Is Bitcoin 21st century's prime example of 'greater fool' theory?

Bitcoin had a spectacular 2023 – over the 12 months, its market cap went up from Rs 26,00,000 crore ($319 billion) to Rs 69,00,000 crore ($830 billion) For context, the latest quarterly Indian GDP is almost equal at Rs 71,00,000 crore and market cap of 30 Sensex stocks on BSE is twice that at Rs 142,00,000 crore.

Reliance Industries runs the largest crude oil refinery in the world, the third-largest telecom company in the world by subscriber count and the largest retailer in India by revenue. In COVID-hit 2020, the largest equity fundraising in the world was by Reliance at $20 billion. And its market cap is Rs 17,50,000 crore. What then is the contribution of Bitcoin to command a market cap four times that of Reliance? Nothing.

Last year, India’s second richest man Gautam Adani had to face a short seller attack from Hindenburg, inquiry by a Supreme Court-appointed committee and probing by market regulator SEBI. It was also the subject of investigative journalism from the Financial Times and others. India’s largest airport and seaport and largest green energy producers are part of his group.

Adani Group ended 2023 with a market cap of Rs 15,00,000 crore from Rs 21,00,000 crore at the start of the year. But what has Bitcoin done in 2023 to add Rs 43,00,000 crore to its market cap and be valued at 4.6 times the market cap of the Adani Group? Again, nothing.

Bitcoin has simply gained in value – without producing any product or service that we use, without giving any cashflows to its investors such as interest or dividend, without owning any real or financial asset like factories or bonds and without having any intrinsic value of a commodity such as water, crude oil or rice. So where does its value come from?

Bitcoin enthusiasts might say that it is a currency and it is valued differently. If so, how does Bitcoin compare with official national currencies such as the Indian rupee or US dollar? Official currencies are backed by assets held by the issuer. That is, a Rs 100 note represents a claim worth Rs 100 on the assets in RBI's balance sheet. And what are those assets? Gold, bonds issued by the Government of India, USA, etc. And the government bonds are backed by the monopoly taxation power of the respective governments. In other words, Indian sovereign bonds are backed by the productive capacity of the Indian economy and US treasuries by the productive capacity of the largest economy of the world. So what is Bitcoin backed by? For the third time, the answer is nothing.

Value from scarcity?
Another argument offered in defence of Bitcoin is that its supply is capped and hence there is scarcity which leads to the continuing appreciation in value whereas national currencies can be issued without any limit and hence may result in inflation and hyperinflation. How true is this?

Imagine a city where no restaurants serve biryani since it is unknown in that city. Sensing an opportunity, someone starts a restaurant serving biryani and it becomes a huge hit. As the demand goes up, the restaurant owner comes up with an idea to increase profits – he caps the number of biryanis sold per day at 500 even when there is a demand for 1,000 or more. Thus each biryani can be sold well above cost and will fetch super-normal profits. It is better than increasing the supply to match demand and selling at reasonable prices. Will this strategy succeed? Certainly not as new suppliers will set up shop to fill the unmet demand and thus super normal profits will remain just a dream. Capping Bitcoin supply and creating artificial scarcity is also like this as new private currencies will emerge to meet the unmet demand as there are no entry barriers.

Is Bitcoin digital gold?
Gold is special because water, air, fire and acid will not corrode it. Thus all the gold ever produced still exists as shiny as ever. Most importantly, gold has natural scarcity which helps it retain and grow in value. But Bitcoin? One among the thousands of private virtual currencies with the only uniqueness being the first private virtual currency – which may make it a collector’s item and nothing more.

The genesis of Bitcoin
Bitcoin was created shortly after the global financial crisis to solve two problems. One inflation – inflation could eat away the value of your savings held as currency when central banks print money without limits. And banks going bust – banks often lose money when reckless lending creates unrecoverable loans. Bitcoin sought to solve these problems by capping the supply and keeping the currency under the self-custody of the saver. Legitimate goals, though in practice Bitcoin delivered neither.

But current advocates of Bitcoin promote it for a different reason. Their theory goes like this – the entire world would ditch national currencies and shift to Bitcoin which would be the lone global currency. As Bitcoin supply is capped and 90% of the total supply is already in the market, there will be a mad rush to buy Bitcoin from current holders and thus current holders will make huge gains. But 8 billion people, 190-plus sovereign states and all the entities in these states simply accept Bitcoin as the global currency – such a scenario looks Utopian.

For a moment imagine that such an economy does come about. Who will get rich? Those holding the Bitcoin. At whose expense? Those who work, create and produce; those who solve our problems; those who take humanity forward. Thus owners contributing nothing prosper and doers contributing everything get impoverished – is that fair by 21st century standards?

What then explains Bitcoin’s price?
There are plenty of true believers in Bitcoin Utopia and then there are those who know Bitcoin is worthless, yet buy it at absurd prices hoping there will be that greater fool who will buy it for a still higher price from them. Bitcoin seems to be the 21st century’s most enduring example of the greater fool theory.

Does that mean only national currencies will survive in this world? Currency on its own has no value. It is valued simply because it can be exchanged for goods, services and assets. Currency will be exchanged with goods, services and assets as long as everyone is confident that everyone else will accept it. Also, the currency should store value without much erosion. For this, the money supply should move in tandem with changes in economic output and the productive capacity of the economy. So far only national currencies have met both these requirements to a reasonable extent.

We may create algorithm-based currencies which pass both the confidence and money stock tests successfully. But that currency is certainly not Bitcoin. Where does that leave Bitcoin? It is nothing more than a speculative token whose prices can go up or down for no particular reason.