Sometimes we elevate belief beyond factual truth. This a core principle of religion and politics. When belief supersedes reason in finance, we call it speculation.
Is belief crowding out reason when it comes to Bitcoin and other cryptocurrencies? While I think that blockchain technology is promising, I don’t know if we should be betting on Bitcoin and other virtual currencies as if they’re a new discovery of gold or silver deposits.
Prof. Robert Shiller, who teaches economics at Yale and is an expert on bubbles and speculation, says we should pay close attention to the story behind Bitcoin. He claims it bears some huge similarities to the Wizard of Oz, which was really a veiled satire on the folly of the gold standard (the “yellow-brick road”).
As someone who has carefully analyzed both the housing and dot.com bubbles – and won a Nobel Prize in economics for his research – Shiller has called the Bitcoin craze a bubble. This is what he told Quartz earlier this year:
“I think that has to do with the motivating quality of the bitcoin story. And I think, what’s so exciting? You have to think like humanities people. What is this bitcoin story?”
For one thing, millions believe that Bitcoin will make them rich with little or no effort. After all, the virtual currency’s reference price has climbed more than 600% in recent months, although it’s retrenched this month – off 50% from its peak value.
Then there’s the allure of blockchain technology: The government doesn’t control it, computers around the world monitor it and it’s embedded in cryptic code, so it would be hard to hack. So goes the story, although there are some strange aspects to it.
When I saw Shiller speak recently, he elaborated when I asked him a question about Bitcoin. Shiller was lecturing at the Chicago Humanities Festival.
I’ve seen Shiller several times in the past and have interviewed him for two of my books: The Cul-de-Sac Syndrome and Keynes’s Way to Wealth.
How do you value Bitcoin when there are no earnings, dividends or price/earnings ratios? I asked Prof. Shiller.
While he didn’t offer a direct reply on the valuation question, he gave me his observations on the story behind Bitcoin and why it’s valued so highly.
“Bitcoin is the best narrative possible,” Shiller replied with a smile. “It’s a great story. It’s a mystery based on a person who wrote a brilliant paper that nobody seems to have found (Satoshi Nakamoto).”
“Who is this person? Maybe he doesn’t exist. But when I’m lecturing at Yale, my students wake up when I talk about Bitcoin. I can see it in their eyes. I’m interested in the narrative.”
For now, you’ll also need to pay attention to the other parts of the Bitcoin story. It’s unregulated, although government agencies are casting a gimlet eye on it. Big banks hate it. Drug dealers reportedly use it on the dark web. Transactions are really hard to trace, if at all.
The CBOE and CME Group is offering derivatives that allow you to hedge or speculate based on the cryptocurrency’s price.
Certainly blockchain and Bitcoin and its many cousins aren’t going away. But their popularity will hopefully not obscure the need for more transparency. I would refrain from adding them to your retirement plan until more is known.
Then there’s the underlying narrative. Every story has its ups and downs. Although I have no idea where Bitcoin will end up, keep in mind that all bubbles don’t end well.