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Bank of America Pegs Bitcoin -- Here's Why It's a Waste of Time

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."

Whoa!! What?!?

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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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 08, 2013, at 9:39 PM, ch25061 wrote:

    Does anybody take seriously anymore??

    The Greater Fool Theory does apply here in spades, but not to BitCoin, but to the subscribers to Motley Fool. At least it can be said that the Fool subscribes to the Truth in Advertising precept,and for that, I give them credit, but not for anything else.

  • Report this Comment On December 09, 2013, at 12:11 AM, gtvcmsc wrote:

    Their name suits there model. It's obvious that the fools dislike BitCoin as it interferes with their interests - As people would rather invest in something which solves real world problems then inefficiencies with fiat. And what they don't realize is the more they bash the BitCoin protocol, the more they promote it and make themselves look like...what's their name again?

  • Report this Comment On December 09, 2013, at 5:35 AM, ninthgate wrote:

    wow, this is devoid of analysis. arguing that a lack of short capability making it a poor long, and then likening bitcoin to tulip bulbs misses a key issue. the dutch tulip bulb mania was less about tulips anf more about options speculation. tulips often werent exchanged, but rather derivatives rose and fell in value. bitcoin has no options or derivatives market per se, though second market and winklevosses are working on it (sigh).

    bitcoin is young, and has transactional volume that surpasses western union. and yet, only about half of bitcoin has been mined. bitcoin volatility is occuring because the market is trying to discover the value, all the while that trading bitcoin volume is low.

  • Report this Comment On December 09, 2013, at 6:19 PM, derpy wrote:

    Eventually some day someone from will learn to read a chart instead of parrotting what some other publication has stated.

    "Tulip mania" in bitcoin took place in APRIL 2013!

    But hey.... jump on the bandwagon trashing bitcoin like every other party interested in gaining control over a currency system which competes with fiat currency.

  • Report this Comment On June 20, 2015, at 6:35 AM, john9hoffman wrote:

    This article is well done it seems to me. It doesn't go far enough though to explain the impracticability of trying to eliminate the 'double pay' and 'trust' issues bitcoin supposedly solves on a small scale but doesn't in my opinion on a larger scale. The trouble to hack such systems probably isn't worth the time of a professional team when the sums are in the thousands but when larger amounts are are being bandied about I am sure they would be willing to give cracking bitcoin a try. Trust in a securely encrypted system still depends upon who issues the public/private key pairs and not just on being 'faster than the bad guys' as proposed in Nakamoto's white paper. The public/private encryption key pairs I presume in bitcoins case are issued by the bitcoin Exchanges themselves. These are the keys that the enthusiasts of bitcoin propose using to conduct trillions in transactions and to 'validate' the hashing of billions of such transactions daily by the bitcoin miners. Ultimately any encryption key service can be hacked or intercepted without a central body (physically) regulating at the least the generation of the master encryption keys used to generate other keys in the network. The master keys need to be entered physically at a secure facility in a room at a secure location to be totally safe. This could possibly involve two agents of possibly two regulating agencies each possessing 1/2 of the key unbeknownst to the other keying in their separate parts at the console individually. Each key would need to be entered by the two agents and stored directly into 'protected' memory in a chip on a hardware encryption card possibly brought by the regulators themselves to the location. They would then need to enter the keys using an algorithm accessible only at the server console and not by other user sessions. Guards would be limited to opening the door to the logged-entry room in a secure location impervious to wimea and any em signalling and operators asked to leave the building. Each key would need to be physically keyed into the system at the console by the agents in halves into protected memory on the encryption card (encrypted itself) for the bitcoin master key to be truly 'safe'. Until such regulatory agencies exist or big banks assume the role I might personally be less than confident about trusting the future of the world's currencies and markets on hipsters, currency anarchists and gangsters. Once this is done basing an eCurrency system on a publicly-funded distributed system similar to DNS based on multiple point validation to quickly identify and correct any attacks I would be a little more tempted to invest in bitcoin but not before then.

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