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BITCOIN HIT A NEW high last week, topping $112,000. Over the past 12 months, it’s climbed an impressive 55%.
What’s driving this gain, and what should you make of it? I believe there are three key factors. Two are new. One is not.
The first factor was a policy change last year. The federal government approved the launch of new exchange-traded funds (ETFs) that offer easier and more direct access to bitcoin. Following this rule change, 11 new bitcoin ETFs were launched in quick succession. These new funds collected more than $100 billion in assets, which then helped drive up bitcoin’s price—and sparked even more interest among investors.
The second factor was the Trump administration’s friendlier posture toward cryptocurrency. The president declared his intention to become the “crypto president” and issued executive orders loosening restrictions on crypto firms. There is now a “crypto czar” in the White House. The administration also discussed the idea of funding a strategic bitcoin reserve akin to Fort Knox.
A third factor, however, may be the most powerful driver of bitcoin’s gains: The reality—justified or not—that asset prices tend to go up when other people think they’re going to go up. While this might sound circular, it’s a well-understood economic concept, one first articulated by John Maynard Keynes in his 1936 book, The General Theory of Employment, Interest and Money.
Keynes compared the stock market to what he called a “reverse beauty pageant.” Investors, he said, were no longer looking to choose the most attractive investments. Instead, “we devote our intelligences to anticipating what average opinion expects the average opinion to be.” In other words, investors want to buy what they think other people will want to buy, regardless of the investment. Using that yardstick, bitcoin looks eminently appealing. In addition to its most recent runup, bitcoin delivered more than a 1,000% gain over the past five years and is clearly what other people want to buy.
To a degree, investors’ attitude toward bitcoin is rational. There’s a concept known as “rational ignorance” that helps explain some of the enthusiasm. According to this theory, there’s too much going on in the world for any one person to follow. Instead, we rely on the opinions of others to help fill in our knowledge gaps. If someone else has done the research and reached a conclusion on a particular topic, it makes sense for others to piggyback on his or her efforts. While this can be helpful, the fly in the ointment is that this same channel can inflate investment bubbles.
A related concept also helps explain the rise of bitcoin. It’s what author Chimamanda Adichie refers to as a “single story.” Whenever there’s a simple, easy-to-understand story associated with an idea, that story will help spread that idea. Bitcoin has several compelling stories. One is the idea that, unlike traditional currencies, it’s independent of any government’s control. Another is that its total supply is structurally limited to 21 million coins, making it resistant to inflation. There’s also mystery surrounding its creator, who used the pseudonym Satoshi Nakamoto but has never been identified. No one has ever even claimed to know someone who knows him.
I believe these stories help explain much of bitcoin’s popularity. No one really knows where it will go in the future, but because bitcoin seems like it’s going somewhere, more people are likely to get on board.
In fairness, investors have been taught to believe in markets and to trust market prices. This is the cornerstone of the efficient market hypothesis (EMH). This theory—for which economist Eugene Fama won a Nobel Prize—argues that asset prices are always “correct” because they reflect all available information. According to the EMH, if bitcoin is trading at $112,000, then that must be the right price, because it reflects the collective wisdom of millions of investors everywhere.
This notion, that prices are “informationally efficient,” goes back as early as the 1900s when a fellow named Francis Galton conducted an experiment at a livestock exhibition. He set up a lottery, asking contestants to guess the weight of an ox on display. He collected 787 votes, and then compared the average to the actual weight of the animal. The crowd was remarkably accurate: The average guess was 1,207 pounds, while the actual weight of the animal was 1,198 pounds. Galton dubbed this vox populi—the voice of the people.
More recently, author James Surowiecki took a closer look at this phenomenon in a book titled The Wisdom of Crowds. Surowiecki points out that crowds aren’t always accurate. Instead, the following criteria are required for the vox populi to deliver a reliable answer:
I believe this is where the bitcoin story is flawed. Markets today are generally not independent. In the age of the internet, opinions are rarely independent. Investors all influence each other, especially when it comes to something like bitcoin. Bitcoin has turned people into millionaires and even billionaires because opinions are shared broadly and publicly. Services such as Google Trends can quantify this. This constant public discussion sits in contrast to the secret ballots cast at the livestock competition, where each contestant made a strictly independent judgment.
Hedge fund manager Clifford Asness argues that this phenomenon reaches beyond cryptocurrency. Because the internet—and especially social media—have made communication so easy, Asness says, the collective investment judgment of crowds has gotten worse, not better. He calls this the “less-efficient market hypothesis.”
