This week, Bank of America (NYSE: BAC) became the first major U.S. financial institution to cover the digital currency Bitcoin. In the report, analyst David Woo estimated a maximum fair value of $1,300 and a maximum market capitalization of $15 billion.
Let's hope this is just a PR stunt, an attempt to make the bank appear younger, hipper, or part of the tech in-crowd. Because for actual investors, this exercise in prognostication is a waste of time. Here's why.
Covering tulips in 1637
What is Bitcoin, exactly? Proponents will tell you it's a nonfiat currency. It's a way to do transactions in the modern age free from the government, bank, and regulatory restraints of our current fiat system. They'll tell you it's the future of commerce. It's a panacea from financial oppression.
Others will tell you that Bitcoin is a flash in the pan asset, not a currency at all. It's a tulip bulb. It's a series of ones and zeroes being traded -- no, speculated upon -- without any underlying value or practical application. There is even a website devoted to maintaining the current Bitcoin-to-tulip bulb exchange rate (690 at the time of this writing, if you're looking to trade your leftover Thanksgiving orange tulips).
At this point in time no one really knows what bitcoin really means in the big picture. It seems equally likely to me that it could be the start of a commerce revolution or yet another time- and money-wasting folly of group psychology.
Bank of America's calculation assumes, preposterously if you ask me, that bitcoins will become "a major player in e-commerce and money transfer, and a significant store of value with a reputation close to silver."
Why is that preposterous, you ask? Several reasons.
1. Pump and dump
Like it or not, bitcoin is wrought with fraudsters, schemers, and other clever bad guys. The New York Times has reported of several instances of such schemes, including Boiler Room-style pump and dumps executed using Twitter.
Earlier this week the Chinese central government barred the nation's banks from accepting bitcoin. The Bank of France issued warnings as well. Despite these soft actions, the fraudsters still act without fear of repurcussion. From the Times article:
[The lack of law enforcement] has allowed more than 30 episodes in which at least 1,000 Bitcoins -- or $1 million at the current rate of exchange -- were stolen or transferred illegally, according to a frequently updated list on the most popular online forum for Bitcoin. Of those cases, 10 involved losses of more than 10,000 Bitcoins, or $10 million at the current value. The authorities have only been publicly involved in one of these cases.
Hard to justify bitcoin as a major player in e-commerce or as anywhere near the store of value of silver when scammers can operate with this much impunity.
2. Its essentially impossible to bet against bitcoin
Fortune magazine's Stephen Gandel spent a good amount of his time this week attempting to short Bitcoin. Gandel, a very smart financial mind, couldn't figure out a reasonable method to achieve the trade.
Traditionally, a short trade requires shares to be borrowed from a current owner. Besides the fact that no mechanism to allow borrowing exists, would you be comfortable letting digital cowboys borrow your money in the Wild West?
Gandel was able to buy put options, derivative contracts that did allow him to bet against a rise in bitcoin value, but the costs involved with executing the trade didn't make economic sense. The trade would have lost money even if the value of a bitcoin plummeted 55%! Hard to justify losing money when a price moves 55% in your favor.
Does this sound like the silver market to you? Me either.
3. The entire bitcoin market is vulnerable to a complete shutdown
Would you consider illegal drugs as a viable investment? Drugs are in demand, and as the War on Drugs raging on, the product is in short supply.
But the economics don't matter in that example because of government intervention. Your entire investment could be scooped up by the DEA at any time (and also, there is the whole legality/jail time issue).
The same is true of Bitcoin. With the Chinese government all but banning the currency from mainstream adoption, a significant portion of the market is wiped out overnight. The New York Times estimated that about 30% of global bitcoin purchases come from China.
The supply and demand implications of this fact are huge! The supply of Bitcoins is essentially fixed (not technically, but close enough for this point). Overnight the demand side declines by 30% based on the decision of just one government. With no inherent value, the downside risk to Bitcoin prices are absolutely tremendous.
What happens if and when the U.S. government changes from its current "watch and wait" policy? Or European Union states? Or Japan?
Thanks for the effort, BofA, but no thanks
Bank of America should be applauded for attempting to stay ahead of the curve. Unfortunately, this report provides no real value to investors or even bitcoin speculators. The assumptions built in are simply erroneous at this point in bitcoin's evolution.
Perhaps time will prove me wrong, but for now I won't be buying any bitcoins and I'll only be buying tulips for Mother's Day.
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