Billionaire investor (and self-professed "Bitcoin Dinosaur") Howard Marks made headlines in July when he called Bitcoin a "unfounded fad.. a pyramid scheme" in one of his famous memos, igniting a firestorm of backlash from cryptocurrency advocates.
There has been particularly spirited response to my comments on digital currencies. It prompted me to sit down with people ranging from some of my Oaktree colleagues to Steven Bregman and Murray Stahl of Horizon Kinetics (my July memo incorporated some of Steven’s observations on ETFs), and I learned that I’ve been looking at Bitcoin the wrong way. In particular, I realized that the memo incorporated the wrong joke from my father; instead of “the half-million-dollar hamster,” it should have been this one:
Two friends meet in the street, and Jim tells Sue he has some great sardines for sale.
The fish are pedigreed and pure-bred, with full papers and high IQs. They were individually de-boned by hand and packed in the purest virgin olive oil. And the label was painted by a world-renowned artist.
Sue says, “That sounds great. I could use a tin. How much are they?” and Jim tells her they’re $10,000.
Sue responds, “That’s crazy, who would eat $10,000 sardines?”
“Oh,” says Jim, “these aren’t eating sardines; these are trading sardines.”
I had been thinking about digital currencies like Bitcoin as investing sardines, and that may have been a mistake. Their fans tell me they’re spending sardines, and while that may be the case, I think at the moment they’re being treated largely as trading sardines. The question remains open as to whether Bitcoin is (a) a currency, (b) a payment mechanism, (c) an asset class, or (d) a medium for speculation.
The main complaint expressed in my memo was as follows:
Serious investing consists of buying things because the price is attractive relative to intrinsic value. Speculation, on the other hand, occurs when people buy something without any consideration of its underlying value or the appropriateness of its price, solely because they think others will pay more for it in the future.
In the memo I talked about Bitcoin as an investment asset that should have a value that can be appraised. While its fans tell me this isn’t the right way to view it, I note that in their February “Bitcoin Review,” even Steven and Murray called it “a new asset class.” I think this is the weakest claim being made about Bitcoin. As I said in the memo, “it’s not real” – there is no intrinsic value behind it.
What Bitcoin partisans have told me subsequently is that Bitcoin should be thought of as a currency – a medium of exchange – not an investment asset. Given that the evolution of Bitcoin is so topical, I think further discussion is in order. To start, I’m going to present the case for it as a currency. What are the characteristics of a currency?
- Most importantly, it’s something that people agree can be used as legal tender (to buy things and pay debts), used as a store of value, and exchanged for other currencies.
- Currencies generally are created by governments. However, there have been exceptions: banks issued their own currencies in our nation’s first century, and it can be argued that the “Green Stamps” of my childhood, and airline miles today, have a lot in common with currencies.
- For a long time currencies were backed by (and exchangeable for) gold or silver, but that’s no longer the case. The truth is, there’s nothing behind currencies these days other than their issuing governments’ “full faith and credit.” But what do they promise? New currencies are sometimes created out of thin air (like the euro, which wasn’t legal tender sixteen years ago), and sometimes they’re devalued.
- Currencies change in value relative to each other, in theory based on differential purchasing power, and in practice based on changes in supply and demand (which can stem, among other things, from changes in purchasing power).
Bitcoin fans argue that it qualifies as a currency under these criteria: most importantly, it’s something that parties can agree to accept as legal tender and a store of value. That actually seems right.
When I first responded to comments on the memo – even before my recent enlightenment – I found myself admitting that much of the criticism I had leveled at Bitcoin is applicable to the dollar as well. Whereas I said Bitcoin “isn’t real” because it has no intrinsic or underlying value, that’s certainly true of the dollar and other fiat currencies: there’s nothing behind them either. You can no longer exchange them for gold (and what is gold, anyway? But that’s another subject). In fact, government-issued fiat currencies are accorded value only because of a government edict. Why, the fans of Bitcoin ask, is such an edict superior to an agreement among people to accept a non-government-issued currency? Fiat currencies have value simply because of faith in the governments that issue them. If enough people believe in it, why can’t faith in Bitcoin suffice? If you consider the properties of fiat currencies, these are darn good questions.
So my initial bottom line is that I see no reason why Bitcoin can’t be a currency, since it shares the characteristics listed above, especially the fact that there are people (and businesses and even countries) that accept it as legal tender.
But that’s not good enough for Bitcoin’s fans. It’s not the same as the dollar, they say; it’s better. In all the following ways, they’ve told me, Bitcoin is superior to government-issued currency:
- All the relevant data regarding Bitcoin – number outstanding, number newly created, and transactions – are recorded in the “blockchain,” a sort of transparent electronic ledger of which everyone can have his or her own copy.
- Bitcoin can’t be debased by unlimited issuance, since the blockchain process has been set to permit only a gradual increase from today’s 16 million, to 21 million in 2140. In this sense Bitcoin is better than the dollar, of which a lot more can be issued at any time, diminishing its purchasing power through inflation. As Steven and Murray have written, “a purchase of Bitcoin is nothing other than a short sale of the currencies of the world.Merely by limiting the growth of supply, Bitcoin would become more valuable as other currencies devalue.”
- Since the blockchain exists on each person’s individual computer, rather than in a central location, it can’t be hacked, and thus Bitcoin can’t be stolen, counterfeited, or secretly created in amounts exceeding the authorized total. Likewise, Bitcoin isn’t subject to the currency controls on portability that are often imposed by failing governments. (But I wonder whether the technological claims made for the blockchain might be its Achilles’ heel. While I certainly don’t have the ability to assess these claims for myself, I wonder how many of Bitcoin’s advocates do either.)
