5 Bitcoin Fallacies: Bitcoin Bears
Dec. 4, 2017 11:41 AM ET About: Winklevoss Bitcoin Trust ETF (COIN), Includes: BITCF, BTCS, GBTC
SA Article by Lynn Sebastian Purcell
In the financial world right now, one can either have a reasonable discussion, or “discuss” Bitcoin, but not both.
This is the first of a two-part series on Bitcoin fallacies; it focuses on the terrible arguments Bitcoin Bears make.
In doing so, it provides guidance on how to think about Bitcoin’s recent price movements, and to what extent they are reasonable.
I am a professor of logic. What I cannot help but notice, as a result, is the way that discussions concerning Bitcoin make otherwise sensible minds careless in a way that would make my first-year students blush. It is as if one is confronted with an exclusive disjunction: either one can discuss Bitcoin, or one can have a critical and reasonable discussion, but not both.
My goal in this piece (and its companion, which develops two more common fallacies) is not to convince the reader that devoting a small portion of one's portfolio to Bitcoin would be reasonable, given the risk-reward profile (which I have done here). Nor is it to develop grounds for identifying Bitcoin's price in an "objective" way (which I have done here ... and also here). I want simply to clear the ground of some of the commonest misconceptions about Bitcoin, so that the reader can decide whether there is a reasonable basis for using Bitcoin in a broader portfolio. It is this ground work that appears to be missing in the present discussion.
Additionally, however, while this part focuses on fallacies among Bitcoin bears, a tacit thesis in their favor emerges: Bitcoin is somewhat "bubbly" right now (though not for any of the reasons bears suggest). As a result, a trading strategy, or at least dollar-cost averaging might be more suitable for anyone who is bullish at present. Now let's move onto the fallacious claims.
1. It's a Fraud!
"It's a fraud!" - Jamie Dimon
"Bitcoin is successful only because of its potential circumvention, lack of oversight, so it seems to me it ought to be outlawed. It doesn't serve any socially useful function." - Joseph Stiglitz
"There ought to be a hard look at the policy of anonymous currencies, because the ability to track information of money flowing is one we use against terrorism and as [a tool] against improper, illegal behavior." - Brian Moynihan
"Bitcoin just shows you how much demand for money laundering there is in the world." - Larry Fink
Among the stars of the finance world, some form of the claim that Bitcoin is a fraud, or related to fraudulent and illegal activity, is the most common objection.
Perhaps the most common reply by Bitcoin enthusiasts is that these stars all have a vested interest in maintaining financial institutions as they are. But that too is a fallacy, an ad hominem fallacy, turning on the circumstances of the agent. If T. Boone Pickens (noted oil tycoon) said, when West Texas Intermediate was priced at $32/barrel, that he thought oil was going to recover, it is true that he would profit from that recovery. He would also have been right. Similarly, Dimon and Moynihan stand to lose a lot if Bitcoin replaces banking, but that does not make them wrong either.
What does make their reasoning fallacious is if they support it by pointing to the illegal uses of Bitcoin. This would be just like pointing to the illegal uses of US cash dollars, and then claiming that the US dollar is a fraud. The past illegal uses by some individuals does not generalize to the entire group (hasty generalization fallacy).
Dimon and Moynihan might respond that Bitcoin has no central authority tracking it, and that transactions are anonymous. But cash transactions can be anonymous, and it is simply false that central authorities cannot track money through market exchanges. The truth is that Bitcoin is quite easy to track (especially because people use web-browsers most of the time for their transactions). To avoid this lack of anonymity, specific coins such as Monero and Dash exist. Monero, for example, sends spoof transactions to make trades literally impossible to track. At the very least, the objection is directed at the wrong target. In which case, I note that ignorance of the subject matter does not a sound argument make.
2. It Can't be Valued!
"People get excited from big price movements and Wall Street accommodates … You can't value Bitcoin because it's not a value-producing asset." - Warren Buffett
"I don't believe that cryptocurrencies are now or will ever be an asset class." - Aswath Damodaran
Among our best asset assessors, including Buffett and Damodaran, the most common objection seems to be that Bitcoin cannot be valued. Damodaran, always careful to qualify his claims in a professorial way, does not go on to claim that it should not have a price as a result. The reason is that he thinks Bitcoin is a currency, and so like any other currency, including the US dollar, it has no value. Still, he is skeptical of its price, since he thinks it is a bad currency.
What I find exasperating about these sorts of claims is that they ignore relevant replies. One, and perhaps the most obvious, is that Bitcoin might be a revolutionary financial technology. If that is right, then an inability to classify the coin along traditional lines does not entail that it has no value. Since the whole question is whether Bitcoin is a revolutionary financial technology, simply pointing out that traditional methods of value assessment do not indicate value in it is begging the question.
Another reply notes that this objection is either uncharitable, or equivocal. The term "value," even in finance, can be used in a number of ways, so to point out that Bitcoin is not a cash flow producing asset does not answer the question of whether it can be priced (i.e., "valued") objectively. What people want to know is whether Bitcoin is priced too richly right now, and not whether it qualifies as an asset (and hence has "value" in the strict sense). Yet the objection treats this question about value-as-price as if it were value-as-asset. When it is concluded that Bitcoin has no asset value, it is assumed that the question about price is settled. But this line of reasoning trades on two different meanings of "value," or it uncharitably assumes that value-as-asset was the primary focus in the first place.
