Almost everyone has heard of Bitcoin – a digital payment system and self-described electronic cash for the Internet. It is the first decentralized peer-to-peer (P2P) payment network powered and governed only by its users.
The first step was made in 2007 with the writing of the code. Later, on November 2008 the whitepaper was published on The Cryptography Mailing list at metzdowd by a programmer, or a group of programmers, using the name of Satoshi Nakamoto. It was titled “Bitcoin: A Peer-to-Peer Electronic Cash System.”
Nakamoto has conducted a series of experiments with Bitcoin’s software before revealing it to others in January 2009. On Jan. 3, the first ever Bitcoin block has been mined, marking the beginning of Bitcoin’s existence. Later on Jan. 9, 2009, Nakamoto has released the updated 0.1 version of Bitcoin software on Sourceforge, which contained some minor bug fixes.
Nakamoto has also created the Bitcoin.org website, which he used to collaborate with other developers. Satoshi remained a mystery, as he – or she – did not reveal any personal information during the entire time of cooperation with other developers. After two years of collaboration, Nakamoto has handed the leading position to Gavin Andresen and ceased all involvement in the project in December 2010.
Satoshi showed up once again on April 23, 2011, when he emailed a software developer, Mike Hearn, with “I’ve moved on to other things. It’s in good hands with Gavin and everyone.” From then no one knows what Satoshi is up to.
Ever since the dot-com and housing bubbles popped in 2000 and 2008, spotting bubbles has become a national obsession. Investors have spotted bubbles in bonds, credit, equities, gold — you name it — over the last several years.
I wouldn’t use the B-word to describe any of those investments — yet. In fact, I wouldn’t even nominate any of them for Most Likely to Bubble Over. I would give that distinction to a certain cryptocurrency that is quickly making its name and fortune: Bitcoin.
Bitcoin has all the attributes of a bubble in the making. First, it’s radically new. It’s a digital payment system that allows users anywhere in the world to transact directly without interference from intermediaries, governments, regulators or central banks — at least for now. Transactions are administered by a decentralized network of computers, much like the internet.
In his book about the 17th-century tulip bubble in Holland, “Tulipmania,” British journalist Mike Dash points out, “It is impossible to comprehend the tulip mania without understanding just how different tulips were from every other flower known to horticulturists in the 17th century.” The same could be said about the internet in the 1990s and about digital currency today.
Second, Bitcoin is shrouded in secrecy. Buyers and sellers of Bitcoin can trade anonymously, which makes the digital currency a favorite of criminals and hackers demanding ransom. Its origins are shrouded in mystery. Its creator goes by the name of Satoshi Nakamoto, but it’s unclear who that person is or if it’s even one person. That, too, is reminiscent of another bubble. At the height of England’s South Sea Bubble in 1720, one company floated shares “”For carrying-on an undertaking of great advantage but no-one to know what it is.” Of course, that didn’t stop investors from throwing money at the company.
Third, Bitcoin has no value other than what a buyer is willing to pay for it, which makes it susceptible to the argument that underlies all bubbles. Namely, that any price is appropriate. But there’s already reason to worry that Bitcoin’s price is excessive. An investment in Bitcoin has returned a breathtaking 351 percent annually since its inception in July 2010 through Tuesday. To put that in perspective, an investment of $100 in Bitcoin from the beginning would be worth close to $3 million today. It’s not easy to justify that kind of return for any investment.
Bitcoin is similar to other currencies and commodities such as gold, oil, potatoes or even tulips in that its intrinsic value is difficult — if not impossible — to separate from its price. But there are governments standing behind currencies and reliable currency markets for exchange. And with commodities, investors have something to hold at the end of the transaction. Bitcoin feels more speculative because it’s just digital ephemera.
That isn’t true for all investments. Stockholders are entitled to a share of a company’s assets, earnings and dividends, the value of which can be estimated independent of the stock’s price. The same can be said about a bond’s payments of principal and interest.
This distinction between price and value is what allowed many observers to warn that internet stocks were absurdly priced in the late 1990s, or that mortgage bonds weren’t as safe as investors assumed during the housing bubble. A similar warning about Bitcoin isn’t possible.
During the dot-com craze, Warren Buffett was asked why he didn’t invest in technology. He famously answered that he didn’t understand tech stocks. But what he meant was that no one understood them, and he was right. Why else would anyone buy the NASDAQ 100 Index when its price-to-earnings ratio was more than 500 times — a laughably low earnings yield of 0.2 percent — which is where it traded at the height of the bubble in March 2000.
Thinking back on investors’ credulity during the last two bubbles, I can’t help but wonder if buyers of Bitcoin understand what they’re invested in. They would be wise to ask themselves that same question. We all love ballons, but not this one.