The general argument provided by crypto enthusiasts is that the currency is valuable for two reasons:
- Blockchain technology is revolutionary.
- Supply of cryptocurrency is limited.
I'll address these two arguments simply.
Blockchain technology is revolutionary because it is new. The code could be used on a variety of applications. It could be very useful. It's also open source. Anyone has access to it. Are the barriers to entry so great that the existing cryptocurrencies cannot be replaced? The answer is no.
When Gutenberg created his printing press, he printed Bibles and sold them for the equivalent of three years' wages in 1455 at the Frankfurt Book Fair. For a brief time he had a small monopoly, but by the year 1500 AD, 2500 cities in Europe had their own printing presses. The printing press eventually became a ubiquitous tool of society. The price of a printed Bible is now about $4.00, and the original technology of the printing press has been replaced innumerable times. Improving technology has a way of lowering asset prices, not raising them.
The second argument regarding Bitcoin value is the limited demand argument. Yes. The supply of Bitcoin is limited, but as I argue above, the ability to create competing cryptocurrencies is not limited. In fact, thousands of others have already been created. Thousands more will likely be created due to the rising demand of these existing "currencies." The crypto market will eventually reach a saturation point, and the "currencies" will become victims of their own success.
I'll stop quoting myself and summarize the whole argument. Crypto generally has neither a limited supply nor significant barriers to entry. It has no value due to a scarcity argument.
Further, it must have utility as a payment method or a secure store of value. That still is yet to be proven, as well. Bitcoin is a target of successful hacking. There are numerous articles including the one linked here.
So, why has Bitcoin (the prominent crypto) been surging in value?
You can thank global central banks for continuing to fuel the asset bubble. Bitcoin, with 0% yield, is a place to park your money, earning higher interest than the bonds of 18 countries.
The upswing in Bitcoin price also corresponds to the significant drop in bond spreads on 10-year and 3-month Treasury bonds. Money has been flowing into U.S. denominated assets like bonds and that includes Bitcoin, which is reported in U.S. dollar value. The recent parabolic moves in Bitcoin should be a warning to those holding it.
The crypto enthusiasts will point to this correlation as an "I told you so" about the value of Bitcoin and similar assets. However, this ignores the way speculative assets trade in a bull market. Corporate equities are still at stretch valuations, as measured by market capitalization compared to GDP.
Other valuation measures show similar conclusions. The Shiller PE ratio at 29.64 is nearly double the historical mean and median values, 16.62 and 15.72 respectively.
Investors are paying a premium for risk assets. That generally means they are overpaying.
As long as central banks hold rates below normal levels, crypto could continue to inflate. Eventually, markets will function rationally and the parabolic price movement will be corrected. At the time of this article submission, Bitcoin has surged to $8,121, which represents a 34.5% increase since May 5th, less than 9 days ago. The cost of mining Bitcoin is somewhere in the range of $2,000 to $4,000. Like any commodity, the value should correlate to the cost of production. Thus, my short-term price target is in this range.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.