Thursday, January 2, 2014

Bitcoin Bubble

"Money, again, has often been a cause of the delusion of multitudes...... Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one." 
-Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds (1841)

Actual money existed when banks/governments issued notes representing gold/silver on deposit.  Fiat money exists when governments decree their notes to have value and mandate their use. Bitcoins are digital tokens.

An infinite number of digital pseudo-currency systems that aren't backed by government or assets can be created at virtually no cost.  Why will the herd continue to assign an inflated value to one (Bitcoin) when its functionality can easily be duplicated by lower-cost crypto-currencies?

Many have made theargument that "nothing backs Bitcoin." And this is true. Bitcoin cannot be redeemed for any fixed value, nor is it tied to any existing currency or commodity. But, neither is gold. Gold is not backed by anything - it isvaluable because it's useful and scarce.

Bitcoins are scarce.  But unlike gold, which has myriad uses besides money (jewelry, electronics, etc.), bitcoins wouldn't be useful if people stopped believing they served as a store of value.  It wouldn't take much (government crackdown, network failure/fraud/hack, emergence of superior alt-currencies, etc.) to completely and forever destroy the beliefs on which bitcoin valuations rest.

I would not own Bitcoins, or the S&P 500, or fixed-rate bonds in this environment, which I perceive as stagflationary.  Whether inflation accelerates remains to be seen.  But I think precious metals-related assets, such as gold mining stocks and antique 90% silver coins, represent good value in 2014.

Unlike Peter Schiff, I think it likely that the stock market will head lower in spite of the Fed's stimulus.


  1. Hey LR, I enjoyed these two videos. Regarding the price action for gold and silver, there are two youtube channels you may want to know about. Both are run by guys who were right in calling the run-up in prices and also right in calling for the price drop.

    Josh Galt:

    DayTradeShow (Don Harrold):

    The second one tends to delete his older videos from time to time, but he also from time to time offers his insights on what he thinks the price action for silver will be and why (using charts) for what I think is are cheap prices (around $2-$5). He has been right in calling the movements ahead of time and I has done a better job then some other more well-known people who charge much more but have been far less right. He said silver would trade again for sub-$20 when it was up near $50 in 2011. He also talks about his approach for figuring out at what levels he plans to buy and sell.

    Anyway, both of the above are starting to get bullish on silver again. Don thinks silver has the possibility to get down to the point that it could have a $13 handle on it but that now is still a relatively good time to buy. He plans to put money to work right now and at around $17, $15, $13, with putting more money into it the lower it goes. He says that silver may not get that low and that it could just go up from here.

    There is also a guy named Martin Armstrong ( you may want to look into and check out his blog at the linked site. He called the drop in gold and the run up of the stock market. He does cycles work and says that he thinks the stock market will go generally upward until about the third quarter of 2015. He also says that is when gold will really start to go up again (though he thinks most of it's decline has already happened, but may still go a little lower until then). He did an interview November 27th that I think is worth listening to:

    Hope you like the links.

    1. Don nailed it last year, and virtually nobody took his advice. Most people would rather listen to gurus who reinforce their own worldview, so they don't bother to seek contrary opinions.

  2. Where your analysis goes off the rails is in asserting that 'money' has to have an intrinsic industrial value independently of its monetary value.

    This is wrong. In fact the exact opposite is the case.

    Anything which is a candidate for a tokenised storage of value has to have certain properties - scarcity, resistence to counterfeiting, fungibility etc. But it does not have to have an industrial utility value.

    Conversly, (contrary to the allusion of your paragraph 3), gold does not derive its value from its industrial uses. Most of its value comes from its popularity as a monetary unit (or 'store' of value) and fungibility. Its industrial uses are incidental to this nowadays since there's almost nothing that's manufactured which depends on it. Likeways, there is an abundance of Jewellery which is far more expensive than gold which does not contain gold.

    Bitcoin, on the other hand, is potentially far more valuable than gold in terms of both a store of value and an industrial technology. For a start, it is the first ever peer-to-peer monetary transmission mechanism which does not require a counterparty. That has huge implications for a multi-trillion dollar counterparty industry (which includes the banking system). Secondly, Bitcoin - as a form of money - is unlevered. That makes it far more desireable than credit money in a crisis (there is already substantial historical evidence for this from Cyprus, Spain and Argentina). It also gives rise to the possibility of a debt-free economy which credit money does not.

    So Bitcoin's (and cryptocurrencies in general) value derives from it's unique technological benefits which allow it to function as a peer-to-peer monetary unit globally. As such, it's currently undervalued by about 100 to 1 at least and is certainly a long way from being 'nothing'.

    Finally, please think through what you mean by "backed" when you say "backed by government assets". I cannot go to a bank and exchange my dollars for government assets (as one could when there was a gold standard). Nor will the government guarantee the purchasing power of my dollars if they devalue against the price of cornflakes. So there is no backing in terms of exchangeability.

    Possibly what you mean is that you can pay taxes using government money and it's defined as "legal tender" which gives some confidence to people. Confidence is a whole lot more volatile form of 'backing' than exchangeability for assets and is rapidly disappearing.

    Bitcoin on the other hand, as with gold, isn't backed by anything. It is therefore *base money*. The human race has found very few things which have the unique properties capable of allowing them to function as 'base money'. Gold was the "Bitcoin" of the physical market, but unfortunately can't travel through wires which puts it at a disadvantage now that we have a fully developed worldwide electronic trading platform which reaches into every household.

    A new 'gold' is needed and cryptocurrencies are it.


  3. Libertarian Realist
    It is not true that Gold does not have intrinsic value. Gold does have intrinsic value. Tell me a period of time where gold is not valued. Even a person who has no clue of the price of gold and the economics of gold will still perceive Gold as a valuable metal. That is also the reason why Gold was used as money because it is really THE standard in terms of "preciousness". For this and only this reason alone, gold has intrinsic value beyond just it's utility. Even if there is one day whereby the utility of Gold is being replaced. For example, if other metals replace gold in electronics, Gold will always be valued because of it's physical appearance and also perception by almost everyone that it is a naturally valued commodity.

    1. I agree. Gold has what could be called intrinsic value. Digital currencies backed by nothing don't.

  4. I am dissapointed that libertarians are now pushing for bitcoins. People who I thought should have more integrity are promoting something that has the potential to become zero one day. In the past, they keep saying that there is intrinsic value in Gold but now just for the sake of pushing their agenda, they are now decrying gold saying that gold is not useful as a currency as you cannot carry gold around. It's hypocritical and shows that most of them probably do not understand economics as well as you expect them to.

  5. Thanks for sharing this interesting post. I hope you share more about bitcoin currency.

  6. “Gold is not backed by anything - it is valuable because it's useful and scarce.” - So as bitcoin. Bitcoin has many uses as well; it is a medium of exchange, a payment method and a public ledger. It is valued because it has many uses and is scarce. But unlike gold, bitcoin has a lot to offer like its ability to transfer money fast and easily.

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