Brokers Need to Know that Bitcoin has an Economic Flaw

by Victor Lund on January 10, 2018

But the biggest gains may be ahead.

If you took economics class in college, you understand that currencies of any type have a relationship between four very important metrics: MV=PQ.

M is the total amount of money supply in circulation.
V is the velocity of money and the frequency that it is being circulated.
P is the price level
Q is the inflation adjusted index of goods and services.

The economic flaw with Bitcoin is that you cannot buy much with it. Sure – we hear these isolated discussions about people buying houses with Bitcoin, but those are isolated one-offs. There are companies like Filecoin that pay people in coin for hosting files, another called Steam that allows bloggers to earn coin by writing. Many more are emerging every day, but generally speaking, Bitcoin is investors investing in a currency that nobody uses for goods or services. This is a major problem for cryptocurrencies like Bitcoin and others.

Investors Caused the Bitcoin Bubble

Here is where the speculation comes in. There is no government involved in cryptocurrencies like Bitcoin. It is a truly free market economy.

Sovereign currencies are managed. The United States and other nations use the equation of MV=PQ to keep the economy balanced with artificial stimulation – government spending, putting money into circulation, setting interest rates, issuing or buying bonds or treasury bills, etc. The ability to tax the economy is a big control lever.

There is no doubt that the money pouring into Bitcoin and other cryptocurrencies is outpacing the economic output. The value run up in Bitcoin value after an 8 year trend of about $1000 that has been caused by the capital markets buying Bitcoin. The buy side demand is outpacing the sell side. We believe that Bitcoin and many other crypto currencies are being driven by hedge funds and electronic traders. They have electronic buy and sell points that are executing. When a few major investors follow the same trading pattern, the currency gets erratic. If a bunch of people sell, then the currency will fall to the bottom. As long as speculators continue to buy and hold – it will go up.

In the case of Bitcoin, the traditional value that lasted from 2008 to 2016 was $1000. Investors poured a lot of money into the currency in 2017, driving the price up as high as 19,000 before a year end correction down to $15,000. Investors get this, so some are taking gains and looking for the next cryptocurrency run up – probably Ripple or the some next currency.

Tip of the Iceberg

The lack of government intervention in cryptocurrencies means that nobody pays any tax. And there is nothing that artificially controls the value. It is like a return to the gold standard. Depending on where you live, this is a major impact. When governments take a third or half of the profits in a company away each year, it is dilutive to the company and the investor. Imagine the growth of your company without any tax consequences. Imagine the growth of your portfolio without any capital gains taxes.

Startups and small businesses represent new opportunities to put Bitcoin to work. They have the highest cost of capital, and represent the largest and most profitable segment of the economy. This demand for capital among these emerging companies is underserved in the marketplace. Venture Capital firms rarely make investments in tiny companies or boring companies on mainstreet. But there is good news! Cryptocurrencies need to find a real trading economy. The coins need to be put into real businesses with real people who are buying and selling real goods and services that have real value. The economy has not emerged with Bitcoin yet, or any other currency. But we believe that it can.

This is what I mean by tip of the iceberg. Startups are emerging that embrace the blockchain and cryptocurrency economy. Investors are looking for substance. That is what creates an emerging market. The money needs to flow somewhere, and the stock market is oversold already.

I think that we are looking at the tip of an iceberg. The volatility of cryptocurrency will balance out as real companies start growing within the new economy. There is lots of capital available to the first companies in – without the onerous government oversights government manipulation, or regulations like Dodd-Frank or the SEC. Investors in cryptocurrency deals and blockchain deals are investing with a small amount of their treasury in high risk ventures with the understanding that losses are as likely as 20x gains. This is definitely not over.

Additional Note:

We are watching Kodak with great interest. They have launched an initiative to help photographers secure the rights to their images using Blockchain. The announcement doubled the value of the stock, and this may be the initiative that saves the company as they emerge in the new economy. Anyone who has dealt with Getty Images understands the amount of economic value that is possible from recovering licensing fees on photos used illegally. In real estate, the MLS is at the center of most photo copyright submission on behalf of the broker, but the Library of Congress is making it difficult to register copyright in bulk. More on this soon.

Leave a Comment

Previous post:

Next post: