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My Thoughts On Bitcoin

|Includes: COIN, Bitcoin Investment Trust (GBTC)

Summary

Bitcoin's appreciation certainly validates its place in your portfolio

But the promise that it can replace money turns out to be an empty one

Start by exploring the properties of what makes money

Bitcoin is many things—a cryptocurrency, a risk asset, an investment—but the claim that it can eventually replace currencies like the dollar or yuan as a viable form of money is pure fantasy.

When the first Bitcoin was mined in early 2009, very few mainstream financiers had ever heard of it, let alone knew what to make of the damn thing. It's stated purpose (as laid out in a white paper published by its creators) was to become an electronic form of peer-to-peer money. It utilizes block-chain technology—a virtual, anonymous ledger that records each transaction—to prevent double-counting and fraud. The first bitcoins could be bought for less than one tenth of one US cent and were first used to purchase two Papa John's pizzas, which cost 10,000 bitcoins at the time. Free-market guys loved Bitcoin because it bypassed government regulation and influence; central banks hated it for the same reasons.

But does Bitcoin stand to live up to its claim as money? And what really constitutes money anyway?

All good money has three basic properties. First, money is a unit of account. Think of it like a yardstick that measures the economic value of stuff. I can go to any 7-11 in my city and easily know exactly how much a frozen pizza costs when priced in terms of dollars, but knowing how expensive something is in terms of bushels of corn is much more challenging. So money acts as a universal tool to measure value.

Second, money is a medium of exchange. This is where Bitcoin—along with your Back to the Future clock radio—fails to meet the basic requirements of money. Before money, bartering was the only way to exchange goods. This meant that in order to trade with someone you both had to want something from each other. If I ran a chicken farm and wanted steak, I would have to find a beef farmer that wanted my chickens. Money solved this problem by reducing economic value into one universal quantity. But It only works if it's ubiquitous—a market where goods are priced in many currencies is only slightly less useless as a market where stuff is not priced in currency at all. Try going on Amazon and buying that new Echo Dot with Bitcoin, or your clock radio for that matter; they simply won't except it. Outside of the Silk Road and few obscure online stores, the only way to purchase the goods and services you want with bitcoin is by converting them into dollars first. Money is widely excepted as payment and Bitcoins are not.

Third, money acts as a store of value. You would not want a monetary system where the value of your currency fluctuates wildly over time. When I walk out of my office park with my paycheck every second Friday, I can be confident it will purchase roughly the same amount of stuff tomorrow as it would today. Bitcoin does not provide this stability at all. Over the last month, Bitcoin's intraday volatility averages 3.8% and has run as high as 7%! As a comparison, most major currencies around the world run in the 0.5% to 1.0% range. These wild up-and-down swings in the value of Bitcoin mean it cannot perform one of the basic functions of money—storing value over time.

Over the past couple of months, Bitcoin has drawn the interest of more and more investors, pundits, and internet prognosticators as it's price climbs ever higher. And while its price appreciation might validate its place in your portfolio of investments, it should not be mistaken for something that it is not—money.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.