By Jeremy Sullivan*
A colleague of mine was recently on his way to the airport when he struck up a conversation with the driver regarding Bitcoin. Very pleased with his returns to date, the driver proclaimed the end of traditional currencies and the endless upside potential of Bitcoin; and cryptocurrencies in general.
[As we publish this article Bitcoin has just broken through US$10,000 on the Coindesk platform for the first time, pushing the local price to NZ$14,537. Ed.]
Bitcoin is a decentralised digital currency which was created to solve the problem of needing a central depository, such as a bank or credit company, to facilitate payments. Think of it as a peer to peer payments system. Bitcoin needs to be separated from its underlying technology or code called ‘Blockchain’.
Blockchain is the technology or algorithm which was created to keep a ledger of all the transactions electronically to verify their authenticity and safeguard against hacking or other malicious activity.
Blockchain itself has many potential applications including faster, cheaper settlements in financial services, electronic voting, or even the transfer of ownership for things like cars, boats or artwork. This in my view is where the value is within the cryptocurrencies, the technology behind them. As at the 27th of November 2017 there are 1324 cryptocurrencies and growing. What makes Bitcoin special compared to the other 1323 you can choose from? The answer is nothing, except that it was first.
Bitcoin has so far proved to be a good gamble, but it is far from investing. There is no cash flow derived from the investment, unlike shares, fixed interest or property. It has no lasting unique value proposition, as it has been replicated 1300 times and counting, with little difficultly.
What we have here is mania built on speculation.
The earliest recorded speculative mania dates back to the Dutch in the 17th century. At the peak of 'Tulip Mania', in February 1637, some single tulip bulbs sold for more than 10 times the annual income of a skilled craftsman. The 1637 event was popularized in 1841 by the book ‘Extraordinary Popular Delusions and the Madness of Crowds’, written by British journalist Charles Mackay. At one point 12 acres (5 ha) of land were offered for a Semper Augustus bulb.
Some may say, “Oh well it’s a bubble, but if I can get in before it’s too late I can still make a quick buck”. If this thought has crossed your mind you know for sure that you’re gambling. This is known as the ‘Greater Fool Theory’, where all you need is someone to be a little slower (or dumber) than you. Pity the person who is left holding the candle when the party is over.
To use a well known quote from the Great Depression “You know it's time to sell when the shoeshine boys give you stock tips”.
Unfortunately human nature doesn’t appear to change all that quickly, it has just moved to a different tulip.
*Jeremy Sullivan is an Authorised Financial Adviser at Hamilton Hindin Greene Ltd. This article represents general information and does not constitute personalised financial advice.