Newswise — Bitcoin was on something of a hot streak recently, touching an all-time high above $50,600. And the move had debate about the cryptocurrency heating up as well. Is Bitcoin a viable currency for trade? Or is merely it an overheated asset, poised to cool down? Maryland Smith experts Brent Goldfarb and David Kass recently weighed in.
Goldfarb also is an associate professor of management and entrepreneurship, academic director of the Dingman Center for Entrepreneurship and co-author of "Bubbles and Crashes: The Boom and Bust of Technological Innovation," (2019, Stanford University Press). Kass is a clinical professor of finance and previously served as an economist in senior positions with the Federal Trade Commission, General Accounting Office, Department of Defense, and the Bureau of Economic Analysis.
First, on a question of value, Kass says, “Bitcoin has no intrinsic value but is being valued by the market by supply and demand. It is a form of digital gold, but gold has some value as jewelry and has some industrial uses.”
Kass, with Goldfarb, gave more insights in the following Q&A:
Q: Where is Bitcoin’s price ceiling Bitcoin and who benefits from a high price?
Kass: People who bought early at lower prices and sell at higher prices will benefit. The greater fool theory applies here – people who are foolish to buy Bitcoin at a high price expect to sell it at a higher price to a greater fool. It can be used to hide illicit activity.
Goldfarb: There is no theoretical limit to the price of Bitcoin. It will continue to rise so long as there are people who think it will continue to rise. At the same time, without an anchor point, it can also crash very quickly. I can say with certainty that the floor price for Bitcoin is zero.
Q: Now that the Federal Reserve is paying attention to Bitcoin, is it already worried that it poses a challenge to the international status of the dollar?
Kass: The U.S. Treasury and the Federal Reserve are likely to issue a digital dollar in the future which would render Bitcoin and other cryptocurrencies as less useful, resulting in substantially lower prices for them. Other countries are likely to issue their own digital currencies.
Q: What will be the impact in the future? Some argue that Bitcoin is similar to gold, but with its price so volatile, who would dare use it as a store of value?
Kass: Bitcoin cannot be used as a currency or medium of exchange because its value is volatile and unstable. It is not a store of value.
Goldfarb: Bitcoin, like gold, has value because it is an agreed-upon medium, not because it is generally useful as a currency. Currencies become more useful when they have a stable, predictable value. Bitcoin fails this test because if there is a belief that its value will increase, people will hold it as an investment. (Why buy a cup of coffee with Bitcoin today if you can buy two tomorrow?) If they believe the value will fall, they will seek to sell it and move to more stable assets.
Some additional sources of risk for Bitcoin are that it is used for illicit activity, and Bitcoin mining wastefully uses considerable energy resources. These issues may lead to regulatory pressures by world governments. For example, the Fed does not believe Bitcoin is a competitive threat, and it is in the U.S.’s best interests that this remains true. But given its volatility, I think that the Fed is right.
Q: What are the similarities and differences between Bitcoin and the 17th century Dutch Tulip bubble?
Goldfarb: Bitcoin’s soaring price inevitably has drawn comparisons to early 1637, when prices for some tulip bulbs in Amsterdam were briefly on the order of 17 years’ wages, before collapsing by 99.99%. In other words, speculators inflated the prices of the bulbs up to 20 times, before the market collapsed and reached normal levels in February of that year. All this happened in coffee houses. They bargained, raised the price, but only for future tulips. Many of these deals never took place.
Bitcoin is similar, only a very small share of Bitcoin is traded on any given day. This makes Bitcoin particularly volatile, given that large price changes may occur if a slightly larger group of Bitcoin holders become spooked.
Just as Bitcoin is hailed by some as the next great tech stock, the tulip bubble was a technological bubble. Growers were engaged in crossing the seeds, but they were never sure what the color would turn out until the tulips grew. This uncertainty contributed to an aura of mystery around certain tulips that, in turn, pushed their price upwards. The only part of the analogy that holds for Bitcoin is the narrative of a technology in that Bitcoin’s use will be as a currency replacement. However, central banks work very hard to stabilize currency values, and they are generally quite successful at this.
The potential for rising value that makes Bitcoin attractive as an investment, makes it unattractive as a currency. So long as this is true, the Bitcoin-as-currency-tech prophecy will be confined to the true believers.
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Clinical Professor of FinanceUniversity of Maryland, Robert H. Smith School of Business
Dean’s Professor of Entrepreneurship | Academic Director, Dingman Center for EntrepreneurshipUniversity of Maryland, Robert H. Smith School of Business