John Chatfeild-Roberts: No making sense of Bitcoin mania

Logic has no place in such a market and nor do serious investors

What does it mean for an asset, such as a currency, to have intrinsic value? From prehistory onwards, economies and trade were built on things that had undeniable utility: trading furs for iron, for example.

The invention of currency changed those dynamics, of course, but as long as the currency was backed by something – for example, gold reserves – then the whole system remained anchored on physical goods.

Since the end of the gold standard and the universal adoption of fiat currency – an event that is still bitterly lamented in some quarters – it is much harder to say on what a currency’s value is truly based.

What do investors make of the Bitcoin craze?

Alternatively, who determines that one pound sterling can be used as currency in your local supermarket, but a glass bead, fur pelt – or indeed a cryptocurrency – cannot?

“I promise to pay the bearer…”

The simplest answer is that a sovereign state decides. I have just taken a £10 note from my wallet (one of the new polymer ones, which still feel peculiar) and there I can see the Queen’s face, the signature of the chief cashier of the Bank of England and those authoritative words: “I promise to pay the bearer on demand the sum of ten pounds”.

How can we be certain that the Bank of England can fulfil that promise? Because it can just print more money if needed. We know there is a great deal of sterling already in issue and in recent years the Bank of England has created vast amounts more out of thin air through quantitative easing.

QE is sometimes described as “printing money”, but there are not sheets of notes coming out of printing presses to represent the QE money; it is all done electronically.

So what, the libertarians and cryptocurrency evangelists might ask, is the difference between the Bank of England conjuring electronic money out of nothing and the mining of a cryptocurrency?

Energy for what benefit?

There are several important differences. Perhaps most significantly, sterling is of universal value in the UK, because it is the only asset the UK government accepts in payment of taxes.

Anyone holding their entire wealth in glass beads, fur pelts or Bitcoin would frequently need to convert a meaningful percentage of that wealth into sterling to pay the taxman. That creates a large and reliable demand for sterling while simultaneously making any alternative currency extremely inconvenient to use.

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Secondly, the amount of time, effort and energy required to produce sterling is negligible. The same cannot be said of Bitcoin, which relies on high-powered computers solving complex mathematical problems in order
for its network to perform and
verify transactions.

It does so very slowly: reportedly the whole network can process at most seven transactions per second, compared to 24,000 per second for Visa’s network alone. It is also an extremely energy-intensive endeavour, so much so that some people estimate the global Bitcoin network consumes more energy than more than 150 countries, including Nigeria – a country of 186 million people with the 27th largest economy in the world.

If Bitcoin energy usage increases at the current rate, it is said it would equal the energy usage of the entire world by 2020.

Such growth is completely unsustainable. It is also extremely environmentally unfriendly, but if you are not the sort to be swayed by a green argument, then consider that everything has an opportunity cost.

The energy poured into operating the Bitcoin network acts as a drag on the world economy, and that millstone around our necks will
only get heavier as cryptocurrency usage grows.

And cryptocurrencies are proliferating at an alarming rate. According to a recent article in the Financial Times, there are 1,387 cryptocurrencies, 39 of which have a market cap of more than $1bn. This explosion seems self-defeating, given a key part of the appeal of cryptocurrencies is that the supply of each one is limited. If there are so many, that scarcity value disappears in a puff of smoke.

What is fair value?

Even among the true believers in Bitcoin, you will struggle to find much consensus of its “fair value” price, even to within an order of magnitude. I certainly do not claim to be a cryptocurrency expert, but as a long-time student of markets and investment I think I know a mania when I see one – and this has all the classic signs.

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Irrational exuberance has taken hold. The excitement for cryptocurrecies is at fever pitch and the market is being driven by the madness of crowds.

Just one example of the lack of rationality was when the Long Island Iced Tea Corp decided to change its focus from refreshing beverages to blockchain, changing its name to Long Blockchain Corp in the process. Its share price soared by 289 per cent.

Logic has no place in such a market and nor do serious investors. Wherever the price of Bitcoin finally settles is anyone’s guess, but from where I’m sitting, by far the most likely answer is zero.

John Chatfeild-Roberts is head of strategy for the Jupiter Independent Funds Team

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  1. All very well argued and probably correct … at least in the context of Bitcoin, which has dropped in price by some 60% since its peak in December 2017 (incidentally still up sevenfold on one year ago, though). True, people buying Bitcoin are obviously not buying the net present value of future cash flows, but they are making a bet on the future demand for it – which may not be entirely worthless. What might have more future relevance though is the underlying blockchain technology which, irrespective of opportunists like the Long Blockchain Corp, may well go on to pose a challenge to traditional structures (by the way, in the 1960s any company including “tronic” in its name carried a hefty premium as well).
    The pioneer (like Betamax) may fail, but associated companies such as Ripple, which is already shaking up the banking sector with its faster and cheaper payments transfer system might go on to revolutionise the sector. It may be unwise to rule these initiatives out completely, as crypto-sceptical hubris could one day be regretted.

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