A third reply is that there are well-known ways to price bitcoin (I reserve the word "price" as a neutral term, since "value" appears to be contested) in objective ways. Tom Lee has argued that bitcoin should be worth $25,000 a coin by 2022 because it will take 5% of the existing gold market. In my own articles, and this is a point developed in a peer-reviewed article by Ken Alabi (as well as something that Lee's team has verified), I have developed a price-to-Metcalfe value, using Metcalfe's Law. The Law (for network effects) claims that the "value" (sorry) of a network is proportional to the square of its nodes (given a constant modifier k, identified through regression analysis). Expressed mathematically one has:
V(NYSE:N) = kN^2
If one uses this formula, with data easily retrieved from blockchain.info, and uses k = 4*10^-9 for one's regression, one finds that apart from bubbles, this tracks Bitcoin's price well. In what follows, Bitcoin's price is in blue, and its Metcalfe value is in orange.
It also shows that Bitcoin is somewhat "bubbly" at this point, but this is a completely different reason for avoiding Bitcoin than the argument that it cannot be valued.
What proponents of the "it can't be valued!" camp need to do is provide a good-faith reply to these objective measures of pricing. Ignoring the opposition is not an argument; it's a fallacy called subjectivism (I want or believe P to be true, therefore P is true!).
Finally, there is an odd way in which Bitcoin might even be something like a traditional asset: it has forked coins. What those coins do, for Bitcoin holders, is provide a type of "dividend." They result whenever there is a significant technology update to the underlying technology and one group of developers decides to take a different route in the update. We have seen the possibility of one of these for nearly a month, and it is not unreasonable to imagine that Bitcoin will continue to fork regularly in the future. Suppose that when receiving a forked coin, one sold it immediately. Suppose additionally that one would receive $500/year by these coins (which is less than received in 2017), and that this increased at a rate of 10% a year for five years, afterwards maintaining a flat payout (something which is not unreasonable given broader adoption for bitcoin). Add a discount rate, admittedly quite difficult, sum the results, and one has a traditional discounted cashflow analysis.
To reiterate, ignorance is not a sound premise in an argument, and ignoring the opposition is a fallacy (subjectivism). It may be that these arguments are wrong, and that is fine. My point is that they are presently unacknowledged.
3. Obvious Bubble
"Bitcoin today is, in my view, very clearly in a bubble." - Severin Cabannes
"It's very much speculative. People are thinking, 'Can I sell it at a higher price?' so it's a bubble …. With Bitcoin you can't make much transactions in it and you can't spent it very easily. It's not an effective store-hold of wealth because it has [too much?] volatility, unlike gold." - Ray Dalio
"The best example [of a speculative bubble] right now is bitcoin." - Robert Shiller
"Bitcoin has gone parabolic, so that usually doesn't end well." - Art Cashin
There are two problems with this line of reasoning: (1) pictures aren't arguments, and (2) they (perhaps) succumb to a well-documented cognitive bias human brains have against non-linear phenomena. If (2) is not right, then I think they reduce to question begging.
It looks like bitcoin has increased in price too fast to be credible. The problem with the chart is that it is not an argument on its own. It is a visual representation of facts, which can serve as premises for an argument. The additional premise, which Art Cashin supplies, is that anything that increases in price in a parabolic fashion is in a bubble. The problem with that line of reasoning is that it is false, making the argument unsound. What follows is a chart of Amazon's price increase, and it also has non-linear returns.
Non-linear returns, in fact, are characteristic of high-growth technologies. If one is going to disbelieve the chart, then one needs reasons.
This is especially true in this case, since human brains have a well-known cognitive bias against non-linear phenomena. We tend to think linearly, and that is why we are often anchored to nearby prices. If anything like Metcalfe's Law holds (see point two above) then we ought to expect something different. In fact, given the increase in average daily users with Bitcoins recent price moves, the Price to Metcalfe Value ratio has actually decreased in the past week-meaning that Bitcoin is less bubbly now (at $10,000+) than it was at $8,000.
The new green line tracks the Price to Metcalfe Value, in a way that is a bit like the Price to Book Value of a firm. What one notices is the recent downward trend (the dotted black line is the seven-day average). This means that if Metcalfe's Law accurately tracks Bitcoin's "value," then Bitcoin has become more of a bargain recently.
One might object to the use of Metcalfe's Law, and I think that's a reasonable point. Nevertheless, the discussion to follow is whether Bitcoin can be objectively price and how (the topic of the second fallacy). As a result, it is again not obvious that Bitcoin is in a bubble, and maintaining such a position thus reduces to begging the question (suppressing the shaky premise about Bitcoin's objective pricing methods). There is a real discussion here, and ignoring it does not help anyone make better decisions.
Concluding Thoughts
On a humorous note, one website dedicated to cryptocurrencies has tracked the times bitcoin has been declared "dead" in the Anglophone world since 2010. December 1st marked the 200th time such a declaration was made, and the 82nd time this year.
We shall surely see more of this, no matter how irrational it is. What I hope this piece has done is give the reader some credible reasons to be wary of these sorts of claims. Perhaps I have also provided a reasonable basis to think that Bitcoin is "bubbly" at present, so that the reader can take appropriate measures to invest or trade (or maybe just avoid) Bitcoin.