Where will we go from here? The partisans claim the outlook for Bitcoin as a currency is bright:
- Since very few people own it today but millions more will want it in the future, demand is sure to rise faster than supply, meaning the price will rise.
- Specifically, the U.S. money supply is almost $14 trillion, so if people and businesses decide to hold just one-third of their wealth in Bitcoin rather than dollars, (and who wouldn’t want to do so given all the advantages described above?), the value of the Bitcoin in circulation will rise to $4.5 trillion, from today’s $73 billion, for a gain of roughly 60x.
- There’s sure to be a network effect: the more people join the Bitcoin movement, the more it will be accepted as legal tender, the more useful it will be, and the more demand will increase.
- Ignoring Bitcoin’s utility as currency, many people will buy just because they believe someone else will pay them more for it. (This time-honored “greater-fool theory” lies at the heart of all speculative manias.) Likewise, people will buy it because of fear of missing out, another bull-market standard.
There’s absolutely no reason why Bitcoin – or anything else – can’t serve as a currency if enough people accept it as such. While I’d point out that no private currency has gained widespread use in a long, long time, there’s nothing to say it can’t happen.
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However, before Bitcoin enthusiasts get too over-excited by Marks' "acceptance," he is not convinced it's not a speculative bubble...
Being willing to agree that Bitcoin may become an accepted medium of exchange is not the same as saying you should buy it now to make money. Think about the fact that the price of Bitcoin has risen more than 350% so far this year and 3,900% in the last three years. To the degree people argue that Bitcoin is a currency, then (a) why is it so volatile? and (b) is that desirable? You might want to consider whether a real currency can do that, or whether speculative buying is determining Bitcoin’s price. And whether what’s gone up can come down.
The immediate issue of Bitcoin as a currency still comes down to the question of whether today’s price is right. The price of a Bitcoin is around $4,600 today. Can one Bitcoin buy the same amount of goods as 4,600 dollar bills? Or the much higher amounts that Bitcoin bulls think it will soon be worth? I don’t think we have enough information to know, but the question isn’t irrelevant. If it were, this would be another case of “there’s no price too high.”
The other purported use for Bitcoin, given its status as what Marc Andreessen calls a “digital bearer instrument,” is as a payment mechanism. Its advantages in this regard include the following:
- transactions in Bitcoin can be anonymous (I understand it is often used to pay for opioids),
- payments are made without fees like those charged on credit card transactions and wire transfers,
- there can’t be fraud and merchant charge-backs like with credit cards, and
- it can be particularly useful in emerging nations lacking developed payment systems.
But I see two issues here:
First, I expect there to be many competing transaction systems. Will the banks and other financial institutions cede this territory to Bitcoin? Wouldn’t banks’ systems be more likely to gain acceptance from people other than perhaps millennials? What would happen to Bitcoin’s utility as a payment mechanism if Amazon announced its own? Would you rather transact in Bitcoin or Amazonians?
Second, if Bitcoin were to become the leading non-governmental payment system, what would cause it to appreciate? If you want to pay me in Bitcoin and I’ll accept it, what would cause its price to rise?Adherents would argue that the limited supply relative to the growing use will make the price rise. But that assumes there’s no price so high for Bitcoin that transferees won’t accept it in lieu of dollars. The “pro” side of the argument foresees limitless appreciation, but that doesn’t make sense. Think of any other currency: isn’t there a price at which you wouldn’t accept it? Would you sell your house for euros that are said to be worth two or three times as much as the dollar?
Marc Andreessen wrote an excellent article in The New York Times’ Dealbook, titled “Why Bitcoin Matters” (January 21, 2014). The article outlined Bitcoin’s potential as a payment system and described many of the advantages listed above. But it didn’t include one word about why these advantages give Bitcoin appreciation potential.
So what’s my real bottom line?
- Advocates say if Bitcoin is accepted as described above, you’ll make more than 50 times your money. Thus success doesn’t have to be highly probable for buying Bitcoin to have a huge expected return. This is called “lottery-ticket thinking,” under which it seems smart to bet on an improbable outcome that offers a huge potential payoff. We saw it in full flower in the dot-com boom in 1999-2000, and I think we’re seeing it in action again today with regard to Bitcoin.Nothing is as seductive as the possibility of vast wealth.
- Several of the “seeds for a boom” that I listed in “There They Go Again . . . Again” are at work in the Bitcoin surge: (a) there is a grain of underlying truth as set out above; (b) there’s the prospect of a virtuous circle: widespread demand will lead to wider acceptance as legal tender, which will lead to widespread demand; and (c) thus this tree may grow to the sky, as there is no obvious limit to this logic. None of these things necessarily make Bitcoin a mistake. They merely say elements that contributed to past bubbles can be detected today with regard to Bitcoin.
- Finally, Bitcoin isn’t alone. There are hundreds of digital currencies already – including eleven with market capitalizations over a billion dollars – and no limits on the creation of new ones. So even if digital currencies are here to stay, who knows which one will turn out to be the winner? Hundreds of e-commerce start-ups appreciated rapidly in the tech bubble based on the premise that “the Internet will change the world.” It did, but most of the companies ended up worthless.
Marks concludes graciously...
Thanks to the people who took the time to educate me, I’m a little less of a dinosaur regarding Bitcoin than I was when I wrote my last memo.
I think I understand what a digital currency is, how Bitcoin works, and some of the arguments for it.
But I still don’t feel like putting my money into it, because I consider it a speculative bubble. I’m willing to be proved wrong.