In 2008 a man named Satoshi Nakamoto posted a research paper on the web that described his design for a new digital currency he called bitcoin. There had been various attempts at digital currency over the years: eCash, bit gold, b-money. But none of these got off the ground. They foundered on the notion of a centralized ownership registry.
Nakamoto got around this by designing what he called a “block chain”: an encrypted, publicly distributed ledger of every transaction involving every fraction of a bitcoin ever created. Bitcoin and its block chain were something new – a digital transaction medium that doesn’t depend on a central clearinghouse to make sure the same currency doesn’t get spent twice.
Bitcoin was initially a digital curiosity. A few retailers have accepted them as payment, but the idea never took off. Bitcoins are cumbersome to use. A typical transaction can take up to 10 minutes, and the price is extremely volatile. Anyone who bought a Dell computer online in 2015 for 3 bitcoins back then is probably kicking themselves now. Those three bitcoins are worth almost $50,000 now.
But the blockchain – a distributed, cryptographically protected ownership ledger – is potentially transformative. Every aspect of recordkeeping could be digitized: digital stocks, digital bonds, digital contracts, digital titles to your car or house. Blockchain could become a very important element of financial technology, and a lot of firms are looking into it.
Crypto-currencies themselves have now gone viral. Crypto is the new “e.” In the late ‘90s, e-commerce was taking over, and firms like e-Pets and e-Trade received premium market valuations just for having “e” in their names. The same thing is happening with “crypto.” Obscure firms like Long Island Iced Tea and TGI Solar Power Group announced that they were focusing on crypto technology and their stock prices tripled. New cryptocurrencies seem to sprout up daily: Ethereum, Ripple, Litecoin, Tether. It’s hard to keep up.
“The Last Spike” by Thomas Hill. Source: Wikipedia
The explosion of bitcoin’s value has been pretty silly. But a lot of good things can come from silly bubbles. The dot-com bubble provided a lot of broadband capacity; the real-estate bubble has inspired more consumer lending protections; the railroad bubble of the late 19th century resulted in a lot of transportation capacity. It may be that the crypto bubble will create blockchain capacity.
This bubble will end, as all bubbles do, with an overshoot and collapse. We know why it will end. The asset price will exceed its fundamental value by several orders of magnitude, and investors will lose their enthusiasm. Some investors will lose a lot more. We just don’t know when.
Douglas R. Tengdin, CFA