Cryptocurrencies, especially bitcoin, have been on an exponential rise for quite some time now. The astronomical rise begs the question: Are cryptocurrencies, specifically bitcoin, in a bubble? Well, Warren Buffett thinks so.
Addressing students during a Q&A session recently, Buffett criticized Wall Street for accommodating big price movements in cryptocurrencies. Buffett was blunt in his comments on bitcoin; he thinks the cryptocurrency isn’t a value-producing asset, and it can’t be valued for that reason. He didn’t go so far as to predict the reversal in the market.
Proponents of the cryptocurrency aren’t silent though. Peter Thiel, the co-founder of Paypal (PYPL, Financial), believes that bitcoin is underestimated. “It’s like a reserve form of money. It’s like gold, and it’s just a store of value. You don’t actually need to use it to make payment,” said Thiel in an interview. Thiel further argues that it’s secure, and it can’t be diluted by government. But all of his bullishness is based on the presumption of bitcoin becoming the cyber-equivalent of gold.
It seems like the bitcoin mania is going to play out in one of three ways: adoption as a currency, adoption as a store of value or adoption as a collectible.
Adoption as a currency is highly unlikely
There are several issues that have be addressed for bitcoin to become a mainstream currency.
First, the volatility in bitcoin’s price is hindering its widespread adoption for payments. Bitcoin is just accepted at three out of 500 top retailers, according to Internet Retailer.
Second, transaction fees are quite high, which makes bitcoin unfavorable for small everyday transactions.
The key problem with bitcoin’s acceptance as currency is regulation. Fiat currencies are highly regulated. Transactions are monitored closely as governments want to maintain control in economic policies, reduce criminal activity and related money laundering.
If bitcoin is regulated, the appeal will fade as it won’t be different than any other digital mode of transaction. Other benefits of bitcoin including speed of transaction can be replicated by financial institutions through using blockchain technology.
All in all, if markets are valuing bitcoin as a currency, then Buffett is right to call bitcoin a bubble.
What about Peter Thiel’s argument that bitcoin will be cyber equivalent of gold? This question brings up the second scenario where bitcoin can be widely accepted as an alternative to gold.
Adoption as a store of value is possible, not probable
This scenario is more likely to pan out than being a currency as bitcoin has all the features of being a store of value. According to Aswath Damodaran, a professor of finance at NYU's Stern School of Business, cryptocurrencies are becoming an alternative to gold for people who don’t trust conventional currencies. He further argues that gold doesn’t have as much of a utilitarian function as other commodities; it’s rather a store of value. Hence, gold can’t be valued; it can only be priced. Similarly, a price tag can be put on bitcoin, but it can’t be valued.
He agrees with Buffett in a sense that bitcoin isn’t a value-generating asset. He differs from Buffett as he thinks that bitcoin isn’t in a bubble. Following Damodaran’s argument, bitcoin is only a minuscule of gold’s value. Gold in circulation is roughly valued at $7.5 trillion as compared to a market cap of $98.4 billion for bitcoin.
Damodaran ignores the fact that gold is unique. Cryptocurrencies can be created using the blockchain. The threat of a new emerging currency will always be there for bitcoin, which isn’t the case for gold. That’s one of the reasons why it’s difficult to compare bitcoin to gold. Moreover, gold has a long history of being used as a store of value. It would not be easy for any cryptocurrency to take that status away from gold.
Takeaways
Buffett is usually right. It wouldn’t be wise to bet against him. He’s right to say that bitcoin can’t be valued because there’s no value-generating aspect of bitcoin. He didn’t comment on bitcoin being a store of value. It’s implied, though, as he commented on bitcoin being in a bubble.
The future of bitcoin is uncertain as a store of value amid uncertainty around its ability to be a dominating cryptocurrency in the long run. Threat of emerging currencies is always there. Unlike gold, bitcoin isn’t unique; it has competitors.
In short, we should listen to what Buffett is saying.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
