Bitcoin, Blockchain, and Bubbles

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.