Ken Martin: Bitcoin: tulip or railroad?
The writer is co-founder and chief financial officer of Honeycomb Credit and a senior adviser to Cryptiv, an investment and technology company.
Press Release – The price of bitcoin broke the $11,500 mark this week, then promptly fell back under $9,500, leaving many asking whether the bubble will finally burst. But a better question would be, “Is bitcoin more like tulips or railroads?”
The nine-page white paper that launched bitcoin now supports a $167 billion market capitalization and a daily volume approaching $10 billion. Bitcoin is like gold in that it produces no cash flow and has value only because people collectively believe it is valuable. But since gold rarely appreciates more than 50 percent per annum, it is reasonable to ask why bitcoin’s 877 percent return in 2017 is anything more than a speculative bubble.
To be clear, there are speculative forces at work in driving the price of bitcoin higher. However, in the same way that long-term stock price trends appear to be gambling to the untrained eye, the price movements of bitcoin are ultimately governed by the same laws of supply and demand.
The supply side of bitcoin is quite clear. The rules of bitcoin dictate there can only ever be 21million bitcoin created, with 16.7million having been mined to date. Unlike gold, whose price has occasionally moved dramatically based on newly discovered mines, the supply of bitcoin is transparent and widely known.
Where is the demand coming from, and why is it happening now? The clearest answer is that institutional investors have begun to notice crypto assets. A steady stream of top money managers have launched crypto funds during 2017. According to research firm Autonomous Next, 99 hedge funds dedicated to crypto assets launched in 2017, compared with just 26 in the previous six years combined.
Despite the significant institutional money pouring in, crypto assets are still nascent when compared to traditional asset classes. Bitcoin is by far the largest, representing over half of all crypto asset value. But bitcoin’s total value amounts to just 19 percent of Apple’s $882 billion market capitalization, and it is insignificant against the $22.6 trillion market capitalization of the Standard & Poor’s 500.
In traditional capital markets, U.S. Treasuries enjoy a price premium as the world’s reserve asset. The size and liquidity of the Treasury market makes it the overwhelming choice for keeping large sums of money. Bitcoin is the de facto reserve asset of the crypto markets. Over time, new and existing crypto assets may grow and capture investment dollars, but for now no other crypto asset comes close to bitcoin in providing the liquidity to absorb large injections of institutional money.
So, is this institutional money purely speculative, and is the bubble soon to burst? Analogies to previous financial manias have been drawn, particularly the 17th century tulip bulb mania in the Netherlands.
Dutch speculators paid ever-increasing prices, and in one case values rose 2,200 percent in just four months. However, the soaring prices were based merely on a consumer fad and bear little in common with bitcoin’s potential for industry realignment.
Perhaps a different boom and bust story better illustrates bitcoin’s current rise.
THE ASSOCIATED PRESS
The first modern commercial railroad was established in 1830 by the Liverpool & Manchester Company of England. It is hard to overstate the impact of railroads on the 19th century economy. Much like the IT revolution of the 20th century, railroads revolutionized and reconfigured the entire economy.
Railroads are a backbone infrastructure, and much like the Internet, ecosystems and industries built on that backbone have had profound and lasting impact.
Forward-thinking investors and entrepreneurs of their day recognized the enormous opportunity and rushed to establish railroad companies. Millions of miles of tracks were laid and thousands of locomotives manufactured.
This rush to market sometimes produced boom and bust cycles. Famously, the United States’ railroad boom of the 1880s ended spectacularly in 1894 with the bankruptcy of nearly one-quarter of all U.S. railroad companies.
Both tulip mania and the railroad panics exhibit classic characteristics of financial crises. An initial demand shock drove prices higher, and a combination of financial leverage and human nature created an unsustainable trajectory that ultimately crashed.
However, railroad bubbles occurred because risk-taking investors saw the potential for a radical transformation of the economy. Even as some companies failed, the assets they left behind were often absorbed and largely put to productive use. Tulips, on the other hand, were largely a consumer fad that had little lasting impact on the world economy.
Is the price of bitcoin today overdue for a correction? Yes. But are many investors betting on a transformational moment that makes a lasting impact on the world? I believe so.
This article was originally posted here.
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