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Electronic copy available at: https://ssrn.com/abstract=3103706
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Eric PICHET, Professor, KEDGE-Business School
Eric PICHET, Kedge Business School, Paris Campus 56 rue de la Victoire 75009 PARIS.
eric.pichet@kedgebs.com
BITCOIN: SPECULATIVE BUBBLE OR FUTURE VALUE?
Published in The Conversation (French edition) 28 November 2017
Created in 2009, bitcoin reaches record heights every week, having hit $17,000 on 11
December 2017 - the first day a bitcoin futures contract traded at the CBOE - versus $1,000 in
early 2017 and $1 in 2001. Yet there is still no consensus among economists whether bitcoin
comprises a new decentralised currency free of central bank influence, or is a purely
speculative instrument.
1. The essence of bitcoin
Bitcoin was first issued in 2009 and valued at parity with one US dollar. This digital (or
crypto-)currency is a unit of account stored in electronic form1. Its creator, the mythical and
mysterious Satoshi Nakamoto, had had the genius idea of developing a new technologies-
based currency issuance and trading system that would be perfectly secured, at least for the
moment, by participants’ use of decentralised online transaction validation system (called
“blockchain”) in which each deal is authenticated by “miners” remunerated through the
creation of new bitcoins sourced from a virtual “mine”. The algorithm limits the total amount
of bitcoin created at 21 million units by the year 2141. 18 million had already been issued by
December 2017 – but given that around 20% are never replaced (for instance, when holders
lose access to their private account), the real number of units actually in circulation is around
5 million. Despite being entirely de-materialised, bitcoin possesses some of the characteristics
of a real acephalous currency. Like all crypto-currencies, it has no intrinsic value, not even as
1 In 2017 there were 700 other crypto-currencies surfing the same wave of speculative interest, usually driven by
relatively youthful traders. Bitcoin accounts for 80% of all crypto-currency capitalisation, epitomising the
economic dictum that “the winner takes all”, i.e. the first to set up shop in a new market tends to dominate it.
This may also be another indication of that a bubble is forming, given all the different assets being created at the
same time. The conclusion here is that these are speculative instruments rather than real currencies.
Electronic copy available at: https://ssrn.com/abstract=3103706
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a collector’s item, due to its immateriality. As a result and unlike official currencies, it can
never be booked as a central bank or financial institution liability. Nor is it a financial asset
like a stock or bond, since it generates no return. The only investment value resides in the
higher price that prospective buyers are willing to pay. In short, bitcoin is a commodity
lacking an underlying asset, with investors only able to recover their initial currency stake if
someone buys their holdings off of them. As the Banque de France has correctly noted2, like
other virtual currencies bitcoin is not a means of payment in the sense that European
legislation attributes to this term. It offers users no protection, whether a redemption
guarantee or against fraudulent transaction. In France, the conversion of virtual currency into
euros or foreign currencies is equated with a payment service and regulated by the Autorité de
Contrôle Prudentiel et de Résolution3.
2. Secondary market and blockchain-based trade validations
Thanks to the cryptographic blockchain clearing mechanism enabling un-mediated inter-
account bitcoin transfers, this kind of open system is extremely reliable. Bitcoin holders -
whether miners operating in the primary market or secondary market purchasers – can re-sell
using encryption and pseudonyms. This is what differentiates bitcoin from cash, where
payments are entirely anonymous. The bitcoin market is only semi-anonymous given the
theoretical possibility of ascending the different blockchain stages. It is, however, more
anonymous than bank transfers. The fact that deals are done using pseudonyms means they
should also be less costly and more discreet than bank transfers4. All in all, bitcoin has created
a new space for financial trading, somewhere between official transactions and cash, a market
that is totally anonymous and cost-free albeit unsecured. As such, its most accurate
description is as a pseudo-currency that is, additionally, pseudonymic.
To own bitcoin, all someone has to do is open a virtual account (called “wallet” in slang) and
pay official currency to a seller found either on the trading platform or else over-the-counter
(where trading can be as as easy as sending e-mail). As a result, there are billions of potential
participants in this market, attracted by the possibility of purchasing bitcoin fractions (up to
eight decimals points or one-one hundred millionth of a bitcoin). The end effect is that almost
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4 Intermediaries using trading platforms are sometimes paid substantial commissions.
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everyone can speculate in this intangible asset. In addition, bitcoin’s use as a means of
payment has been expanding constantly since WordPress announced on 16 November 2012
that it could be used to pay for the company’s commercial services. General interest has also
been bolstered by the fact that payment is cost-free and requires no bank intermediation. The
authorities have also given their blessing, with countries that first prohibited bitcoin - like
Thailand in 2013 or Russia in 2014 - both reversing their stance in 2016. More recent
evidence of its success is the fact that by November 2017 there were nearly 1,700 bitcoin cash
points worldwide. Today it is estimated that somewhere between 10 and 15 million
individuals hold bitcoin, creating in turn a funnel effect, i.e. given the limited supply, the
media buzz has accentuated the global demand for bitcoin, causing the price to rise. The
relative rarity of this virtual product offers a robust explanation for its price rise. In turn, this
indicates what the pricing effects would be if the main factor driving the speculative bubble -
FOMO (or the Fear of Missing Out) - were to spread to just 1% of the global population.
3. Buyer motivation
Four main motivations have been identified so far: the trade in illegal products; money
laundering and tax fraud; flight out of currencies depreciating as a result of hyper-inflation;
and pure speculation. Bitcoin buyers are motivated, for instance, by a desire to launder money
obtained through corruption. China accounted for 80% of all bitcoing transactions last year,
largely for reasons like this but also because many Chinese enjoy a speculative flutter.