Bitcoin’s gains may make it appear that it has a solid foundation. I believe, however, it’s like constructing a building on quicksand. A quick survey of bitcoin’s peers helps illustrate why. For starters, there are now thousands of different coins. One online tutorial describes how easy it is to create a new crypto coin. That’s why creations like the TRUMP coin, launched this January just before Inauguration Day, have achieved market capitalizations in excess of $2 billion.
If coins like this can be created out of thin air and gain millions or billions of dollars in value, there’s no reason to see bitcoin as being less of a mirage than its more obviously comical brethren. I believe the only reason bitcoin carries more legitimacy is because it was first. But as economist Owen Lamont points out, that doesn’t mean it has value that’s more tangible than other crypto creations. “We buy bitcoin because we believe others will buy it in the future,” he says. It’s the “Kardashian of money”—famous only because it’s famous.
In his book Narrative Economics, Robert Shiller puts it this way: “People are interested in bitcoin precisely because so many other people are interested in it.”
It’s for this reason that I recommend standing clear of the frenzy. Unlike real investments such as stocks, bonds and real estate, which carry intrinsic value—that is, the ability to generate income—bitcoin has nothing tangible supporting its value. It is only valuable because it’s popular. But as tulip investors learned the hard way in the spring of 1637, sentiment can shift quickly.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
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Computer scientist here to tell you that blockchain and bitcoin are cons. Bitcoin/blockchain is now seventeen years old, and has not yet found any use case. It excels in:
1. speculative gambling on valuation, bitcoin as poker chip
2. enabling massive ransomware attacks on corporations and government.
No other use case has emerged.
Bruce Schneier is a computer security expert. He wrote,
What blockchain does is shift some of the trust in people and institutions to trust in technology. You need to trust the cryptography, the protocols, the software, the computers and the network. And you need to trust them absolutely, because they’re often single points of failure.
When that trust turns out to be misplaced, there is no recourse. If your bitcoin exchange gets hacked, you lose all of your money. If your bitcoin wallet gets hacked, you lose all of your money. If you forget your login credentials, you lose all of your money. If there’s a bug in the code of your smart contract, you lose all of your money. If someone successfully hacks the blockchain security, you lose all of your money. In many ways, trusting technology is harder than trusting people. Would you rather trust a human legal system or the details of some computer code you don’t have the expertise to audit?
Of course you can make money on bitcoin, you can make money betting on horses too. That doesn’t make either of them an investment.
Not sure about intrinsic value or how broad adoption may grow to – but for those that want to swing for the fences (based on the limited supply play) and understand that they can strike out (go to zero) a small allocation (5%ish) could quench their speculative thirst.
I’m not interested in purchasing bitcoin. For three reasons. First, it still lacks wide acceptance. Even if it gets wider acceptance, trust in it is in general a mile wide and an inch deep. Second, no government offers it “full faith and credit”. Thus, it will always be viewed as inferior to the dollar until there is some reason for a country to back it. And third, it purports to be a true currency. My perception of traditional currencies is that they are turtles when it comes to value changes. Slow and steady, one direction or the other, and back and forth according to how events in the world occur or the impacts that might occur from them. These traditional currencies may suffer a few shocks from time to time, but I doubt we’ll ever see the dollar, pound, euro or yen be as volatile as cryptocurrency (thank God!), and I doubt we’ll ever see any of them go up (or down) 1000% in five years.
I’m still thinking about your article, Adam. Bitcoin is the best-performing asset in history. Why not spend more time trying to thoroughly understand it? Bitcoin’s returns are 36x greater than Berkshire Hathaway over the entirety of Berkshire Hathaway’s existence. Maybe, just maybe there’s something to it that suggests further research would be beneficial.
If someone does not like this post they don’t like historical facts.
And the blockchain upon which bitcoin is based was the “next big thing”, hear the crickets……. The energy consumption of bitcoin is also worrisome. So much consumption just to churn an algorithm. A comment made that stocks are also based on belief, but stocks represent companies that produce a product.
I’m sticking with one of my core investment beliefs, if I can’t explain it I’m not investing in it
I bought some IAU (a pure gold play) not because I think gold is a great investment, but because other people believe it is.
Stocks themselves have no intrinsic value, but other people believe they do, so I invest too.
Not that different than bitcoin in general. But bitcoin’s technology is different, and as comments on this column and one a fews weeks ago discuss, it may not survive for technical rsasons.
You say, “Stocks themselves have no intrinsic value.” What about the earnings that companies generate and the cash that they kick off, through both dividends and stock buybacks? If stocks have no intrinsic value, nothing does.
This sounds like you agree with me. “If stocks have no intrinsic value, nothing does.”
