The Bitcoin Bubble

As of the time of writing this article (3:45 PM PST on 11/27/2018), the quoted price on bitcoin is $3,782 from www.coindesk.com/price.

“Avoid bitcoin like the plague. Did I make myself clear?” This was the advice of the legendary John Bogle, the founder of Vanguard Group Inc. and the father of low-cost passive investing for retail investors. Bogle, speaking at a Council on Foreign Relations event a little more than a year ago (when Bitcoin was trading at about $10,000) explained his view as follows:

“Bitcoin has no underlying rate of return. You know bonds have an interest coupon, stocks have earnings and dividends, gold has nothing. There is nothing to support bitcoin except the hope that you will sell it to someone for more than you paid for it.”

Bogle distilled the essential difference between an investment (stocks and bonds) and a speculation (gold and bitcoin). The former has an expected return while the latter does not. As shown by the French mathematician Louis Bachelier, the expected return of speculation is zero. This is before costs, so the expected return after costs is negative. As Bogle points out, a speculation relies solely on the greater fool theory.

Bitcoin and its blockchain ledger represent a remarkable application of a rather arcane area of mathematics (algebraic geometry over finite fields). Overall, it boils down to finding solutions to problems that require very high amounts of computational power. Conceptually, it’s not that different from saying that a currency unit will be assigned to each of the approximately 3.5 billion prime numbers between 1 and 1.1 trillion, and whoever finds these numbers first can claim ownership of them, which of course, is nonsense.

As we see it, bitcoin is a solution to a non-existent problem. When it began to grow in popularity, we were told how it would be the currency for the digital age and render the world’s fiat currencies obsolete. Down about 40% for the month of November 2018 and about 80% from its peak in 2017, it does not begin to meet the basic requirements of a currency as a medium of exchange (When was the last time you bought something with bitcoin?), a unit of account, or a store of value. It goes without saying that everything said here about bitcoin applies equally to all the other cryptocurrencies. As always, listen to Saint Jack.