day, after the greatest fool of all has been discovered and exploited, they pop.
In an interesting book, "Manias, Panics and Crashes" (1978) Charles Kindleberger tried to identify the telltale signs of a speculative bubble. He was a serious economist, but these bubbles are surprisingly difficult to identify before they pop. Kindleberger studied the tulip bulb mania and others, and came to the following conclusions:
Bubbles occur during good economic times, when individuals feel optimistic about the future, and, crucially, lending is loose.
The objects of a bubble are often new and different - exotic even. Tulips were introduced to Holland from the Ottoman Empire in the 1590s. More recently, think of the dot com bubble, or junk-laden CDOs from the years leading up to 2008. These things were all new and different. No one of the time knew how to value them properly. In some cases, fraud was afoot.
Often, but not always, the objects of bubbles have no intrinsic value at all.
You can probably see where I am going with this. Bitcoin fits the model to a T. It has no intrinsic value (no currency does, come to think of it), and it is certainly new and different. It holds out the possibility of all sorts of new and interesting methods of commerce, making it very intriguing. I think that we are at a great economic point for a gigantic speculative bubble in something. Bitcoin looks like that thing. I wouldn't touch it with a ten-foot pole.
By the way, Bitcoin and its ilk threaten all governments. If universally accepted, they would remove from governments' hands control over their own economies. There would be no monetary policy and nothing for central banks to do. Fiscal policy would become irrelevant. Tax collection would become impossible. Stupendous wealth, far greater than anything which we have seen so far, would fall into the hands of very few people. I don't want to think about the social and global political implications of such a scenario. I'm a moderate man who appreciates order.
But I do like the idea of currency competition, much as it exists today between the dollar and the yen and the euro. If competition among alternative currencies developed inside the United States, for example, and did so peacefully, and if we figured out how to retain a role for our central bank to help keep markets calm, I can't speculate as to the changes which we would experience, but they might be great.