The closest we can get to intrinsic value is possessing our next meal and cup of clean water.
Where we draw the line (gold, fiat paper, bonds, stocks) to define intrinsic value is merely the level of collective hallucination and trust in laws that we have.
Stocks? The only value stocks have is what someone else is willing to pay me, via a broker, for them. I cannot walk into XOM offices, slap my stocks down on the counter, and roll a barrel of oil out to my car in exchange. A barrel of refined diesel to keep me warm is arguably intrinsic value. The XOM share registered in my brokerage account doesn’t even guarantee a dividend payment.
Of course, it all depends upon what one defines as investible assets. A few centuries ago tulips were all the rage. More recently there were NFTs. Couple the “less-efficient market hypothesis.” with herd mentality and things can become dangerous for one’s financial well-being.
One of the challenges with crypto is the professed security of the blockchain. Many experts agree that this can be hacked, but “not yet”. But do they really know the current limits of quantum computing and where it will be in 5 or 10 years? They don’t, although they profess that they can see that distinct future, too, and tell us “don’t worry”.
If I owned crypto it would only be with the understanding that there was a real possibility that my holdings might be compromised and be worth nothing at some time in the future. Until there is some real consensus on this possibility, I do think that greed will propel crypto upwards. In that respect it might be a sure thing, until it isn’t. Because I can invest in many things and make money, I see no compelling reason to go crypto.
Here’s a little anecdotal evidence: If bitcoin is so legit, why is it that almost every day somebody is trying to post a spammy comment on HumbleDollar promoting bitcoin? Fortunately, the site’s spam filter catches these comments. I’m also constantly dealing with spammy bitcoin promotions on HumbleDollar’s Facebook and Twitter accounts.
This is an excellent recap of various “opinions” on Bitcoin. I don’t gamble because I’m not good at it. Most people aren’t but they don’t realize it. When I talk to people who do gamble, I always hear about their winnings and not their losses. I guess that’s human nature.
Now, NFTs (Non-Fungible Tokens), that’s where the money is! (humor intended)
The greater fool theory.
Unwavering loyalty to an investment belief when that loyalty is based on flawed logic is a recipe for investment disaster in my opinion. I am following the late Charlie Munger’s thinking regarding Crypto and will not directly own and I will avoid indirectly investing in it to the extent I am able. Such avoidance is now harder as many large broad based index funds now include a de minimis amount of companies where owning crypto is their primary business model.
I will not be surprised to see the introduction of new broad based mutual funds or ETFs that exclude crypto based investments. I will not be a buyer of such ..Xcrypto investments. The investment thinking of owning the entire US or world market in a low cost index as a core principle of diversification means I will hold my nose and be a part owner of an investment with crypto and other companies that I do not like.
So what happens to crypto once the current White House is gone? Does it just implode? Surely it’ll see a large drop, because I seriously doubt the next president will be one making billions (on paper) off of meme coins.
Bitcoin did quite well prior to the current administration and IMO will continue to do well long after President Trump is gone. Most “crypto” (often referred to as crap coins) may struggle, or go away altogether, but Bitcoin is different with a >$2 trillion market cap and growing to one of the top five currencies in the world. Bitcoin is not going away. “Surely it will see a large drop” is not a given, or even likely, or I would be sitting next to the short button.
I am long BTC for the long-term (it has grown to >10% of my investable assets). I will be very surprised if BTC is not 5x-10x in the next 10 years, but my retirement plan is not dependent on it.
Crypto shows humans are the ape which imitates and tells stories.
The wisdom (and humor) of the Nobel committee showed when they awarded the 2013 Nobel economics prize jointly to EMH proponent Gene Fama with “Irrational Exuberance” author and economist Bob Shiller. It seems markets are efficient, until they go barking mad.
Great article that I hope will be widely-read. Thank you for writing it!
Berkshire Hathaway’s legendary Charlie Munger’s take on Bitcoin sums things up nicely – and memorably:
“I think it’s rat poison,” he famously said in 2013, when Bitcoin was worth $150. When asked to revisit his comments five years later, when the world’s largest cryptocurrency was trading at $9,000, he said, “So it’s more expensive rat poison.”
When pressed on the returns some Bitcoin investors were able to make, he called them “idiot booms” that harm the U.S.
“In my life, I try and avoid things that are stupid, and evil, and maybe look bad in comparison with somebody else,” he said in 2018. “Bitcoin does all three.”
“It’s stupid because it’s very likely to go to zero; it’s evil because it undermines the Federal Reserve system… and third, it makes us look foolish compared to the communist leader in China,” he explained. “[Xi Jinping] was smart enough to ban Bitcoin in China… we are a lot dumber.”
