Beware Of Bitcoin

Bitcoin is not a futuristic currency but a speculative mania. Greed is pushing prices skyward but fear will quickly bring those same prices crashing back to earth. Investors need to separate the promising technological innovation of digital currency from the Bitcoin Ponzi scheme that will harm those that fail to exit before the bottom falls out.

Bitcoin is another example of “market innovation” that deserves closer scrutiny from the Securities and Exchange Commission. SEC Chairman Mary Jo White has said virtual currency itself may not be considered a “security,” but interest issued or returns gained by it likely would be and therefore subject to regulation. Federal Reserve Chairman Ben Bernanke told Congress that the Fed “does not necessarily have authority to directly supervise or regulate these innovations.” And the Justice Department says Bitcoin is legal, but that doesn’t mean it is adequately market tested, investment safe and ready to be a global currency.

Bitcoin is not a currency with intrinsic value but a hyper bubble fueled by a get-rich-quick mindset.

Asset bubbles have three phases: growth, maturity and pop. Bitcoin was created in 2009, hitting its growth stage in 2011 and maturity stage in 2013. Now it is ready to pop, having reached the nosebleed price of over $1,000, up from $13 since January. In addition to high-tech stocks, Chinese real estate and high-end artwork, Bitcoin can be added to the list of speculative bubbles that will not end well for investors.

Unfortunately, the bubble run-up in Bitcoin and reputational damage will destroy a potential innovation that could have been used for legitimate market purposes. Silk Road, the deep web purveyor of drugs, guns and prostitution was its biggest promoter.  Dangerous price movements — over 5,000 percent increase this year — also hamper its adoption as a trusted currency. Unlike the U.S. dollar, which is backed by faith in the largest economy in the world, Bitcoin has no backing and lacks a stable or predictable price, inhibiting commerce. Placing high risk bets on a fad asset is not for the faint of heart. Compared to other assets, Bitcoin is over 7 times as volatile as gold and over 8 times as volatile as the S&P 500. Recent Bitcoin price movements make owning Zambian kwacha seem boring.

The benefits of digital currency to reduce transaction cost and compete with Visa and MasterCard has real promise for consumers. But to claim that volatile Bitcoin is the currency of the future in its current "Wild West" stage is intellectually dishonest. There are numerous digital currency alternatives evolving including PeerCoin, Litecoin and Anoncoin that are gaining investor interest and challenge the notion that Bitcoin will be the market standard.

Very few credible retail shops even accept Bitcoin which leaves the bulk of interest with speculators. Bitcoin has no underlying value and is simply a digital way to place bets and attempt to capitalize on it by claiming built-in scarcity and hyped demand. In reality, it is a virtual coin created by computer programmers out of thin air. These are computer geeks — not central bankers that understand capital markets and how global economics works. Bitcoin only has value if speculative interest remains. Prices could drop as dramatically as they have risen, inflicting substantial financial losses, causing investors to flee. In the last week, prices have risen by over 60 percent and could easily fall by that same amount or more. Once sellers outnumber buyers, prices will eventually drop below $10, erasing all gains. This price collapse will occur by the first half of 2014.

Bitcoin is not a currency with intrinsic value but a hyper bubble fueled by a get-rich-quick mindset. Can the 12 million digitally manufactured Bitcoins in circulation really be worth $12 billion? If so, why can't 12 million rare clamshells discovered on a remote island be worth $12 billion? At least with clamshells there is history supporting their use as viable currency.

Recent Bitcoin price movements make owning Zambian kwacha seem boring.

In the last month, Bitcoin has increased over six fold — from $150 to over $1,000 — despite the fact that underlying fundamentals have not changed, nor do they support such lofty prices. Is one Bitcoin mined by a computer really worth the equivalent of close to one ounce of gold? The supposedly maximum number of Bitcoin that will be mined remains at 21 million. Yet these internet coins can also be broken down into almost infinite bite sizes. Skyrocketing prices have increased the number of computers participating in this modern gold rush, raising legitimate concerns about whether existing controls will be adequate to prevent market manipulation schemes.

If Bitcoin is not backed by anything and has no underlying value, why have prices risen to the clouds? Speculators are being sold on hype and recent price spikes have been used to claim this flawed investment premise is rock solid. Real value is created through meaningful innovation and adoption — not from smoke and mirror deception.

In recent U.S. Senate testimony, soon-to-be Fed chief Janet Yellen missed an important opportunity to call out Bitcoin as an example of a dangerous speculative bubble. Smart investors needn’t wait to be told.

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