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Bitcoin = Tulips

tulip

Korean and Japanese gardens, unlike their Western counterparts, tend not to feature many individual flowers. That might explain why residents of these countries are perhaps less familiar with tulips.

If so, maybe Korean and Japanese investors can be forgiven for piling into bitcoin. The rest of us should know better.

The Wall Street Journal reported last week that “bitcoin mania” had reached new highs. The cryptocurrency’s price briefly surpassed $19,000, after earlier jumping about 40 percent in under 48 hours. Bitcoin’s year-to-date gain is about 1,560 percent. A large share of bitcoin transactions these days come from South Korea and Japan; the Journal reported that Japan alone comprises about 60 percent of bitcoin trading. But there are plenty of people around the world lining up to jump on this craze, despite the warnings of financial and economic professionals. As Derek Thompson recently wrote for The Atlantic, “If every currency is a consensual delusion, then bitcoin […] feels more like a consensual hallucination on psychedelic drugs.”

As I have written in this space before, bitcoin is not money. If anything, it’s tulips. The bitcoin craze is presently feeding itself voraciously and turning a commodity with limited and specific real-world uses into something a lot of people suddenly feel they must have, even if they cannot articulate why.

Money has been defined as having two purposes: as a store of value and a medium of exchange. Bitcoin serves neither of those purposes well. As a medium of exchange, bitcoin remains cumbersome to use, when it is accepted at all. As a store of value, its failings are even more obvious.

Suppose you hire a contractor to add a room to your house. You agree on a price of five bitcoins for his labor. Within a 40-hour period last week, the price for your new room expressed in dollars would have increased from $50,000 to $90,000; it could have just as easily gone the other way, however, tumbling from $50,000 to $10,000. In either case, if you and the contractor had agreed to price this service in bitcoins, one of you was liable to walk away from the transaction deeply disappointed.

Neither you nor the contractor could know at the outset of the project exactly how much of your labor it would take to equal his labor in adding a room to your house. After all, you are not paid in bitcoins. You are paid in a traditional currency like dollars, which you would have had to convert to bitcoins at some price. The contractor would presumably have to convert the bitcoins back someday at, potentially, a wildly different price if he wanted to use them to buy much of anything.

This is why virtually no one prices tangible goods or services in cryptocurrency, at least in mainstream commerce (though all bets are off if you are in the market for cartoon cats). Doing so would be equivalent to basing the price of a home improvement on futures contracts for the delivery of oil, or pork bellies, or any other commodity you like. Yes, these contracts have real value. But what that value will be on a given date is anybody’s guess. And in the current atmosphere, it is significantly harder to guess the future value of bitcoin with any reasonable accuracy than it is to guess the future value of pork belly contracts.

What we are seeing in bitcoin right now is a pure speculative mania. I have seen people I know, whose work has nothing to do with money or finance, encouraging all their friends to pile into bitcoin with tales of how much money people have made. I’m hearing other friends voice regrets about not buying into the fad sooner. These are sober, sensible people, not ordinarily given to financial flights of fancy.

Yet most people buying bitcoins are not hoping it use them as a form of currency. They are hoping to hold them while their dollar value rises and then cash out. In other words, what is driving demand is speculation, not buy-in to cryptocurrency as an idea. As personal finance blogger J.D. Roth recently observed: “If you want to speculate in Bitcoin, go for it. But don’t delude yourself that what you’re doing is investing.”

We have seen this drama before, based on everything from tulip bulbs to internet stocks. It never ends well for the majority. The bitcoin bubble will be no exception to the rule. The only money anyone should put into bitcoin is money they can afford to lose without regret.

At the end of the day, tulips were not a financial miracle. They were just a bunch of pretty flowers.

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