Maybe, just maybe, Charlie was wrong. Wrong when BTC was at $150, wrong at $9000, and very wrong at $105,000. Charlie’s views on Bitcoin were “rat poison” and cost individuals that embraces views millions of dollars. Charlie was a stock savant, but missed Amazon (which Warren later lamented). “It’s stupid because it’s very likely to go to zero” is a foolish statement in retrospect. BTC market capitalization is currently greater than $2 trillion, and will likely forever be greater than the market cap of Berkshire Hathaway. That said, I should have bought Berkshire Hathaway long ago instead of investing in broad market indices. I would have benefited immensely, not only from Berkshire’s performance, but also the tax treatment I would’ve received.
From day one I have regarded all these “coins” as a sucker’s bet and invitation to lose whatever you pay for them.
If you want to invest in coins, make them gold ones.
There’s a big difference between using a product / asset and investing in it. Crypto advocates can point to many advantages (legit or illegitimate) of using crypto currencies – anonymity, flexibility, ability to transfer value internationally, etc. I can also choose to use an airline to get me from City A to City B. That’s not the same as me deciding that I want to own crypto, or buy shares in United, Delta, or Southwest. When I hear crypto enthusiasts discuss BTC and other coins, the arguments in favor of use of the product often conflates into the main reason to own the coins as an investment. That feels a bit too simplistic of an investment rationale to me. I pass.
Bitcoin’s design has a few more desirable features than Mr Grossman suggests. First, the supply is limited to 21 million units. This means its inflation rate is known to be less than 1% today, decreasing over time to 0%. That makes it a good store of value and a hedge against fiat currencies like the US Dollar. Second, it’s transferable anywhere globally at a very low cost. Third, suppose you live in a country with even more irresponsible fiscal management than the United States. In that case, you can protect the value of your earnings by transferring whatever local currency you are paid into BTC. Over time, the dismissive posts like this one by Mr Grossman will be proven shortsighted. The question in my mind is how an investment manager at a wealth management firm can fail to appreciate these design features.
Bitcoin provides an option that wasn’t available 15 years ago. It has value because it offers an alternative to a fiat currency being run into the ground via irresponsible fiscal governance. It may grow to the point where treasury bills and bonds must compete with it for investors’ money. That could pressure legislators to be more responsible with the federal budget in the next decade. The US Dollar has value because the government decreed it a legal tender. Bitcoin has value due to growing adoption and limited supply.
The Achilles Heel of cryptocurrency is its dependence on a functioning internet. Fires, floods, hurricanes, etc. can knock out power grids and communications networks. During such times, people will not be able to use cryptocurrency to purchase what they need. The same can be said of credit/debit cards and mobile payments.
The failure of the Texas power grid in February 2021 is a good example of cashless payments rendered useless when the ability to transact is most needed. It’s not likely cryptocurrency would have helped Texans who were stuck for days in freezing temperatures without power.
Blockchain databases and crypto wallets are, no doubt, prime targets for hackers looking for ransom payments. During wartime, our communications networks will be a prime targets for our enemies.
A cashless society is likely a vulnerable society dependent on power grids and communication networks that are not as robust as we believe or wish them to be.
I believe there will always be a need for a fiat currency (aka cash) which enables us to transact during extreme circumstances.
If people hope to use cryptocurrency to conduct their financial affairs, that’s fine with me. But I personally would oppose any attempt to eliminate cash from our society.
Adam’s lack of knowledge of Bitcoin is appalling. Opposing opinions are helpful, as iron sharpens iron, if an opinion is informed. The applause section is not much better. It’s okay to not understand, but there’s not a lot of merit in continued willful ignorance combined with a need to say something, anything, no matter how ill-informed. Twitter wouldn’t exist without the need to spout off.
For a primer try “The Bullish Case for Bitcoin” by Vijay Boyapati, “Layered Money” by Nik Bhatia, and “Broken Money”, by Lyn Alden as starters.
At the time of this reply, this comment has -13 votes. I don’t believe bitcoin will survive technological challenges, but until that time, the comment makes very good points about strengths of bitcoin.
It’s remarkable there that many knowledgeable people on HD that have studied Bitcoin enough to have informed opinions. It’s a given they read the white paper. I wonder how they feel about SHA-256, the Lightning Network, various L2’s, multisig versus single sig cold storage (I use Cold Card), POW and why it is superior to POS. And don’t forget Adam Back’s contribution and Hal Finney enthusiasm.
Great article about crypto (I refer to it as creepto) which is one investment that is rarely if at all discussed in HD. Thank you Adam.