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Bitcoin: a millionaire-making investment, or a bubble waiting to burst?

From a value of more than $19,000 in December, bitcoin fell dramatically, quickly shedding more than 60% of its value. Then came a mini recovery, but that faltered and the price dropped to around $6,600.

But since the start of April we’ve seen a steady rise back up to $9,400. So, is it once again set to make you rich beyond your dreams? I say no.

Warren Buffett thinks the same, identifying bitcoin as a gamble and not an investment. Comparing it to ownership of a business, Mr Buffett points out that “if you buy something like bitcoin or some cryptocurrency, you don’t really have anything that has produced anything. You’re just hoping the next guy pays more.

I think there’s one glaring reason why gambling on it is a mug’s game, and that’s because it isn’t working. And it isn’t working, precisely because so many people are gambling on it.

Bitcoin is supposed to be a currency, and some folk suggest all currencies will work the same way one day. But it is missing one key feature that’s required for a successful currency — stability.

Burn the pound

The Bank of England could start burning pounds tomorrow and drastically cut the supply. That would force demand up and boost the pound’s value, just like bitcoin. But the pound would stop working as a currency.

Would you spend your cash today if you thought you could buy twice as much with it in a few months, or even overnight? Of course you wouldn’t, you’d hoard it and only spend the absolute minimum you had to.

Relying on a massively volatile currency, you’d effectively be in an economy that’s lurching between hyper-inflation and deflation. The price of a tomato could quadruple next week, and then drop to dirt cheap the week after.

And if we’ve learned one thing from the past couple of centuries of pondering on economics, it’s that price volatility is a bad thing.

We don’t want high price inflation, but at the same time we don’t want deflation either. The former discourages saving and investment, while the latter discourages spending and consumption.

An economy needs a happy medium between the two, which is usually seen as inflation of around a couple of percent — and that’s simply impossible if it’s based on a highly volatile currency.

If we did away with all our traditional currencies and switched everything to bitcoin, we’d destroy the world’s economies overnight.

Why buy it?

So why do people buy it? The value of an asset is dependent on its utility in the long term. That is, what it’s worth for the purpose it is intended. For bitcoin, that will be its value as a currency.

But bitcoin is not currently valued on its long-term usefulness as a currency at all, it’s valued on an “I wonder what the next mug will buy it from me for” basis.

Bitcoin can surely not work as a currency until the supply is geared to some sort of stability measure in the way the supplies of pounds and dollars are geared to economic productivity measures. And the gambling mania has to come to an end.

I fear its eventual value as a currency will be considerably lower than as the latter-day tulip bulb it is right now.

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