Nor is it impossible that bitcoin’s current astronomical rise is also related to Saudi Arabia’s
recent anti-corruption campaign. A number of wealthy individuals whose money can no
longer leave that country might be trying to use bitcoin to achieve this goal (a process where
they abandon legal transactions for the “Darknet”).
Some residents in hyper-inflationary countries have started purchasing bitcoin instead of their
benchmark currency, being the US dollar someplace like Venezuela or the euro in other zones
of influence. Rather than a search for salvation, such behavior represents a flight forward.
With a financial asset as unstable as this, the economy finds itself stuck between Scylla and
Charybdis. It is entirely unrealistic to suggest that bitcoin might rival the world’s two leading
currencies one day.
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4. An archetypical bubble
Bitcoin has soared past gold when its price exceede $15,000 in early December 2017 (at a
time that gold was trading around $1,300/ounce). The comparison makes little sense,
however, since the total value of all the bitcoin ever issued - around $180 billion - is far below
the total capitalisation of the world gold stock ($8 trillion), without mentioning the $150
trillion currently invested in financial assets and $240 trillion in property worldwide. At
$15,000 per bitcoin, however, a bubble has definitely formed, one congruent with the
definition customarily attributed to this term relating to an asset purchased solely to capture a
price rise without no concern for intrinsic value. New bitcoin buyers know nothing about the
currency and simply acquire it in the hope they can re-sell at twice the price two months later.
The problem with a bubble is the impossibility of predicting how far and how long it will go.
It is inevitable that bitcoin prices will crash one day but no one knows when or to what extent.
Of course, the bitcoin bubble may be nothing else than the latest in a long series of
speculative follies that have regularly stirred the world of finance since the Tulipmania of
1637, Law’s system in 1820 or the 2000 dot.com bubble. Having said that, it has singularities
that render it unique (a reality some of its supporters misrepresent to further argue, as has
been done so many times before, that “this time it’s different”). Even more than the 2000
dot.com bubble, this speculative instrument probably constitutes the first hyper-modern
bubble, given its complete immateriality. The globalised network means there are potentially
7 billion buyers (especially since it can be divided up to eight decimal points), largely
explaining the funnel effect materialising, inter alia, in the first bitcoin futures contract that
began trading in December 2017.
5. Who and what might kill off bitcoin
The main question under these conditions is exactly how the bubble will pop. One possibility
would be widespread theft (i.e., password hacking, the old culprit) or someone penetrating the
blockchain system, flooding the market with false bitcoin and causing the price to collapse.
Bitcoin’s famous blockchain security system is split between thousands of computers
worldwide and considered infallible and inviolable – even if history teaches that no private
security system is 100% safe. The process is, however very different than, for instance,
storing gold at a central bank. Paradoxically, the risk - long considered marginal - has become
increasingly plausible precisely because the price rise increases potential profits hence
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incentivises sophisticated hackers to penetrate the system and create millions of false bitcoins,
flooding the market and sending prices crashing.
The second possible outcome might see all national authorities and central banks deciding
jointly to prohibit bitcoin as a means of payment, all in the name of the battle against fraud. It
should be remembered that in 2013, the US authorities closed Silk Road, a company that used
bitcoin as a means of payment for the drug trade. Given leading nations’ ever growing and
shared desire to coordinate the battle against money laundering, tax havens and terrorism
funding, it is very possible that the same sort of initiative might be taken against bitcoin.
It is also possible that central banks will, for the sake of financial stability, ask national
legislatures to prohibit bitcoin as a means of payment. Even if bitcoin is currently considered
legal tender nowhere in the world, it is also not really prohibited anywhere - with, as
aforementioned, countries like Thailand and Russia having reversed their previous
prohibition.
6. The risks of bitcoin and what will remain from this experiment
A collapse in bitcoin prices is not a serious danger for the real economy given that total
investment in this crypto-currency is much lower than its current capitalisation (around $180
billion). Bitcoin speculation is like gambling at a casino. The fact that money has been
exchanged does not mean that any additional value has been created. People who dream of
becoming billionaires are bound to be disappointed. On top of this, anyone whose bitcoin
purchase was funded through bank loans will have to pay them back – although total
borrowing associated with this particular form of speculation is much lower that subprime
debt had been. It is therefore unlikely bursting the bitcoin bubble will trigger a series of crises.
Instead, the effect should be similar to what happens when a giant casino shuts down.
At the same time, blockchain and decentralised transaction validation mechanisms hold real
promise and are likely to become the most interesting legacy from this adventure. In the
future, secure decentralised systems using blockchain-like innovations will rival traditional
trusted third parties (banks, notaries, etc.), if only because they cost less. In and of itself, this
would be a revolution.
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As for central banks, they will still be here in the medium term (although it is worth recalling
that from 1830 to 1913 the United States prospered without any such institution). If they do
disappear, however, the market will sell-regulate. Of course, the environment will become
extremely uncertain, featuring recurring bank failures – although (and to repeat), this did not
prevent the United States from experiencing rapid development in the 19th century.
CONCLUSION
Any remotely lucid observer knows that even if it were possible to short-sell bitcoin, the
strategy is prohibited and potentially disastrous. After all, it is impossible to predict how long
and how high this speculative wave is going to go. As Keynes once wrote, “A market can
remain irrational longer than you can remain solvent”. All that is left is to sit this one out and
wait for the rivers of fortune to carry off bitcoin and its debris.