Bitcoin, Blockchain, and Bubbles

Ryan M Dec 19, 2017

Warning: Read on for an unpopular opinion…

Bitcoin is NOT a bubble.

Blockchain is NOT the future of everything.

For the record, I do think Bitcoin is a bubble but a dose of skepticism to the consensus opinion is always healthy, and that consensus goes like this:

‘Bitcoin is clearly a bubble but blockchain is the real deal and will change the world.’ 

When I hear this in the context of digital currencies and blockchain, which is always, it really makes me think of subconsciously hedging an opinion. The reality is that no one really knows where this industry and story is going to go but playing the probabilities and calling a bubble on Bitcoin but saying blockchain is the future is a way to be on the right side of history regardless of the outcome. Bitcoin crashes; you’re a genius. Bitcoin rises, well you still had that blockchain call to ensure you looked like you were on top of the cutting edge and knew what was going on.  It is a piece of commentary that is just starting to sound too common and a bit too easy to say.  So let's take a closer look at the unpopular opinions.

Bitcoin is not a bubble

Again, everything is pointing to this likely being a bubble. Of course, that does not mean it cannot double or triple before it pops. We have public companies that merely need to whisper Bitcoin in a press release and see share prices surge. We are seeing more and more public listings of companies whose operations revolve around digital currencies but have no cash flows let alone revenues. Bitcoin itself is making any modern day bubbles look like a joke in comparison. Perhaps the only thing that may indicate there is more gas left in the Bitcoin tank is that the broader investor base (retail and institutional) has yet to get into the currency in a big way (but this looks like it is starting to happen).

So maybe the price of Bitcoin is a bubble, but what if the idea of it being an asset class longer-term is not. Essentially, what if Bitcoin is the ‘gold of the future’, which is a store of value to protect against inflation and investment shocks? The idea that there will only be roughly 21 million Bitcoins in circulation (count is currently in the 16 million range) is intriguing, and only because it has already become the de-facto digital currency. In other words, the 21 million coin cap would not matter if no one cared, but because it already has a following, some sort of value on holding it has been intrinsically placed on the asset. This is very similar to the idea of gold in that a lot of the value is bestowed upon it simply because a large group of people have agreed it to be so, but this could be said about currencies in general. So long story short, the idea of Bitcoin being the store of value for those in the digital age is not unreasonable and maybe it is something we should not be so quick to write off. What I still have trouble wrapping my head around though, is what stops a new digital currency being created that supplants Bitcoin and in turn destroying the store of value argument? Store of value is one thing, but the actual value of Bitcoin is a bit different.

Valuing Bitcoin

I am the farthest thing from a Bitcoin expert but it is such a young industry, experts are few and far between. The intrinsic value of a Bitcoin is something that is particularly interesting though and unfortunately there still does not seem to be anything I have come across that seems to hold weight on valuing the currency. What is mostly cited is the idea that there will be 21 million Bitcoins out there, so even if X% of the population owns them, they would be worth $X. This reminds me of first year University business pitch competitions that went like this: 

Our widget/idea has an addressable market of X people. If we capture just 1% of the market, our business will be worth billions of dollars.

That is all well and good, but first, just because it is 1% total market penetration, does not mean it is easy. For context, Facebook which as we all know is a FREE social service ‘only’ has ~25% of the world population (its addressable market) as a monthly active user. It goes without saying that most businesses are not Facebook. Second, the product or service also needs to be in demand and economical. So essentially, the whole population demand argument is probably a weak one.

The idea that it is hard to value bitcoin (no cash flows, or fundamentals) may be what is adding to its growth. We can’t help but think of a scene from the show Silicon Valley where a tech startup is advised to not generate revenues because they can get a better valuation when no one has an idea what the company might actually be worth. Once they generate revenue, a valuation can be applied and that is viewed as a bad thing. We think it is the same idea for Bitcoin where since no one really knows how to value it, it garners a bubbly valuation because of the ‘potential’. 

So where Bitcoin goes from here remains a mystery, but once the dust settles, a real investment case may exist for a ‘digital gold’.

