If you had a spare $1000 back in 2011, and wanted to add some risk at a rock-bottom price to your portfolio, you could’ve purchased 1,000 units of the cryptocurrency Bitcoin. At the very least, it would’ve been a real good conversation piece. As it turns out, you’d be considered a genius now. Today, your investment would be valued at over $16 million dollars (one Bitcoin is currently valued at $16,784) giving you a 1.6 million percent return on your investment. Try that with a mutual fund.
The question now is whether or not to sell off your position, or hang in there until you can identify a more profitable bailout point. I'd sell it today, and take the windfall. Who knows, maybe the “experts” telling me Bitcoin’s a bubble now are right. The key to maximizing your profits in a bubble is to be one of the last ones to sell before the bottom falls out, but I have no stomach for waiting until there's no longer a “greater fool” to sell to. Anyway, I wouldn't waste my time trying to figure out if the bubble existed, as it's beyond my understanding.
The bubble may or may not exist, but Bitcoin was valued at $880 in January, meaning that it's appreciated around 1800 percent in less than a year. The average real return on the S&P 500 since 1928 has been about seven percent, to provide some sort of perspective. Conventional analysts, like those who couldn't see the 2007-2008 market meltdown coming, will tell you Bitcoin’s a bubble now. Some said the same thing a year ago. Market insiders, many of whom have no concept of cryptocurrency, are now comparing Bitcoin to the infamous 17th-century tulip bubble known as Dutch Tulip Mania. At its peak, speculation drove the price of a single bulb to more than 10 times the annual income of a skilled craftsman. Greed pumped air into the bubble until the pin was inserted and it all collapsed spectacularly.
Among the more notable financial bubbles since Tulip Mania are the 18th-century South Sea bubble, the Wall St. crash of 1929, the Japanese real estate bubble in the mid- to late-1980s, the 1990s dotcom boom and bust, and the U.S. housing bubble that started cratering in 2006. Bubbles exist when the price of an asset deviates from historical norms or its intrinsic value, or both. Emotion rather than reason prevails. As Bitcoin has only been around since 2009, historical norms are not all that relevant. So what's Bitcoin’s intrinsic value?
Perhaps it's not even possible to distinguish its intrinsic value from its market value, no matter what the financial gurus say. That could easily be said about the U.S. dollar as well. If you take a $100 dollar bill to the Federal Reserve Bank, they'll give you two 50s, not anything that's commonly thought to have intrinsic value like gold. What gives the dollar value is that it's backed by the full faith and credit of the U.S. government, which some will tell you means it springs from the barrel of a gun. Its value, just like Bitcoin’s, is determined by supply and demand.
Bitcoin is not backed by any threat of violence—it’s backed only by its investors’ faith in it, just like the dollar, although the reasons for that faith may not be the same. When skeptics say Bitcoin’s fundamental problem is that it's not backed by anything, they mean it's like all the fiat currency that the developed world runs on. Much of the doubt can be attributed to fear of the unknown. Though libertarians and conservatives yearn for the gold standard that the U.S. abandoned in the early 1970s, you could even make a case that gold has no real intrinsic value. It's not like a piece of farm equipment that you could work your fields with and then sell a crop. Gold relies instead on the fact that people have trusted its value for centuries, just like the many investors who haven't sold their Bitcoin since January, when it began its ascent, trust its “intrinsic” value.
Trust requires a leap of faith, which is why so many people, especially conservatives, find the concepts of fiat money and cryptocurrencies hard to swallow. Bruce Flatt, chief executive officer of Brookfield Asset Management Inc., recently said Bitcoin has no intrinsic value, so he's not interested in it. He could’ve bought it in May 2016 for $450 (when it also had no “intrinsic” value) and sold it today for over $16,000 (still with no intrinsic value). Perhaps some of his clients wished he'd focused more on market value, which is what actually puts cash in their pockets. I'd like to see someone ask Flatt to explain why, if he could travel back in time, he still wouldn't have invested $5000 in Bitcoin when it was at $1.
Jamie Dimon, JP Morgan Chase CEO, has called Bitcoin a “fraud,” and claimed it's only for criminals, but he could have bought it when it was selling for a dollar too, so are people relying on him for an informed evaluation of the asset? A sudden price run-up isn't sufficient to predict bubbles, which are notoriously hard to call—it’s generally 20-20 hindsight. Unlike the U.S. dollar, of which there are an infinite number, there are only 21 million Bitcoins that can be mined electronically. In this way, it's similar to gold, which is mined mechanically. Bitcoin protocol would have to be changed when the 21 million threshold is reached to increase that number. Limiting the supply serves to support its valuation.
If the cryptocurrency collapses, those predicting it will be hailed, even though they're generally right only half the time. Whether or not Bitcoin is in a bubble now is a coin flip, no matter what anyone tells you. You may have missed your chance for windfall gains if you buy it now, but maybe you haven’t. Maybe it will be at $30,000 in a year, or maybe it will crash in January when market corrections often occur. If you're thinking of buying it, don't pay any attention to what mainstream people call intrinsic value, though. They don't know what they're talking about. Jean-Michel Basquiat's paintings don't have any intrinsic value, and there's a finite number of them. One of them sold this year for $110.5 million.