What Is Driving Bitcoin?

Written By Briton Ryle

Posted May 24, 2017

I feel like I let you down on this one — like I really dropped the ball.

You see, on March 29th of this year, I was in New York City for an investment conference sponsored by StockTwits, called StocktoberFest. There were a lot of startup founders and venture capitalist types there, pitching their big moneymaking ideas. There was lots of “fintech” — financial technology.

One app, for instance, sought out and allocated your savings into the highest-paying internet banks. This was a good one — there was no fee, and the app could take your savings account from making 0.004% at Bank of America to making 4% in a reputable internet-based bank. 

But by far the most popular topic was cryptocurrencies, like Bitcoin and Ethereum. It seemed like all the venture capital people were scrambling to get their money into funds or exchanges or companies that dealt with digital money. 

Onstage interviews would go like this: 

Q: So, what stocks do you like right now?

A: Well, obviously Apple and Amazon are amazing, and they aren’t going to slow down. Google is amazing, too. But I’m putting my money into Ethereum.

Really, nobody wanted to talk stocks and companies. When they did, they could only mention the big ones: Apple, Google, and Amazon. Honestly, I was disappointed. But like I said, I’m more disappointed now. I was getting some fantastic investment insight, and I didn’t recognize it at the time.

At the time of that conference — March 29 and 30 — Ethereum cost about $50 each. Today it’s around $180. Yep, that’s a 260% gain in two months. Bitcoin has just about doubled in that time frame. Those are impressive gains. The kids in my office are whooping it up pretty much every day.

And I missed every damn bit of it. But I’m not going to be a grumpy old man on this one.

Because get this: All the Ethereum together is worth $17 billion. All the Bitcoin is worth $35 billion. The total value of all the different cryptocurrencies is about $80 billion. That’s just a little less than the entire Starbucks corporation. 

$80 billion means this is more than just a fad…

So, what is going on with these cryptocurrencies?

What Is a Cryptocurrency? 

Let’s get the definition out of the way. Investopedia says a cryptocurrency is:

A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of this security feature. A defining feature of a cryptocurrency, and arguably its most endearing allure, is its organic nature; it is not issued by any central authority, rendering it theoretically immune to government interference or manipulation.

Is that helpful? Probably not. Bitcoin and others are like internet money. They exist only in cyberspace and can only be used there. But since our bank accounts also live in cyberspace, it works out. 

The biggest contribution cryptocurrencies have made is the use of the blockchain. Each unit of a cryptocurrency is represented or expressed by its blockchain. Where a $1 bill is represented by the cloth it’s printed on, the iconography, and the serial number, the blockchain is a series of digital numbers and symbols that “are” the currency. So if you buy something online that costs half a bitcoin, then half the blockchain of your bitcoin gets immediately sent to the other party, and the transaction is complete.

It’s all encrypted, and my understanding is you can’t fake it.

Now, here’s the really interesting thing: Blockchain transactions settle immediately, in the nanosecond it takes for the blockchain to move across the Internet. Bank transactions don’t settle like this. Even though you might use a credit card to buy an item, and you can see your balance change and you can actually take possession of the item, the transaction hasn’t actually settled. The merchant has simply accepted an IOU from your credit card company. It’s a loan that won’t be settled until the actual cash shows up in a day or two. 

This is why you pay a fee at an ATM. You’re actually accepting a loan from another bank. 

It’s pretty archaic when you think about it. There are lots of vulnerabilities, and this was a real problem during the financial crisis. Banks literally didn’t trust that these overnight settlements would happen as scheduled. What if your counterparty declared bankruptcy like Lehman and Bear Stearns? 

This is why all the major banks and credit card companies are testing the blockchain. They will all use it at some point fairly soon, and this gives the technology behind cryptocurrencies instant legitimacy. 

But the bigger questions are: Why is a cryptocurrency worth anything? Why does it have value?

The Eye of the Beholder

So, that’s a big question. And there’s no reason to drill down to the point where we say, “All paper money is worthless unless it’s backed by gold, and what’s gold worth anyway, it’s still based on belief.”

You may have heard that Bitcoin gets its value because you have to have a computer “mine” it. That is, you have to invest in a lot of processing power, and then that processing power has to run a bunch of algorithms, until — POOF — a bitcoin is created. That bitcoin has value based on how much that processing power (the computer) costs and how long it took to run the algorithms. 

Maybe the cryptocurrency called Ethereum is a better example. There are startup tech companies right now working on really cool stuff, and the only way you can invest in them is with Ethereum. They don’t take cash. They are actually building an economy based on Ethereum. If a startup company is successful, then that adds value to Ethereum. Its value becomes tied to the company. It’s not that different from how stocks gain and lose value. 

For the record, I find the notion that Ethereum can get value because it represents ownership of an enterprise very interesting. The notion that Bitcoin is valuable because it’s difficult and expensive to create isn’t as fun. 

Now, final question: Why? Why does anybody want to own and use cryptocurrency? 

For many of those VC people at the conference I attended, technology has its own value. And so if they can do something with technology, like create a digital currency, they do. It gains legitimacy and value as more people adopt it. 

As we all know, when an asset starts going up in price, people become aware, and they buy in. It happened with tulip bulbs, it happened with Beanie Babies, and it’s happening now with cryptocurrencies. They are moving higher, and so people are buying in, making them real. The kids whooping it up in my office are doing that right now. Their purchases — and their sales — are making these cryptocurrencies legitimate. 

And it’s getting big. Japan has basically recognized cryptocurrencies as legitimate. Use of them is apparently surging there.

But there’s another side to the value of cryptocurrencies: the criminal element. You know how India recently banned high-denomination bills to help fight black market activity? Well, some of those criminals are putting money into cryptocurrencies because they are anonymous. Same with drug cartels, Russian mobsters, and Chinese trying to get money out of China. 

Cryptocurrencies are the perfect vehicle for criminals. And, strangely enough, their purchases also help to establish a true value for cryptocurrencies.

Bottom Line

As I see it, cryptocurrencies are here to stay. But I can’t for the life of me figure out how to value them. I can tell you that the moves we’ve seen so far this year absolutely can continue.

And while the grumpy old man in me wants to say, “That’s it! It’s a bubble, get those cryptocurrencies off my lawn,” I’m also about to buy some because, well, what if?

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.

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