Blockchain is overrated

Again, full disclosure, I am far from a blockchain expert. I get the whole decentralized benefit and the idea of frictionless transactions that are harder or impossible to hack. The reason I think it is overrated is that everyone is so certain that Blockchain is the future while I am not sure that most people even know what it is or what it can do! Society is facing some life-changing innovations and for most of them it is easy to get behind them conceptually:

Self driving cars – Higher productivity, less stress, less gridlock/pollution, less accidents

Renewable energy – Sustainable energy sources, improved climate

Augmented reality – Changing the way we interact with the real world (I actually think this space does not get given enough credit for how much it could change the way everyone lives their lives)

Artificial intelligence – Robots/algorithms doing the hard work for us and likely doing it better than we can 

For any of the above ideas, a blanket statement on how these technologies will change our lives is easy to swallow because it is pretty clear. We still have no idea HOW it will change our lives but it is easy to see that it WILL in some shape or form. From what we have been reading, Blockchain will disrupt the way entire industries work and institutions are developing their own use of Blockchain. However, assuming that just because there are savings, it will get passed on to the customer or even implemented in a pure form is probably naïve.  From the perspective of security, I can see the value of blockchain technology. What is less clear, however, is how this is a life changing innovation, a brand new industry or even how long it will take for this technology to get implemented in a big way.

Anyone who has worked at a large institution can likely relate. Large companies firstly move very slow when updating technology. Their system infrastructure is also generally old and intertwined with many moving parts, that implementing disruptive technology takes years if it even gets done at all or in the form initially intended. Watching financial institutions adapt to the whole robo-advisor trend should be a great example of this. And one could argue that something like Blockchain would likely be even more disruptive to the core operations or processing within a business. So, just because it is disruptive, does not mean it will catch on. It is akin to the fact there are many great ideas out there that do not come to fruition. Just because it is a good idea is not always enough. There needs to be a solid business case behind something as well, and I am not sure I have heard of any developments yet that really make one do a double take (except for maybe cloud storage). 

The main question I continually come to is that for it to become something that is used throughout society, there likely needs to be a profit motive. However, one of the big selling points is that these networks are decentralized, i.e. no central authority controls or profits from it. These two aspects seem to be at odds with each other, at least at this stage. The other potential problem is that in a lot of cases, individuals want a central authority and they want someone to be accountable. If you lose a file in the cloud, you can e-mail the business and figure out what happened and yell at someone. If you lose it on the blockchain (regardless of likelihood), you are on your own and only you are to blame. Sometimes just having someone else to blame is a powerful incentive, and I am not so sure people will be quick to give up important documents, details, etc. to a blockchain network. But maybe I am just old and this is what people were saying when the internet was created! 

The one business case you often hear is that of real-estate and drastically cutting transaction fees and inefficiencies in the handover process. It sounds interesting, but back to the institution point, at least in Canada, it is likely a bit of a jump to think that the industry will let something like this happen quickly or in a big way. Regardless of all of the innovation out there, we can still largely only get data on what houses are for sale from a single website! 

So while I agree that there could be significant implications from blockchain technology, aside from blanket statements, I have yet to see a compelling argument for a specific use. There are a lot of great sounding ideas for blockchain and in the future, but just like it is early days for Bitcoin, I don’t think Blockchain deserves a free pass quite yet. The potential is more likely to be surfaced over a number of years, but it feels like everyone expects it to take over in a matter of weeks. 

13 comments

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Robert
Dec 31, 2017
Cyber currencies and blockchain technology seem set to upend business as usual over the next 20 years. I am sure we can not see what these will morph into over that time anymore than we could see what the internet is now as opposed to where it was in 1994. But I do believe we are on the fringe of something that will upend how business has been operating for the past few centuries. That is to say as intermediaries. The diluting factor of Bitcoin is the ability of any group to invent their own currency. The Achilles heel of en masse blockchain technology is hydro generation. It will be very interesting to see how this develops over the coming years.
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Fred
Dec 22, 2017
Some people, seem to have trouble getting their heads around the fact that Bitcoin exists entirely in "cyberspace". The have a problem visualizing it because they can't see it, touch it or pass it to the cashier at the supermarket. But when you think about it, that's not much different that what many of us are doing now. We pay by credit card - we never see physical currency. We pay the credit card on-line - we never see the currency. Yet money has been transferred. I have never passed actual currency for my membership in 5i yet I have benefited greatly from my membership. (and I have never passed actual cash to my on-line trading account). I personally, use very little actual currency but I still somehow manage to spend like crazy every month. Bitcoin may be quite different in many ways but in this, it's really not much different than how we live our financial lives now.
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ralph
Dec 22, 2017
Thanks for this comment. Quite informative. I get the Bitcoin issues but I'm still in the dark mostly about Blockchain. Is there a comment someplace around here that explains what blockchain is in words that I can understand? I kind of get the decentralized thing but is that akin to saying that my ISP being different to everyone elses ISP is part of a decentralized internet? I don't really understand how blockchain is functional for a business. Thanks
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Richard
Dec 20, 2017
I feel it should be noted that at no point in time has bitcoin been a more risky investment. Bitcoin cash is proclaiming to be the original bitcoin. No one is taking about it but bitcoin has 7 hard forks coming out this month alone. Total dilution of its coin count. One day someone from fast money will say they moved all their money to bitcoin cash since it closer resembles the original version with quick transactions and cheep transfer fees. They will say how bitcoin went from 21 million coins to over 168 million coins with these hard forks. The bubble will be burst much sooner then later.
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Elliott
Dec 20, 2017
Excellent! Very interesting perspectives. Glad to see more content like this on 5i. Well done Ryan!
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Michael
Dec 19, 2017
Quite a good discussion of blockchain and its shortcomings can be found here:

