Ignore the talk of new paradigms in bitcoin

A single unit of the virtual currency bitcoin this week was worth more than 17 times what it was at the start of the year, yet it wasn't until two bits of information landed here the same week that a reasonable conclusion was finally clear: Bitcoin had left the earthly realm of finance and zoomed off into the thin air of fantasy.

One was just a short piece in Bloomberg on the future of ConnectX. This company plans to replace a common practice of bitcoin owners of keeping a "wallet" key safe from hackers by burying them in the backyard by instead blasting their digital wallets up into space. Seriously, on satellites.

The other bit of information was a Twitter message from John McAfee, an early innovator in computer security software and now a high-profile cryptocurrency enthusiast.

"Those of you in the old school who believe this is a bubble simply have not understood the new mathematics of the Blockchain, or you did not [care] enough to try," he wrote. "Bubbles are mathematically impossible in this new paradigm. So are corrections and all else."

LOL, as the teenagers say on the internet.

If assets have a price and can trade, people can easily convince themselves that the price only goes up and then pay far too much to own them. That's a paradigm as old as market economies.

This is not to say bitcoin is overvalued. Sure seems like it is, but if there is a way to carefully analyze bitcoin and arrive at its fair price, it's completely unknown to me. Some famous skeptics on bitcoin don't have it quite right, including JPMorgan Chase & Co. boss Jamie Dimon. He explained in October he couldn't understand the value of "something that has no actual value."

Money is the medium of exchange, and for it to work all that's really needed is everyone trusting what it is worth. Without it, two parties would end up having to barter. The hassle of doing that all day in a market with lots of things for sale is why the ancients settled on items like silver rings as money thousands of years ago.

Bitcoin, as a medium of exchange, seems to be gaining acceptance.

That partly what explains its dramatic rise in price, said Bryce Doty, a senior vice president of Minneapolis-based Sit Investment Associates and fixed income portfolio manager working hard to stay on top of cryptocurrency developments. Doty suggested there's likely not enough bitcoin to facilitate all the transactions people would use it for. Because it's easily divided into smaller pieces, the way to create more for transactions is a higher price.

The big threat that Doty sees for bitcoin owners comes from ethereum tokens, litecoin and other newfangled virtual currencies. If a few of the alternatives become more broadly accepted, too, then no one will need to chase down bitcoins for their transactions.

"There are initial coin offerings happening all the time," Doty said. "There's something like 700 cryptocurrencies, and probably 200 of them are frauds."

A good store of value is something stable and predictable that you can use later to pay a bill. If on Jan. 1 you agreed to pay one bitcoin, it would be kind of nice to know that when the bill came due in December, the cost of what you bought hadn't gone up about 17 times.

Clearly, in the last year people have not decided that bitcoin was useful to pay a bill or that its underlying technology sure looks to have a bright future. It was that bitcoin prices are going to the moon.

But to state the obvious, no one can really "invest" in bitcoin. Just speculate.

Bitcoin creates nothing of value, like interest, rent from an apartment building or greater output from a new machine on the plant floor. The only reason to buy bitcoin is the hope that in two months somebody else won't care that it is not productive and pay more for it.

If that case for owning bitcoin sounds familiar, that's because it is what people talk themselves into before buying gold. As Warren Buffett famously observed, if you buy and hold one ounce of gold for an eternity, you will only ever own just one ounce of gold.

As a reminder, price bubbles have popped in gold, too. If grandpa was unlucky enough to have bought gold on the wrong day in 1980 he owns an asset still worth less than half what it cost nearly four decades ago, adjusted for inflation.

So please try to ignore the talk of new paradigms in bitcoin, of pure markets beyond the reach of corrupt regulators or innovative math that rules out the chance an asset is mispriced.

Even Sir Isaac Newton, a famous smarter-than-average guy who more or less invented calculus, came too late to truly understanding the limits of human thinking when it came to pricing assets. He finally figured it out during the infamous South Sea Co. stock bubble, losing what would be roughly $4 million today when it collapsed.

"I could calculate the motions of the heavenly bodies," he said, "but not the madness of the people."