A clue that the bitcoin craze was descending into sheer madness came in a recent e-mail from my investment adviser – subject line, Bitcoin: new kid on the block.
The body of the message shows a graph of the exploding price of bitcoin. It looks like one wall of the Grand Canyon. A straight line, soaring upwards from the flat valley floor.
Who wouldn't want a piece of the best performing financial asset of 2017? Bitcoin's market capitalization, at nearly $300-billion (U.S.), makes it worth as much as a Top 50 U.S. company.
The launch last week of trading in bitcoin futures gives the coins an aura of legitimacy.
The problem is that bitcoin is not an investment – at least not in the conventional sense. It's more like a lottery ticket, a piece of art or an obscure over-the-counter mining play.
Bitcoin, the most popular of hundreds of cryptocurrencies, was created in 2008 by a shadowy group of software geeks as an alternative to traditional money. Users trade and create, or "mine," bitcoin over a vast network of peer-to-peer computers linked together using special software, known as blockchain. This creates a verifiable, encrypted and ever-expanding record of transactions, conveniently beyond the control of financial institutions and central banks.
There is a fatal flaw in this utopian scheme. There isn't a whole lot you can do with the stuff, even as the price for one bitcoin soared to more than $17,000 from less than $1,000 this year. It and other cryptocurrencies are not a particularly good store of value (the price is too volatile), nor a convenient way to buy things (OverStock.com is one of few retailers who accept it). The markets it trades on are shady and completely unregulated (one of the largest bitcoin exchanges collapsed this year after hackers stole nearly half a billion dollars in coins). And unlike a stock, it will never pay interest or a dividend.
That leaves secrecy as the clearest benefit of bitcoin, allowing criminals to launder money, move cash and evade taxes. Among the heaviest early users were wealthy Chinese eager to duck government restrictions on taking money out of the country. Chinese authorities have now cracked down on bitcoin exchanges – a hint of what regulators might do elsewhere to counter illegal use of cryptocurrencies.
Indeed, regulators in Canada, the United States and elsewhere are now raising alarms about the risks that cryptocurrencies and other linked products pose to investors. This week, both Bank of Canada Governor Stephen Poloz and U.S. Federal Reserve chair Janet Yellen issued apparently co-ordinated warnings to investors. Both made it clear that cryptocurrencies are not, in fact, currencies at all, or good stores of value.
That is hardly the future of money.
The hype about bitcoin is misplaced. The nascent technology behind cryptocurrencies is much more promising than the coins themselves. That's why central banks, lenders, insurers, utilities, retailers, stock exchanges and a wide range of businesses are all investigating blockchain's intriguing possibilities.
For example, the Bank of Canada is working on a so-called "digital ledger" project with the Big Five Canadian banks, the Canadian Payments Association and R3, a New York-based fintech consortium owned by roughly 50 of the world's largest banks. The experiment, dubbed Project Jasper, involves banks pledging cash collateral into a special pool, which the central bank would then convert to a digital currency, called CAD-Coin.
Any industry that depends on large-scale record-keeping could find a use for what is essentially a vast user-managed database. The technology could become a cheap and efficient platform for clearing bank transfers, credit card payments and other financial transactions. Retailers and product manufacturers might use it to track the safety of items they sell. It could also find a role in the real estate industry for selling and transferring homes, or in the auto business tracking vehicles' accidents and repair history.
But don't confuse these promising applications of blockchain technology with the explosion of companies offering investors some dubious connection to either bitcoin or blockchain technology.
And what about the arrival of bitcoin futures and other derivatives? Optimists argue they'll allow serious investors to go long on bitcoin, giving even more upside to the currency. Well, crypto-speculators should recall what happened during the U.S. housing crash. In 2006 and 2007, investors shorted derivatives linked to mortgage-backed securities, contributing to the implosion of the subprime market.
If all that doesn't make you pause before getting on the cryptocurrency bandwagon, here's a good investing maxim: If you don't understand it, don't buy it.