Money Matters Monday 5th February 2018
Is Bitcoin an Investment?
There is never any shortage of people attracted to the idea of getting rich quickly without effort. The latest evidence is the bitcoin story. Financial advisers are often asked if bitcoin offers a real investment opportunity.
Bitcoin is not an investment opportunity, if investment means buying something and holding for a reasonable time, say a year, so it can produce earnings. However bitcoin offers a speculation opportunity.
As with anything traded in a free market the price of bitcoin is determined by the law of supply and demand. Demand for most goods is underpinned by their usefulness for some practical purpose. This is known as their intrinsic value.
What is Bitcoin’s intrinsic value?
Bitcoin has no intrinsic value, zero. It does not produce any income or pay any dividends and it cannot be used for any practical purpose in the real world. Some may argue that it can be used as a store of wealth like gold.
Although, gold is used extensively in jewellery production and to a limited extent in industrial processes. Bitcoin has no equivalent uses.
Despite having no tangible or intrinsic value bitcoin is driven by the law of supply and demand. Individual bitcoins are “mined” by using high powered computers to test large quantities of random numbers until they find one that solves a problem.
However, the rate at which new correct random numbers are discovered is restricted to an exact schedule known in advance. There will be a specific number of bitcoins in existence at any given date. The final number to be created is 21 million in the year 2140.
The effect of supply and demand
This gives us the first clue to bitcoin’s price – scarcity. Bitcoin has a very limited supply. But rarity cannot lift the price alone. There also has to be demand. How do you create demand for a product that has no intrinsic value?
You publicise it. Bitcoin exchanges and promoters have put a great deal of money (real dollars) and effort into promoting bitcoin as a legitimate investment via traditional media and online chatrooms that ban negative opinions.
Once a few people are keen to buy something that has limited supply the price starts to rise. Those early holders then announce their “profitable investment” to friends and contacts which creates more demand and the price rises further. Repeat.
This is the speculation opportunity. If you buy now the price may rise further making you a profit. But it may not. Until now the “Bigger Fool Theory” has held true – that there is a bigger fool than you who will be prepared to buy from you at an even higher price.
Eventually, people will realise bitcoin has no fundamental value and the price will fall back.
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