Bitcoin has recently come under fire from JPMorgan CEO Jamie Dimon, who critiqued the cryptocurrency as “worse than tulip bulbs.” He further emphasized his disdain stating that “it won’t end well. Someone is going to get killed.” Dimon’s remarks sent its value down 6% on Wednesday.
Now, you might be wondering what’s the root cause of the hesitation with this and other cryptocurrencies.
Although it has been around since 2009, a little over a year ago, most investors had never even heard of Bitcoin … a 100% digital alternative to government-issued money. What a difference a year makes. Not only is Bitcoin a household word (even if not utilized by every household), there’s even an exchange-traded fund linked to the value of the so-called cryptocurrency itself, appropriately called the Bitcoin Investment Trust (OTCMKTS:GBTC).
In many regards the establishment of a cryptocurrency ETF lends credibility to the very premise of Bitcoin (as if the digital currency’s 600% appreciation in value wasn’t a compelling enough reason by itself). But before you plow any of your cash into Bitcoin, Ethereum or any of the other newly minted digital currencies though, there’s something you may want to mull.
The short version of a long story: Bitcoin, like most cryptocurrencies, is digital currencies that can be used to electronically buy and sell goods and services. The attraction to it is that it’s fast, free and anonymous … if anonymity is a factor.
It’s also not regulated, by design.
Unlike money — dollars, yen, deutsche marks or whatever — the amount of actual Bitcoins out there that will ever be in existence is capped at 21 million. The limit is imposed by the underlying formula that determines whether a particular Bitcoin is valid. To-date, a little over 16 million of those Bitcoins have been “mined” by the computer-based process that has to look for the digital strings of data that qualify as a legitimate Bitcoin; they can’t be digitally faked.
In that regard the very notion seems brilliant. Potentially unlimited demand but a finite supply means the value of Bitcoin may have no cap. Indeed, it’s already being used to transact business for key players, including Microsoft Corporation (NASDAQ:MSFT) and Overstock.com, Inc. (NASDAQ:OSTK), so usability isn’t an issue either.
Nevertheless, there’s one fatal flaw with Bitcoin and its peers.
Why It’s a Doomed Idea
For some observers it’s arguably the way it’s “supposed to be,” and the way it was before 1971 when the value of the U.S. dollar was backed by (and represented) physical gold. In the same sense there’s only a limited amount of gold on the planet, there’s a limited number of Bitcoins that will ever exist — its value is real, set by market-based rates, rather than arbitrary and ultimately manipulated by a government body seeking to tweak its economy.
Here’s the problem … while the number of Bitcoins that will ever be in circulation is capped, there’s absolutely nothing to prevent the creation of another cryptocurrency to bleed off at least some of that price-inflating demand for Bitcoin.
The aforementioned Ethereum is one of those alternatives, though hardly the only one. Ripple, Litecoin, Dash, Monero, Bytecoin, Golem and Tether are just some of the several dozen cryptocurrencies that have come into existence not just after Bitcoin, but because of Bitcoin — their creators are looking to cash in.
They can come into existence because the only barrier to entry is a few hours’ worth of coding that most semi-skilled computer programmers could put together, and for any reason. And as evidence that the idea of cryptocurrency has already jumped the shark, Russia’s Burger King’s have sponsored and supported the Whoppercoin for no clear reason other than just because it can.
In other words, while the supply of Bitcoin may be limited, the potential supply of viable alternatives to Bitcoin is literally infinite. Future demand for cryptocurrency can be met in full, essentially turning it into a commodity that’s nowhere near worth the $4,000 one Bitcoin is superficially worth right now.
But What About?
The counterargument is that a nation’s currency is also theoretically unlimited — any government can also print as much money as it wants, sending the effective value of that currency lower.
The argument holds water, to be fair, but only in a theoretical sense. That is to say, while most governments have the authority to print an unlimited amount of their currency, all of them practice restraint in doing so because such an act would have dire consequences for their economy. There’s no consequence at all for creating a new cryptocurrency, whether or not it fails. Indeed, there’s no actual adverse consequence for the creator and users of Bitcoin should its value implode.
It’s that lack of consequence coupled with no barrier to entry that makes these digital currencies so dangerous. The value of Bitcoin will only hold up as long as all of its users are willing to keep it propped up by themselves. It’s not getting any sort of fundamental support, or even monitoring the way a government-issued currency is.
Bottom Line for Bitcoin
Point being, own Bitcoin, Ethereum or any of the others at your own risk. Although was undeniable a great trade recently, it’s effectively akin to the tale of the emperor who found out the hard way he wasn’t wearing any clothes. Once its fans and followers figure out they’re just trading with air, values could turn real ugly, real fast.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter.