Over the past few weeks, barely a day has gone by without someone asking me about bitcoin. Friends who have never bought a single share, entrepreneurs who are barely keeping their companies afloat, people who until last year thought bitcoin was some kind of video game. They all want to know the same thing: is it too late to get in?
I studied international finance for my MBA and I’ve been working online for more than ten years, so I understand the fascination. Bitcoin started the year at around 1,000 dollars, came close to 5,000 at the beginning of September, and now trades somewhat above 4,000, after China banned initial coin offerings (ICOs). That’s roughly a fourfold rise in eight months. It felt like the right moment to sort out my thoughts, without the hype of online forums and without the disdain of traditional bankers.
What blockchain actually is, in plain words
Picture an accounting ledger that isn’t kept by a bank, but by thousands of computers around the world at the same time. Every new transaction is checked by the network and added to a block, and the blocks are linked together like the links of a chain. To fake a record, you’d have to change every copy at once, which is practically impossible. That’s the whole idea: trust without a central middleman.
Bitcoin is the first application of this technology: a digital currency with a limited supply that you can send to anyone, anywhere, without going through a bank. Ethereum took the idea further: its network can run small programs, so-called smart contracts, that execute on their own when certain conditions are met. That is also where the ICO wave comes from.
Why the price is rising: speculation, not use
Let’s be honest. Very few of the people buying bitcoin today use it to pay for anything. They buy it because they hope it will be worth more tomorrow. That’s not necessarily bad, many markets work that way in their early days, but it has to be said plainly: today’s price reflects expectations, not an economic value you can calculate the way you would for a company with profits and dividends.
Bitcoin has no balance sheet, no cash flow and no central bank behind it. It is worth exactly what people are willing to pay for it. When new money comes in, the price goes up. When people get scared, it falls just as fast. We’ve already seen this several times: the collapse of Mt. Gox in 2014, the sudden drops this summer, and last week’s reaction to the news from China.
Bubble signals I’m seeing
I can’t tell you where the price will be in six months. Nobody can, however confidently they talk on YouTube. But I recognise a few signs I’ve seen in other manias, from the dot-com era of the early 2000s to the property boom before 2008:
- Everyone is talking about it, including people who can’t explain what they are buying.
- Every day there are new projects raising millions of dollars on nothing more than a white paper and a nice website, with no product, no customers and sometimes no real team.
- People are promised guaranteed returns, “ten times your money by Christmas”.
- People borrow to buy, or bet their life savings.
- Any criticism is met with “you just don’t understand the technology”.
Several of these signs are present right now. That doesn’t mean everything collapses tomorrow. Bubbles can grow far bigger than seems rational, and those who call them too early look foolish for a while. But it does mean a serious correction is possible at any time, and that you should go in with your eyes open.
ICOs and the lesson from China
An ICO is a kind of fundraising: a company issues its own digital tokens and sells them to the public in exchange for cryptocurrencies. By market estimates, more than a billion dollars has been raised this way this year. For an entrepreneur, the idea is tempting: fast money, no banks, no investment funds asking for reports. Earlier this year I wrote about Romanian startups that could conquer the world and how hard it is to find funding in Romania, so I get the appeal.
The catch is that an ICO investor usually gets no share of the company, no voting rights and no legal protection. What you get is tokens whose value depends on everyone else’s confidence. In early September, China’s central bank declared ICOs illegal and ordered the money raised to be returned. The market reacted immediately. I expect other countries to come up with rules too. Governments are usually slow with technology, as you can see in Digital Romania, where the state lags behind its people, but when money is being raised from the public, regulation always arrives.
What I think will last
Here I’m more optimistic than I may sound. I believe the underlying technology is real and important, even if many of today’s coins will disappear. A few directions look serious to me:
- International payments: sending money across borders is still slow and expensive, and a shared ledger could cut costs a lot.
- Smart contracts: agreements that execute automatically, with no paperwork and no middlemen, from logistics to insurance.
- Records that can’t be forged: property, documents, supply chains.
- Bitcoin as a kind of digital gold, for people who don’t trust their national currencies.
But there’s a big difference between believing in the technology and believing that any coin with a trendy name will make you rich. In the 2000s the internet changed the world, even though most dot-com companies vanished. It will probably be the same here.
My rules, if you still want to get in
I’m not a financial adviser and I’m not telling you to buy or sell. I’m only sharing the rules I would apply to myself:
- Only put in money you can afford to lose entirely, without hurting your family or your business.
- No loans and no leveraged trading. Losing your own money hurts. Losing borrowed money can bury you.
- Watch out for scams: unknown platforms, “advisers” who cold-call you, pyramid schemes promising daily profits.
- Keep your coins in a wallet you control, don’t leave everything on an exchange.
- Don’t buy out of fear of missing out. If you check the price ten times a day, you’ve put in too much.
One of the lessons I learned from 20 years of entrepreneurship in Romania is that money is lost most easily when you’re convinced you can’t lose. Risk doesn’t disappear just because a technology is new and exciting.
Bubble or new economy?
My honest answer: probably both. We have a clear speculative bubble around many coins and ICOs, and at the same time a technology that could change how we make payments and sign contracts. The bubble may deflate, and the technology will keep moving forward at its own pace, slower than the enthusiasts claim and faster than the sceptics believe.
What do you think? Have you bought bitcoin, or are you staying on the sidelines until things settle down? I’d love to hear how you’re thinking about it.