MOST money these days is electronic—a series of ones and zeros on a computer. So it is rather neat that bitcoin, a privately created electronic currency, has lurched from $1,000 to above $10,000 this year (see chart), an epic journey to add an extra zero.
On the way, the currency has been controversial. Jamie Dimon, the boss of JPMorgan Chase, has called it a fraud. Nouriel Roubini, an economist, plumped for “gigantic speculative bubble”. Ordinary investors are being tempted into bitcoin by its rapid rise—a phenomenon dubbed FOMO (fear of missing out). Both the Chicago Mercantile Exchange, America’s largest futures market, and the NASDAQ stock exchange have seemingly added their imprimaturs by planning to offer bitcoin-futures contracts.
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It is easy to muddle two separate issues. One is whether the “blockchain” technology that underpins bitcoin becomes more widely adopted. Blockchains, distributed ledgers that record transactions securely, may prove very useful in some areas of finance, and beyond. The second is whether bitcoin will become a widely adopted currency in everyday life. Here the evidence is weak.
Bitcoin can be used to buy a few things. But a currency has three main functions: store of value; means of exchange; and unit of account. Bitcoin’s volatility, seen when it fell 20% within minutes on November 29th before rebounding, makes it both a nerve-racking store of value and a poor means of exchange. Imagine buying an iPhone X with bitcoin in January. You would by now be cursing as the same coin could buy ten phones—Christmas gifts for the whole family.
A currency is also a unit of account for debt. Paul Mortimer-Lee of BNP Paribas, a French bank, tartly remarks: “Imagine if you had financed your house with a bitcoin mortgage.” This year your debt would have risen tenfold. Your salary, paid in dollars, euros or whatever, would not have kept pace. Put another way, had bitcoin been widely used, the last year might have been massively deflationary.
Such issues will be of minor concern to those who managed to buy bitcoin earlier in the year. They will just be delighted with the profits. But why has the price risen so fast? One justification for the existence of bitcoin is that central banks, via quantitative easing (QE), are debasing fiat money and laying the path to hyperinflation. But this seems a very odd moment for that view to gain adherents. Inflation remains low and the Federal Reserve is pushing up interest rates and unwinding QE.
A more likely explanation is that as new and easier ways to trade in bitcoin become available, more investors are willing to take the plunge. As the supply of bitcoin is limited by design, that drives up the price.
But it is worth remembering that the cost of using bitcoin is going up. Each transaction has to be verified by “miners” who need a lot of computing power to do so, and a lot of energy: 275kWh for every transaction, according to Digiconomist, a website. In total, bitcoin uses as much electricity a year as Morocco, or enough to power 2.8m American households. All this costs much than processing credit-card transactions via Visa or MasterCard.
The miners are rewarded for their efforts by being paid in bitcoin; they are delighted by the rise in the currency’s price. But some are finding ingenious ways to cut back on their energy costs; one even put computers in his Tesla car so he could mine bitcoins using its free charging stations. Much mining is done in parts of China where electricity is cheap.
There are two ways of thinking about this. One is that the eventual price of bitcoin will equal the marginal cost of mining, which may be rising but is well below the current price. The second is that institutions will not want to use the technology if it relies on such a “Wild West” process; banks are already looking at cheaper forms of blockchain technology.
Whether the investors driving the price higher are pondering all this is open to doubt. It looks like a re-run of the dotcom craze. Adverts for trading digital currencies are appearing on the London tube and celebrities have piled onto the bandwagon. As seen many times before, when lots of investors buy an illiquid asset, the price can rise exponentially.
The top is hard to call. At some point, the urge to turn all those digital zeros into cars and iPhones will prove too great. Getting out of an illiquid asset—as this week, when exchanges struggled to cope with trading volumes—can be harder than getting into it. Some remember Nathan Rothschild’s remark about the secret of his wealth: “I always sold too soon.”