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By Mike van der Westhuizen and Nishlen Govender
RECENT Bitcoin mania has raised a heated debate as to what the world’s largest cryptocurrency (by market capitalisation) is actually worth.
Until recently Bitcoin garnered attention from mostly computer science boffins and the criminal underworld, but the 350 percent price rise since the beginning of the year has started turning heads around the world.
As the famous Wall Street saying goes: “When even shoe-shine boys are giving you stock tips, it’s time to sell.” Is this adage warranted in the case of Bitcoin?
Bitcoin’s appeal centres on the fact that it operates independently of any central bank. As such, it is seen as the new age of global currency and payment methods. Of the roughly $100 billion total cryptocurrency universe, Bitcoin comprises just under half. And although it is prominent now, it has in fact been active since 2009.
Bitcoin’s rapid price acceleration has been attributed to: Japan’s adoption of the currency as an official medium of payment. As well as, possibly, the removal of high-value bank notes in India and Venezuela or even the continued devaluation of the Chinese yuan.
Its potential as a hedge to global market uncertainty.
A relatively smooth “hard fork” — basically a permanent divergence in the (Bitcoin) block chain which would essentially mean that Bitcoin splits into two different “coins” (Bitcoin and Bitcoin Cash), and hence potentially only one of those would be of real value.
But how should Bitcoin be valued? A key factor is to determine whether it is an asset class and, if so, what the appropriate valuation criteria to assess it might be. There are significant stumbling blocks here as there are no underlying fundamentals that allow us to price or value Bitcoin.
If we assume that Bitcoin is a currency, we would try to ascertain a long-run fair value by using various models: relative purchasing power parity, inflation differentials or interest rate differentials. But these values are impossible to ascertain for Bitcoin given the lack of central bank involvement, the absence of a domiciled area or, indeed, any linking economic fundamentals.
If we treat Bitcoin as a basic security, then there are no fundamentals that we can use to assess it, leaving us unable to reach an appropriate valuation assessment.
Despite this stumbling block, there is no doubt that Bitcoin has done exceptionally well. A fact which is clearly evident if you merely consider the performance of the cryptocurrency in recent months.
If we cannot estimate value using traditional criteria, we can still assess a tradeable asset based on its supply and demand. For Bitcoin, we can break down participants into two broad spheres: those using Bitcoin for trading and those who are speculators.
We know from anecdotal evidence that Bitcoin still isn’t widely used as legal tender, based on the lack of vendors accepting it and the relative charges from third-party providers that link consumers with vendors. Additionally, as a store of value, it is extremely volatile and an unlikely source for long-term wealth preservation.
There is also a vast portion of trade that could be based on unreported illicit activity, but without further information it is difficult to understand the supply/demand dynamics from those users. We do believe that cryptocurrencies will be used much more in the future but, at present, this represents only about 0,12 percent of global trade.
If the only way we can value Bitcoin is based on supply and demand, and if those using Bitcoin practically as legal tender comprise just a small part of its demand, then we are left with a large portion of the current demand for Bitcoin being speculative.
With no viable way to determine what price Bitcoin, or any cryptocurrency, should be trading at based on usual valuation criteria, should demand slump it could result in spectacular losses along the lines of those seen during previous bubbles (something which is true even in Bitcoin’s relatively short history).
We believe that the hype and price appreciation of select cryptocurrencies belies any of the underlying traits that we would look for in a sound investment, and rather feeds on optimism regarding the future of cryptocurrencies.
We cannot tell you if these currencies are expensive or not, but we believe that without this knowledge it is impossible for us to invest in an asset class that seems to trade purely on momentum and sentiment.
In addition, there are some headwinds which — at least at this stage — could prevent Bitcoin being rapidly and widely accepted. These include: Bitcoin’s transaction processing is relatively slow, handling up to seven transactions per second, whereas service providers like Visa and Mastercard can handle thousands per second.
The size relative to the global monetary base is tiny. Without acceptance from regulating authorities, involvement in cryptocurrencies by large institutional players and governments will remain limited. It is unlikely that Bitcoin will replace money in the near to medium term because governments have far too much to lose from this move. Although Bitcoin can be used pay for goods and services, its heightened volatility negates the definition of a currency as a store of value.
Ultimately, Bitcoin is just a mathematical algorithm. There is no doubt that the technology behind Bitcoin (blockchain) is revolutionary, Bitcoin itself requires much wider acceptance and continual improvement in order for price moves like we’ve seen to be sustainable.
Other than its pure (but declining) dominance, Bitcoin has no distinguishable competitive advantage over other cryptocurrencies. — How we made it in Africa.
Online Reporter