This Fund Manager Thinks Bitcoin's Value Is Limited

 

Many of the bitcoin's supporters see it as a way to circumvent the existing monetary paradigm, an alternative currency to facilitate transactions outside of the bounds of governments and central banks. (More extreme supporters have gone so far as to argue that it will serve as a way to destroy governments everywhere.) But Spitznagel isn't buying it -- although he argues in his new book, The Dao of Capital, that the current monetary system has set the market up for a crash, he believes the bitcoin is a mere extension of the dollar.

 

Like the U.S. dollar, which lost its gold convertibility in 1971, the bitcoin is essentially backed by nothing. Although the Federal Reserve (or any other central bank for that matter) can't intervene to increase the supply of bitcoins, the bitcoin is, like fiat currency, reliant on general confidence for its value.

 

"A medium of exchange really needs to have an intrinsic value of its own, typically a commodity value, through a long vetting process. We organically created this man-made concept of money because bartering is hard -- I have to find someone that wants exactly what I have to exchange -- money is much more dynamic and fluid. But money must come out of a commodity that has an exchange as well as an intrinsic value of its own," Spitznagel told me. "This has of course been bastardized by government fiat currency."

 

Spitznagel is a proponent of Austrian economics, a controversial school of thought that believes the government should take a very limited role in economic matters. He's critical of fiat currencies, like the dollar, because their value can be manipulated by central banks, in the process creating economic booms and busts. Like other Austrians, Spitznagel favors precious metals as money, and believes gold is the perfect medium of exchange (but he doesn't think everyone should buy it). 

 

Historically, gold has held its value over long periods of time; indeed, the stability of gold prices has been seen as one of the metal's greatest virtues. The U.S. dollar certainly hasn't been as stable, losing about 98% of its purchasing power since 1913.

 

But the dollar's decline has mostly been orderly; certainly nothing like the wild jumps seen in the price of bitcoins in recent weeks. As I write this, one bitcoin is trading for around $800, but earlier this month, that same bitcoin was going for over $900. In October, that bitcoin was worth about $150, and last December, it was worth around one third of that.

 

"The fact that the bitcoin has had such wild swings in value should make you question it," Spitznagel explained. "Real money, a store of value for exchange, doesn't move around that much."

 

"Why 21 million?" Spitznagel asked me, in reference to the bitcoin's limit. Built within the bitcoin system is a hard cap -- no matter what, there will never be more than 21 million bitcoins in existence. The actual number is somewhat arbitrary, and that concerns Spitznagel.

 

To create new currency,  bitcoin "miners" use their PCs to solve complex computational problems. The reward for solving these problems is new bitcoins, but over time, the problems become harder to solve and the number of bitcoins given per reward decreases. Right now, the reward is 25 bitcoins, but in 2016, it will fall to 12.5. The way the math works out, the number of bitcoins will never exceed 21 million.

 

As to why there's 21 million in particular, I couldn't give Spitznagel a satisfying answer, and indeed, there really isn't one -- designed a different way, the bitcoin cap could've easily been 50 million, or a trillion, or five. Bitcoin's supporters would argue that it doesn't matter -- that it's the process, not the limit, that makes bitcoin work.

 

This is intended to keep bitcoin creation stable, and to limit the number of bitcoins in existence. Unlike traditional fiat currencies, which generally depreciate over time due to inflation, bitcoin's hard limit prevents inflation, and bitcoins themselves should actually become more valuable over time. Economist Paul Krugman has criticized this inherent property of the bitcoin for baking deflation into the system, and encouraging bitcoin owners to hoard the digital currency.

 

"I see this as just another expression of the dollar -- [the bitcoin's] value arises from its convertibility into fiat currency. Frankly, it's kind of scary to me," Spitznagel said.

 

Many bitcoin supporters probably agree with Spitznagel on many issues -- the bitcoin has caught on among government critics; the Libertarian Party in the United States even accepts bitcoin donations. But is the bitcoin really the perfect alternative to government-controlled currencies? Is the bitcoin the new gold standard for a digital age?

 

Spitzangel doesn't think so, and I have to agree. The bitcoin remains tied to government currencies -- it only has value because it can be exchanged for fiat currency. The Bitcoin Foundation, for example, pays its employees in bitcoins, but only in a superficial sense. Their salaries are set in dollars, and the number of bitcoins they receive is based on the bitcoin's dollar value.

 

Moreover, opponents of fiat currencies frequently cite their instability as a reason for their opposition, and the bitcoin's orderly creation and 21 million cap should theoretically keep the bitcoin's value stable over time;yet, over the bitcoin's life, traditional currencies have been far more stable -- the sort of wild, regular $50 daily shifts the bitcoin has experienced are unheard of.

 

Behind those wild swings is a group online supporters convinced that bitcoin is the future of money. Sadly, when the bubble bursts, many of those supporters are going to be left holding the digital bag.