Can I Pay You In Bitcoin?

Bitcoin has been all the rage this year.  Will it find it’s way into some Christmas stockings?  Next year, will it be a lump of coal?  My extended family used to have a joke back in the 70’s about who was going to get the Krugerrand.  With inflation what it was back then, I now get the joke even more. This year gold has fallen in value.  Bitcoin has done the opposite. Gold ($GLD) is down 25%. Gold Price in US Dollars Chart

Gold Price in US Dollars data by YCharts

Bitcoin has appreciated this year.  Although recent technical analysis says Bitcoin ($BTCUSD) might be headed south too.  The volatility doesn’t scare me from the idea of Bitcoin.  That is a short term mechanical facet of the whole platform. That being said, my initial thoughts on Bitcoin are here.  Coinbase, a currency exchange, recently raised money from USV and Andreesen Horowitz in the same year!  Impressive for a startup. Marc Andreesen has said Bitcoin is more than just a currency.  It’s a platform, a peer to peer payments network and more. Chris Dixon says as much here,

The Internet is based on a set of core protocols that specify how information such as text, photos, and code should be transmitted. The designers of the Web built placeholders for a system that moved money, but never successfully completed it. Bitcoin is the first plausible proposal for an economic protocol for the Internet.

Economist Brian Wesbury penned an article about Bitcoin today.  He is right in his facts, but he is looking at Bitcoin as a currency only.  Framed as a pure medium of exchange, Bitcoin is not going to survive long term. Wesbury is correct, eventually the hackers will see too much of a good thing and create more of them.

To become a true alternative currency, Bitcoins need to be accepted in a wide enough swath of society to facilitate the normal transaction of business. If they aren’t, they will always trade at a discount to their potential value. Right now, total cash and deposits in the U.S. banking system (the M2 money supply), is roughly $11 trillion. Assuming 21 million Bitcoins are mined and they become an accepted currency, each one could be worth as much as $524,000. This is a massive potential appreciation from their current level. However, the list of companies that accept Bitcoin as payment for actual transactions make up what I estimate to be less than one-hundredth of a percent of all spending, or GDP. Since money gets its value from the goods, services and assets that it can purchase, a Bitcoin is currently worth only 0.01% of its true potential, or about $52.40. And is it really true that no more than 21 million Bitcoins can be produced? Hackers keep getting better, and the temptation to expand the supply of money has been powerful (and profitable, for the issuer) since the time of the Romans. These costs and questions all impact the value of a Bitcoin substantially.

The frenzy that is Bitcoin has caused values to soar far above Wesbury’s imputed price. There are several reasons for the price of Bitcoin far outstripping the value of Wesbury’s price.

  1. The market is highly illiquid.  Markets that are illiquid are extremely volatile.
  2. The world is discovering what Bitcoin is.  As it became trendy, a mania developed around it.  That drove up value.
  3. There is counterparty risk in Bitcoin.  Even though there is a transparent peer to peer general ledger, there is still risk that someone might not perform.  Establishing a true clearinghouse will allay that counterparty risk, and decrease the volatility.  Ironically, an exchange ($CME, $ICE, $NYX) that fancies itself as a tech company could bring that clearing asset to the market, and if Chris Dixon is correct, become the payment center for the entire internet.
  4. There is no way to short Bitcoin and bring any sort of discipline to the marketplace.
  5. There are no derivative markets for Bitcoin, futures, bonds, options or swaps.  That would allow risk to be diversified, and bring stability to the currency part of Bitcoin.
  6. Because of the volatility, Bitcoin isn’t a store of value.  You cannot build wealth by holding Bitcoin.  It’s a pure spec play.
  7. It’s possible to create another virtual currency that will have the same properties as Bitcoin.

So, who is right?  Wesbury or Dixon?  In the short run, Wesbury is correct.  Bitcoin is today’s tulip bulb.  In the long run, I am not so sure.  If it’s a platform and closes an internet loophole, it will be the biggest thing we have seen in a long long time. For a successful VC with patient LP’s, an investment is worth the risk/reward.  But, I believe the big winner in Bitcoin is the company that  owns the clearinghouse, not the currency exchange.

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