As bitcoin rises to almost $10,000 this morning, it might be a good idea to briefly reflect on the conditions that led to its swift acceptance and the quick price appreciation over the last several years.
* Following George Soros' Theory of Reflexivity, investors' and traders' biases can change the fundamentals that assist in determining market prices (read "The Alchemy of Finance" by Soros). This has continued for several years as market participants embrace cryptocurrency.
* Bitcoin is very hard to short and structured with a limited supply - a perfect recipe to trade like a bubble and then burst.
* The absence of IRS tracking or international tax authorities, so that capital gains of bitcoin are, at least for now, non-taxed. This secrecy element has appeal to many! But the demand for bitcoins to hide transactions from authorities eventually must invite regulation. It makes no sense that one needs to fill in several pages of paperwork for a bank withdrawal of more than $10.000 and bitcoins are unregulated.
* The quick adoption of bitcoin as a currency for arms transactions and other illegal activities such as prostitution and money laundering. Again, this has appeal to many!
* Apropos to the prior bullet point, the real estate industry was an early adopter (think, again, Theory of Reflexivity). This is important because a lot of money laundering is done through real estate transactions, both commercial and residential.
* The need for another hard currency alternative other than gold. Think of bitcoin as a digital gold.
These factors help to explain why the planets aligned to accept bitcoin and some other cryptocurrencies.
As to where we go from here in bitcoin, a lot will depend on psychology and outside influences:
- The creation of individual cryptocurrencies by sovereign countries (already Dubai, Russia and India are considering their own blockchain-based digital currencies). This would serve to make bitcoin more like fiat money and less like gold, which could serve to reduce the price of bitcoin as it is seen as a hedge against a fiat money system.
- As to the first point, if major countries step in to introduce their own digital currencies, they could attempt to make competing "private" currencies illegal.
- Continued acceptance as a currency for transactions. To date, bitcoin is not yet valued based on making inexpensive, fast and easy payments.
- The taxing reactions from countries (U.S. and others) should bitcoin's acceptance become more commonplace and should the cryptocurrency become more liquid. (Remember, the total size of the amount of outstanding gold approaches $8 trillion while bitcoin is only a couple of hundred billion dollars.)
- The degree to which bitcoin gains acceptance versus other cryptocurrencies.
- The exposure to security issues (i.e., hacking). Both Ethereum and bitcoin have been victims of large hacks and robberies over time.
- The continued security and control of the supply of bitcoin. Now limited to 21 million bitcoins by a code that is decentralized and governed by tens of thousands of nodes that operate its software, any change in the status will be an important influencer of price.
I continue to view, as discussed yesterday morning, the untested derivative plays that have cryptocurrency ambitions -- among them, Riot Blockchain Inc. (RIOT) , Social Realty Inc. (SRAX) and Xunlei Ltd. (XNET) -- as non-playable for almost all investors. I share my thoughts here and here.
One last point: Though bitcoin's capitalization against gold remains small, I do believe the popularity of bitcoin has sidelined some interest in gold over the last few months. So, the success or lack of success in the development and acceptance of cryptocurrencies could influence the price of gold.
There is probably, for now, room for both bitcoin and gold.
Regardless of view, I plan to reread Charles Kindelberger's "Manias, Panics and Crashes" this weekend.
Note: The above comments are not intended to be a full description of the cryptocurrency debate. That would take thousands of words!
(This commentary originally appeared on Real Money Pro at 9:02 a.m. ET on Nov. 28. Click here to learn about this dynamic market information service for active traders.)
