You probably saw a lot of news about Bitcoin last year. At the beginning of 2017, one bitcoin was valued around $1,000; by the end of the year, that same bitcoin was worth $14,000 – at one point reaching a high of around $20,000. So what created the increase in value? The short and most honest answer – NOTHING. Bitcoin value is based on “The Greater Fool Theory,” which basically states that in order to make money on Bitcoin, you have to find a greater fool than you, who is willing to pay you more for your bitcoin than you paid for it. Which is entirely possible, as seen by the recent increase in value – at least for a while. But like all cons, at some point, you run out of greater fools.
So what is Bitcoin? Basically, it’s electronic Monopoly money with the sexy name “cryptocurrency.” Currency is anything generally used to exchange goods and services, a system of IOUs if you will. It grew out of the need to find a more efficient way to barter goods and services, so that I don’t have to haul around my bushel of wheat to trade for your cow. Legal tender is a currency recognized by law that can be used to pay all debts and taxes. The goal of having a currency recognized by law is to keep it as stable as possible. Anyone can create a currency, just like Monopoly money, and it will have value to the extent that you can find someone to accept it as payment for goods or services.
Instead of creating all the currency at once, the creators of Bitcoin came up with a way to add a little at a time in a process they call “mining.” Basically, it’s a game – using computers, you solve math problems and are rewarded with bitcoins. A bitcoin is a number in code that only you have the password key to unlock. If you lose your key, you lose your bitcoins. The history of each bitcoin and who currently owns it is stored on a program called a blockchain. You can sell or trade your bitcoin to anyone who is willing to trade with you.
The best way to make bitcoins valuable was to make them rare. Therefore, the creators limited the number of bitcoins that could be “mined” to only 21 million coins. But just because something is rare does not make it valuable. Suppose I sign my name on one thousand Monopoly bills and I promise I will not sign any more. I have made my signed Monopoly money rare, but is anyone willing to give me $14,000 for each one? I will gladly sell them to you and hopefully you can find a greater fool who will pay you more then what you paid me. Anyone can see through this con. This is a basic Ponzi scheme or pyramid scam. However, if you make it sound sexier with terms like bitcoins, cryptocurrency, cyber mining, and blockchain security, then it sounds very futuristic and somehow valuable.
Some very innovative and useful technology has been developed to implement cryptocurrency. However, buying a bitcoin does not give you any of the rights to that technology. Currencies have changed many times throughout history and will continue to evolve. This evolution may include some form of cryptocurrency. Also, I will give the creators of Bitcoin credit for coming up with an ingenious way to run a legal pyramid scheme. But all pyramid schemes end the same way – those who make money along the way are paid by those holding the empty bag at the end. They are all zero-sum games.
The truth is, in order for something to become a widely used currency, it must be widely accepted for transactions, scalable, controllable, identifiable, and most important, stable. When a currency is stable, no one expects to make money by just holding it. You do not expect a dollar in your wallet to become worth two dollars. Those who are buying bitcoins today think they are buying an investment. Sooner or later, the music will stop and those holding bitcoins will find they have run out of fools who are willing to pay more. At that point, no one will want to hold them, they will still not be legal tender, and the value will fall to their original worth – zero.
Kenneth J. Simpson is a financial advisor with Onyx Financial Advisors, LLC, an independent fee-only registered investment advisor firm located in Idaho Falls, Idaho. He can be reached at (208) 522-6400 or at www.OnyxFinancial.c