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BITCOIN IS A MIRAGE
Today, if I have to comment where irrationality exists, the same way I commented on the irrationality in the housing market in 2012, it definitely would be in Bitcoin . For Warren Buffett followers Bitcoin is just a mirage. Let’s understand in a few lines why.
Bitcoin is a cryptocurrency, no matter what fancy name you give to it, at best it is just another currency like Dollar, Yen, INR . Although all traditional currencies are backed by central governments of their respective countries, I’m not sure how many people understand that Bitcoin has no backing at all from any or government.
Bitcoin is a currency started by somebody (nobody knows exactly who) and accepted by many. Since it is accepted by so many people, it started trading in the market. But remember Lord Warren “Public opinion is not a substitute for thought.”
The problem is the day people stop accepting it as a currency, it neither has utility nor can you take your bitcoin to some to convert it into a more widely accepted currency. For example, when the demonetization of old 500 & 1000 notes was declared, those notes were still backed by central government and despite the fact that people had stopped accepting them you could still go to RBI or banks and exchange them.
A Bitcoin is very similar to an eclairs chocolate, which many shopkeepers give you instead of a 1 Rs . coin when they are short of change. Chances are that this trend was started by some retailer and was gradually accepted by customers across the country. The advantage an eclairs chocolate has over Bitcoin is if the government passes a law that nobody from tomorrow can use eclairs as money, it would still have the utility for you or your kids because at least they can eat it and derive some pleasure from it.
But the government should be very careful that the amount of éclairs in the market should not surpass the amount that people generally consume. If the number of éclairs produced are more that what can be consumed, and the government passes a law that restricts the use of eclairs as Rs . 1 coin, it will likely create a crisis which would be known as the ECLAIR crisis because the eclairs in circulation in the economy would lose its utility or use value.
Also, the company that produces eclairs will not exchange their product with 1 Rs coin.
In the case of Bitcoin , nobody knows who produced them. Basically, what I am saying is that
1. There is no real backing for bitcoin from any organization, Government or private, which severely questions its usefulness as a currency.
2. Its value is derived primarily from its perception in the minds of people not from its utility.
A similar type of currency is also used in some small businesses in india. When a relatively big player has to pay say 1 lac rupees, he/she writes 1 lac on a piece of paper, signs it and gives it whomsoever is to receive the payment. It is kind of a promise backed by the big player and if the other players in the market believe in the credibility of the big player(which is the promise of the big player) market participants start exchanging that piece of paper as currency among themselves. Although this kind of currency is quiet dangerous to hold, it is still better than bitcoin because , at least it is backed by the promise of that big player. But if the big player collapses or defaults you would be left with just a piece of paper. The utility of that paper for you would be nearly zero, may be slightly higher than zero because you can sell it to newspaper raddi wala (scrap paper dealer).
So to conclude, we should understand that it is very important for currency to either be backed by somebody (lower the credibility of the person or agency that backs it the more dangerous it gets) or at least have some utility in absence of it acceptance as a currency.
Gold, however, still has some utility, it is malleable, ductile and can be used as jewellery etc. and while I am not a fan of gold either, I would say that gold is still better than Bitcoin.
But all said, I still believe bitcoin is important innovation, and the technology (Blockchain) behind it can be very useful. Bitcoin is basically a cheaper and faster way of transferring money. So maybe it is an innovation comparable to Demand Draft, cheque or NEFT/IMPS in the past, which can make transferring money easier and cheaper.
But you don’t buy cheques in the market, it is just a process.
The surprising popularity of Bitcoin also reflects the biggest flaw in an investors mindset, which is that most people focus on the Price NOT the earnings but I don’t blame them either because there is no earning in Bitcoin at all. Bitcoin is pure speculation. Stay away.
It would still be very interesting to see how all this will turn out. Would be a great learning lesson to either people who love it or hate it. But being warren Buffett followers, we always try to follow rule no 1 - we wont invest in Bitcoins and wont be disappointed even if it keeps going higher.
Remember as John Maynard Keynes (A prominent English Economist) says “Markets can remain irrational longer than you can stay solvent.”