How I think about Bitcoin

Tyler Cowen writes,

With crypto-assets, I am carrying wealth more generally into the future. The person who most wants that payoff structure for the wealth carry will end up owning the crypto-asset.

Read the whole thing, with which I do not agree one bit. Tyler knows more than I do about the topic, but for what it’s worth, here is my view.

I think of Bitcoin as functioning like a chain letter, of the sort where you say “Send ten dollars to the person at the top of this list scratch that person off the list, put yourself on the bottom of the list, and then send this letter to six of your friends.” If the chain letter keeps going until you are at the top of the list, you might get thousands of dollars.

A chain letter is a redistribution scheme that creates a few big winners and a lot of little losers. I see Bitcoin playing out the same way. As long as the Bitcoin chain letter keeps reaching new people, its value will rise. Once Bitcoin runs out of new suckers, er, investors, it will crash. Then we will find out who were the winners and losers. The few who sell before the crash will have made fortunes at the expense of those who paid up for it and held on for too long.

If you participate in a chain letter, the odds are very low that you will make it to the top of the list. Similarly, with Bitcoin, the odds are very low that you will sell your Bitcoin before it goes down in value. The majority of Bitcoin investors will buy high and sell low.

17 thoughts on “How I think about Bitcoin

  1. You just mean pyramid scheme right? Requiring superlinear scaling, or is a chain letter different?

    • Surely “chain letter” is a clever allusion to “blockchain”. Granted, blockchains can be used for other purposes, but that’s not why they’re getting attention and resources from the general public.

  2. I think of Bitcoin as functioning like a chain letter

    At this point I tend to think of BitCoin closer to Tyler Cowen although it will be a Widow Maker like Tech Stocks in 1999 or say Gold in 1980. Like Tech 1999 or Gold 1980, there is a good reason why investors moved to them at the start (say 1996 Tech or Gold 1977) but they become a bubble. And remember investors are usually right on the bubble of Tech 1999 or Railroad 1872 but they tend to be too early and too much. And that is what is happening to Bitcoin which is reasonable long term store of value and a market that comes across like a chain letter.

    Probably the one aspect of Bitcoin that does protect its growth is a great way to get your money outta Dodge situation for Valenzuela, China, and Russia. And there will always be a market for those situations.

  3. Yes, a Ponzi scheme, although a useful one for folks that want to hide transactions or get money out of corrupt and failing states. Devaluation of bitcoin is built into it’s design. Bitcoin mining is based on the cost of computer processing, which historically has declined over time.

  4. Like all other assets, the price of bitcoin is a collective hallucination–or at least that’s what I’d conclude from the opinion of a well-known economics blogger.

    I think Tyler is closer to correct here. I think bitcoin has a use value, and therefore it will never drop to zero. But I don’t know what the final equilibrium price will eventually be. My guess is more than it is right now–but that’s just a guess.

  5. Bitcoin and crypto-currencies are the perfect financial instruments of mass speculation. Since they have no intrinsic value, their value is whatever the crowd imagines them to have. What convinces me we are witnessing the madness of crowds is that the arguments made to justify the valuations are delusional. Consider that one of the arguments made to explain the scarcity of Bitcoin is people have lost them and what is lost will never be replaced. Well that’s dandy. Here we have a new currency so wonderful that it is not uncommon for people to lose it! What exactly is the attraction of putting money into something that requires such careful stewardship to avoid being lost or stolen?

    So the crowd responds that the benefit is crypto-currencies provide anonymity. But how is that a benefit and how true is that claim? How can the currency be anonymous if it carries a ledger of every transaction? And how secure is something if it cannot be proven who owns it? There seems to be a lot of hand waving going on to claim the currency is secure yet anonymous.

    Given the realization that the value of Bitcoin is whatever the marginal buyer says it is then I would not be surprised to see the coin exceed $100,000 or even $1,000,000. Why not? If a Monet can sell for $80 million then why cannot a virtual coin sell for a million dollars?

    Of course the the ultimate delusion is the belief by those “investing” in Bitcoin that they will be able to sell when the time is right. That’s right, the smart buyers are confident they will find someone less smart than them to buy their coin when they, the smart ones, recognize the price is heading lower. What the smart investor doesn’t realize is a lot of not so smart buyers have already bought and will also be looking to sell – meaning that when the times comes to sell who will be left to buy?

    • So the crowd responds that the benefit is crypto-currencies provide anonymity. But how is that a benefit and how true is that claim? How can the currency be anonymous if it carries a ledger of every transaction? And how secure is something if it cannot be proven who owns it? There seems to be a lot of hand waving going on to claim the currency is secure yet anonymous.

      It’s anonymous because ownership is tied to a private key, not an identity. Whoever has the private key owns the currency. It’s very easy to prove that you have the private key if you do have it. You can do this without revealing the key, just the fact that you have the key. It’s secure because it’s almost impossible for someone to figure out the private key.

      You do lose privacy if someone manages to associate your key with your identity. But that doesn’t happen in the blockchain itself, it happens at the edges, when you need to exchange real currency or goods.

  6. In inflationary times, crypto-currencies might make sense as an alternative to precious metals. But we don’t live in inflationary times. Combine that with the extreme price volatility (and the likelihood we’re in a bubble), it doesn’t make sense to me. I’m staying on the sidelines.

  7. Wouldn’t it be possbile that bitcoin could create a whole bunch of smaller winners and few big losers?

    I agree with you here.

  8. I own a title to the land I live on. I bought the land, I can sell the land, and if I make a trip to the county courthouse, I can look up the chain of title going all the way back to the legal establishment.

    is my title a chain letter? How does my title differ from my tight to transfer my bitcoins?

  9. The difference between a chain letter/ponzi and bitcoin is that bitcoin aimed to be money. Money is theoretically the bubble that never bursts. The early adopters get the value gain. The later holders of bitcoin are not expected to “gain value”. They are just expected to maintain value and use it as money, to buy whatever they want to. The end game for bitcoin is every productive human on earth accepts bitcoin as payment. There is no competing value standard left to sell to. It’s a very tall order, especially if stated that way. But it is not a fundamentally dishonest proposition like a chain letter.

    The great divisibility is kinda for that. But currently, its very difficult with the transaction costs and limited blocks. Those technical issues need to be overcome.

    • This.

      Also, we’re on the cusp of solving those technical issues. That’s why the first successful test of the Lightning Network on the bitcoin mainnet earlier this month is probably a bigger story in the long run than bitcoin’s current price run up.

  10. This interpretation seems to depend on thinking the bitcoin just is some random asset people are speculating about. But it’s not. It’s blockchain technology, which is unquestionably important and will unquestionably change the way we do a lot of things in the technology and financial space. Bitcoin itself might lose out to another cryptocurrency, though network effects and first move advantage play a large role here. But the underlying tech is important and game changing and that pushes against your view of it as nothing but a speculative bubble. Put another way, that the dotcom bubble was a bubble and crashed doesn’t mean the internet was nothing but a speculative bubble, because the underlying tech was sound. Bitcoin, being a protocol, is more like the early internet than it is like a tulip.

Comments are closed.