KIM: Don’t let Bitcoin turn you into the ‘greater fool’

December 16, 2017

Kim“Greed,” “envy” and “pride” are three of the seven deadly sins, inflating not only the current bubble in Bitcoin but all the bubbles that came before and will follow. As historian Charles Kindleberger wrote, “There is nothing so disturbing to one’s well-being and judgment as to see a friend get rich.”

Bitcoin started 2017 at $968.23 and recently hit $19,000, up about 1,800 percent. Speculators believe it’s going higher and that they’ll sell before the inevitable fall (i.e. the “greater fool theory”).

Bitcoin was launched in 2009 by its creator, the pseudonymous Satoshi Nakamoto. It was designed as a digital currency providing a secure way to make online payments between parties anonymously and without the need for governments to issue currency or banks to process transactions (making it popular among libertarians and the end-of-times crowd).

There are about 16.7 million Bitcoin outstanding. Additional Bitcoin are created by “miners” who solve math problems that become increasingly complex. A key contributing factor to the bubble is that the supply of Bitcoin is limited by design to an illiquid 21 million.

Bitcoin is underpinned by “blockchain” technology—a secure, decentralized electronic ledger or list of entries that is maintained by various participants in a network of computers. Proponents say blockchain is a revolutionary concept that eventually will be adopted across financial and other systems, like health care.

Blockchain might be a brilliant innovation, but that says nothing about its prospects as a widely adopted currency or its fundamental value.

Currency has three roles, all of which Bitcoin fails. First, it must be a medium of exchange. No buyer/seller is going to use/accept Bitcoin if it can rise/fall 20 percent within hours of a transaction. Second, a currency must be a store of value, a useful place to keep savings. Third, it must be a unit of account for business accounts, debts and prices. Again, Bitcoin’s extreme volatility makes it a poor store of value/unit of account.

Bitcoin’s current value of $271 billion (greater than 488 of the S&P 500 stocks) is unjustified. But just as the dot-com bubble of the late 1990s didn’t diminish the revolutionary impact of the internet, neither does the bubble in Bitcoin invalidate the potential of blockchain.

Bitcoin’s meteoric rise also has been fueled by the whiff of legitimacy from the decision of Cboe Global Markets and CME Group to offer futures contracts on Bitcoin. This will enable speculators to place bets (long-positive/short-negative) on Bitcoin by putting down less than 10 cents on the dollar, which could lead to a contagion and catastrophe for Cboe/CME and its clearing member firms if a Bitcoin collapse leads to mass defaults.

Predictably, floodgates have opened, with promoters singing the siren’s song of getting in on the ground floor of the “next Bitcoin” with an initial coin offering, or ICO. This year, 270 ICOs have raised $3.2 billion from investors, 10 times the amount raised from 2014-2016. Most ICOs are not registered with the Securities and Exchange Commission, and less than 10 percent back companies with an active product or service.

The SEC issued an Investor Bulletin on the inherent danger of ICOs in July. But with financial luminaries such as boxer Floyd “Money” Mayweather Jr. (Centra, Stox and Hubiits) and socialite Paris Hilton (Lydian) touting ICOs to their social media followers, what could possibly go wrong?•


Kim is the chief operating officer and chief compliance officer for Kirr Marbach & Co. LLC. He can be reached at (812) 376-9444 or mickey@kirrmar.com.


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