The Bitcoin (BTC 1.01%) bubble may finally be bursting.
The price of the largest cryptocurrency fell below $30,000 on Tuesday for the first time since early in the year in response to a crackdown on Bitcoin mining by the Chinese government. It was the latest piece of bad news for Bitcoin, coming after Tesla CEO Elon Musk said his company would stop accepting Bitcoin as payment. Bitcoin prices peaked with the Coinbase IPO in April and have fallen by about 50% since then. Interest in cryptocurrency is also likely to slide along with the value of the digital coins fall, and with the economy now back open some investors may be choosing to return to pre-pandemic activities, leaving their interest in cryptocurrency behind.
Nonetheless, the most ardent Bitcoin bulls are standing by the digital currency, but their arguments for a cryptocurrency takeover conveniently ignore a number of holes.
Image source: Getty Images.
1. Bitcoin isn't solving a real problem
Bitcoin exists not because it's needed, but merely because it can exist. While there are real-world use cases for it such as in economically defunct countries like Venezuela, and for ransom payments when criminals don't want to be tracked, the notion that Bitcoin will displace fiat currency is far-fetched, if not utterly ridiculous.
Bitcoin backers have invented a war against fiat currency to give the cryptocurrency a purpose, but fiat currency like the U.S. dollar works just as intended, as a medium of exchange or a store of value. While inflation is a concern with holding cash, the volatility in Bitcoin and other cryptocurrencies shows that they're much less reliable as stores of value.
The reaction to the news in China, where officials said they wanted to "clamp down" on Bitcoin, is telling. If cryptocurrency backers believed that Bitcoin offered a true alternative to fiat money, then the price of Bitcoin would have been unaffected or it may have even risen as government overreach offers one argument for using Bitcoin. That wasn't the case, however, as the news wiped out about 20% of Bitcoin's value over the weekend, though the currency has recovered some of those losses.
2. Almost all of its value is speculative
Most bulls argue that Bitcoin's value is attached to its ability to be "digital gold" and to serve as a hedge against inflation. But in reality, Bitcoin's value derives mostly from it being a vehicle for speculation. In many ways, it's the perfect speculative asset. It trades 24/7 globally, giving investors a greater pool of people to trade with and much more time to do it in. There are no fundamentals to attach to its value, making its price mostly a factor of technical charts, emotions, social media commentary, and news. At a time when meme stocks have taken over the market, Bitcoin has also become a meme itself with its biggest bulls adopting laser eyes in their social media profile photos to identify with the phrase, "laser rays until $100k," or until the price of a bitcoin hits $100,000.
Bitcoin can function as a currency, but its primary use case is being traded in the hopes of making speculative profits. This approach essentially boils down to the greater fool theory, whereby traders buy an asset in the hopes someone else will pay more for it. It's mostly worked for Bitcoin thus far, but that's no good reason for it to climb to $500,000 as bulls like Cathie Wood have argued.
3. Scarcity alone doesn't equal value
One of the favorite arguments of Bitcoin backers is that its scarcity gives it value. The number of bitcoins will be capped at 21 million, which Bitcoin bulls believe explains the reason for its value. About 18.5 million have been mined so far, but they will continue to be mined until 2140 due to the periodic slowing of the reward for mining, known as halving.
It's true that scarcity helps add value to some things like gold and precious gems, a piece of art or another collectible. But scarcity alone doesn't translate into value. Every piece of art, for example, is unique, but only a handful fetch sums of millions of dollars in auctions. That's because they are made by famous artists, there's something particularly eye-catching about it, or there's some other cache attached with it. Similarly, a Honus Wagner 1909-11 baseball card recently sold for nearly $4 million, but most baseball cards are nearly worthless, despite being old and out of print, in other words scarce. .
In order to create lasting value, Bitcoin needs more than just scarcity. Being limited at 21 million isn't enough to warrant a valuation as high as the world's most valuable companies.
After the recent boom and broader adoption by mainstream institutions, Bitcoin looks like it's here to stay, but the biggest risk to the currency may be a falling price and a loss of interest from the general public. A further decline in the price could create a negative feedback loop that leads to margin calls, significant losses, and a disenchanted investor base that loses faith in the currency.
At this point, Bitcoin's value is attached to the buzz around it. If it loses that, it may never reach its prior heights.