https://itunes.apple.com/ca/podcast/hidden-forces/id1205359334?mt=2&i=1000393560228

While the focus of the podcast is an arguably better technology called hashgraph, a lot can be learned about crypto based ledger systems.
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Marie
Dec 19, 2017
I am happy you decided to write more Ryan. You, Peter and Michael are exceptional writers. This goes in the vault of good reading!!
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Guy R.
Dec 19, 2017
Very usdful information. Thanks
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Richard
Dec 19, 2017
Dan good point and I don't see those being fixed soon either. There will be a double I have no doubt about. At the same time I wouldn't be surprised if it doesn't happen for a year. Lots of new tech going into some of the main coins. Lots of people still not invested. Think of the dot.com bubble. Every firm had holdings of tech. We aren't near there yet. I think there will be a real etf to trade like there is with gold. This allows everyone to partake in a easy fashion. It will get big profits then will crash and burn extremely hard 80 to 90%
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Dan
Dec 19, 2017
There are various shenanigans that are banned on real securities exchanges for good reason, but are standard in crypto:

wash trades — where you trade with yourself, to pump the price up or down, or just create the illusion of trading volume. You could literally do this in the Bitfinex trading engine quite recently.
spoofing — where you place a large order to create the illusion of market optimism or pessimism, and cancel as soon as the price gets anywhere near it. This is endemic on Bitfinex and Coinbase/GDAX.
painting the tape — like wash trading, but with two or more participants. Mark Karpelès admitted in court that he had been using the “Willybot” to pump up the Bitcoin price on the Mt. Gox exchange during the 2013 Bitcoin bubble.
front-running — where an exchange operator takes advantage of a buy or sell order before other customers can.
insiders with access to the database trading on their own exchange — Bitfinex officers trade on the exchange themselves. They state that they avoid conflicts of interest, but there is no oversight or transparency on this.
The US Commodities and Futures Trading Commission has listed many of these (PDF) as specific problems that are notably worse in the Bitcoin marketplace than in other markets:
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Fred
Dec 19, 2017
Two comments:
Firstly, your talk of more "Bitcoins" or cyber-currencies hitting the market is sort of like the 1800 when every bank had its own currency. You had to trust that the bank was solvent and wasn't going under or that something welse might happen. The central banks issued fiat currency and the monetary system became much more stable. Now, we have the same thing with cyber-currencies. How would we, the great unwashed, know which one to go with?
The advantage with Bitcoin or any other cyber-currency is that it takes out the middleman. And the middleman always takes a cut. Same with the government. They can't trace it so would lose the ability to tax it. You can be sure they will have a say.
I have read that Block-chain is horribly inefficient. I don't understand it but every transaction seems to requires a huge action behind the scene. The whole concept is fascinating and compelling but not ready for prime time. It needs to get much more efficient.


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Richard
Dec 19, 2017
Jeff. Bitcoin can be bought in any denomination. Since it's digital you can buy 0.0000000001 bitcoin if you wish. It's hard to spend at the moment as people are seeing it as an investment like gold. The fees to transfer it are high. You can trade it for something like litecoin. That's quicker to send and cheaper. Yet still not many retailers except it. They are working on tech that would allow an individual to use a tap service or swipe card that would essentially allow a person to pay in any digital currency being converted to fiat. The retailer just gets fiat and doesn't even know you spent crypto. It's both safer and not as safe. If I sent funds to a known address and they say they didn't get it I got like 18 verifications that they did. If I send it the wrong address though it's pretty much lost for good. No tied party to look into it and get my money back. People say it's unsafe because of hacks. This is untrue. It's the exchanges that are holding their crypto that are unsafe. All digital funds should be held in a paper wallet or cold storage.
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JEFF
Dec 19, 2017
Thanks for the above commentary.
I really cannot figure out what the bitcoin really is. Is it an actual coin that you spend? Are there different denominations? Are there physical pieces? How do you spend/use them?

Is blockchain just a different type of digital technology? How is it different? Why is it safer then what we have now? How is it better then what we have now other then the perceived safety?