Bit­coin can be priced, but not val­ued

Mint Asia ST - - Views Otherviews - Harsh Vora


eco­nomic his­to­ri­ans and fi­nan­cial mar­ket ex­perts dis­cuss as­set price bub­bles, mar­ket in­sta­bil­ity, or ir­ra­tional ex­u­ber­ance, one ex­am­ple that of­ten crops up is what is fa­mously re­ferred to as “tulip­ma­nia”—a spec­u­la­tive price bub­ble in tulip bulbs that gripped Hol­land in the mid-1630s. At its peak, the rage for trad­ing tulips was so high that one Viceroy tulip bulb sold for as much as $51,945 in 2017 US dol­lars. Un­der­stand­ably, back in the mid1630s, the Dutch buy­ers had to trade for­tunes for one tulip.

As hap­pens with most price bub­bles, how­ever, the tulip bub­ble burst and prices col­lapsed to a neg­li­gi­ble frac­tion of their peak lev­els as buy­ers be­gan to with­draw from the mar­ket. It should come as no sur­prise, there­fore, when analo­gies are drawn be­tween the tulip­ma­nia of the 17th cen­tury and the dy­nam­ics sur­round­ing cryp­tocur­ren­cies, es­pe­cially bit­coin. The for­mer pres­i­dent of the Dutch cen­tral bank, Nout Wellink, for in­stance, called the hype sur­round­ing bit­coin worse than tulip­ma­nia. “At least then,” he said, “you got tulips in the end, now you get noth­ing.” The chief ex­ec­u­tive of­fi­cer of Jpmor­gan Chase and Co., Jamie Di­mon, sec­onded that view at an in­vestor con­fer­ence a month ago.

To be sure, the com­par­i­son be­tween bit­coins and tulips may seem far­fetched, even un­fair. Blockchain, the tech­nol­ogy un­der­pin­ning bit­coin, prom­ises to rev­o­lu­tion­ize the tradi- tional way of main­tain­ing records— thereby help­ing fa­cil­i­tate se­cure land trans­fers, en­sure ef­fi­cient de­liv­ery of pub­lic ser­vices, or re­duce trans­ac­tion costs for businesses.

But do cryp­tocur­ren­cies merit a po­si­tion as an as­set class in an in­vestor’s port­fo­lio? That ques­tion re­quires us go back to the first prin­ci­ples of in­vest­ing and draw a dis­tinc­tion be­tween value and price.

As New York Uni­ver­sity pro­fes­sor and val­u­a­tion ex­pert Aswath Damodaran ex­plains in his re­cent blog (, value is es­sen­tially de­rived from the fun­da­men­tals of an as­set—its present or ex­pected cash flows, growth prospects, com­pe­ti­tion sce­nario, mar­ket struc­ture, and so forth. Mak­ing in­vest­ment de­ci­sions re­quire us to as­sess this value and com­pare it to the cur­rent mar­ket price. If the fun­da­men­tal value is higher than cur­rent mar­ket price of that as­set, then the as­set mer­its a po­si­tion in the port­fo­lio be­cause the mar­ket price is ex­pected to even­tu­ally con­verge to its fun­da­men­tal value.

In con­trast, pric­ing re­quires us to make a judge­ment about the fu­ture mar­ket price of an as­set, mainly based on the mar­ket mood and mo­men­tum. It ig­nores the fun­da­men­tals be­cause the ob­jec­tive is to profit from short­term move­ments in prices ir­re­spec­tive of the un­der­ly­ing value. This raises the ques­tion: Can bit­coin be val­ued, or priced? Or both?

As bit­coin does not gen­er­ate cash flows, it is not pos­si­ble to value it as an as­set. Like any fiat cur­rency, it must be priced rel­a­tive to other cur­ren­cies. But un­like fiat cur­ren­cies, bit­coin is nei­ther a rel­a­tively sta­ble store of value nor a widely ac­cepted medium of ex­change. Its prices are highly volatile, swing­ing wildly in re­sponse to new in­for­ma­tion. It is there­fore nei­ther as safe as gold nor as trusted as fiat cur­ren­cies.

In their 2008 white paper ( https:// bit­­coin.pdf), the bit­coin cre­ators had pro­posed the new sys­tem chiefly as a means to en­able elec­tronic trans­ac­tions in a more ro­bust man­ner than the ex­ist­ing tech­nolo­gies, in­clud­ing those that in­volve dig­i­tal sig­na­tures. But the tra­jec­tory of the bit­coin mar­ket has hardly echoed that in­ten­tion. This is re­flected in the fact that since the be­gin­ning of 2013, while the price of bit­coin has risen by as much as 456 times, the num­ber of daily trans­ac­tions has risen only by about eight times. For bit­coin to be viewed as a cred­i­ble cur­rency, it must gather steam as a medium of ex­change than merely be­ing a spec­u­la­tive bet.

One of the car­di­nal rea­sons why bit­coins, or for that mat­ter any other cryp­tocur­ren­cies, are not trusted enough for ac­tual trans­ac­tions is their lack of le­gal ten­der and the ab­sence of reg­u­la­tions. But this may change soon. Ken­neth Ro­goff, pro­fes­sor of eco­nom­ics and pub­lic pol­icy at Har­vard Uni- ver­sity, views reg­u­la­tory pres­sure from gov­ern­ments as a ma­jor rea­son for the prices of bit­coins to col­lapse in the long run ( Mone­tary au­thor­i­ties do not tend to view com­pet­ing cur­ren­cies on favourable terms. Anony­mous trans­ac­tions in bit­coins not only en­cour­age tax eva­sion and cap­i­tal flight but also aid crim­i­nal ac­tiv­i­ties.

In 1936, Bri­tish econ­o­mist John May­nard Keynes, in his magnum opus The Gen­eral The­ory Of Em­ploy­ment, In­ter­est And Money, pro­posed that stock prices are based not on their fun­da­men­tal val­ues but on peo­ple’s per­cep­tion of what oth­ers would pay for it. In other words, equity prices were in­flu­enced more by crowd psy­chol­ogy than in­trin­sic value. Keynes il­lus­trated this through the ex­am­ple of a beauty con­test, where par­tic­i­pants are asked to rate the most beau­ti­ful faces from a hun­dred op­tions. Those who voted for the most pop­u­lar op­tion, not nec­es­sar­ily the most beau­ti­ful, would win. The best strat­egy in this case, Keynes noted, would be to choose the face that you be­lieve oth­ers would find beau­ti­ful. This would en­sure that you ended up choos­ing the most pop­u­lar face.

Bit­coin must be viewed in a sim­i­lar con­text. Like any fiat cur­rency, its suc­cess hinges on the trust it may or may not even­tu­ally build among its in­tended users—mer­chants and con­sumers. De­void of that trust, how­ever, bit­coin will con­tinue to be a spec­u­la­tive bet driven by mar­ket mo­men­tum un­til its prices even­tu­ally col­lapse un­der its own weight.

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