Why bitcoin is fool's gold

When most analysts think of bitcoin, they think of tulips. The cryptocurrency's run-up in recent months, in which it's rocketed from around $2,500 in mid-2017 to about $16,000 today, has all the hallmarks of a legendary bubble, right up there with the infamous tulip craze of the 17th century.

But Cameron Winklevoss, the former Mark Zuckerberg plaintiff turned cryptocurrency billionaire, thinks of gold. "We've always felt that bitcoin, given its properties, is gold 2.0 — it disrupts gold," he recently told CNBC. Bitcoin's market capitalization is $300 billion. But if Winklevoss is right that it will eventually displace gold, with its $6 trillion market capitalization, well, you do the math: "Long term, directionally, [bitcoin] is a multi-trillion-dollar asset — I don't know how long it takes to get there," Winklevoss concluded.

So how plausible is this? Is bitcoin set to become "gold 2.0?"

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Answer: Absolutely not — and here's why.

Currencies can serve at least two functions: a medium of exchange or a store of value. People will take dollars as payment for their labor, because they know they can use those dollars to buy groceries or pay the rent or go to movies. (Medium of exchange.) But people also know they could just stockpile those dollars and save for the future. (Store of value.)

Gold is weird in that it solely serves the second function. No one takes their paycheck in gold coins, and then plunks down those coins to pay for their morning coffee. Gold is a boutique investment vehicle for people who don't trust the stability of fiat currencies like the U.S. dollar. Their reasons are a mishmash of bad history and worse economics, but that's what they think.

Bitcoin, by contrast, was supposed to serve both functions. It would be easy to forget amid today's speculative frenzy but bitcoin was originally supposed to be a currency for people who didn't want a payment system administered by a central bank or overseen by a government. Calling bitcoin "gold 2.0" is an implicit admission that this original vision failed.

That alone doesn't mean bitcoin is doomed, however.

For all the weirdness that goes into enthusiasm for gold, it's still managed to survive as a store of value. And that's because gold actually has practical uses in the real world. Obviously, there are artistic purposes like jewelry and building accents and filigree. But gold actually also has other wide-ranging applications, particularly in things like electronics and computing.

This is key. An asset can't serve as a store of value if you can never get the value back out. Sure, there can be a brief bubble, where everyone buys the thing in the hopes of selling it later for a big payday. The bubble could even last long enough for people to build additional financial instruments, like futures, on top of all that buying and selling. But for the market to stabilize and sustain itself over time, like gold (sort of) has, the chain of purchases has to actually end at some point in real-world applications.

That's what allows everyone else in the market to treat the asset as a store of value: They know whatever money they invest can eventually be retrieved.

So what makes bitcoin innately valuable? Nothing. Even its autonomy and the ease of its digital transactions are replicable and found not only in other cryptocurrencies, but in many normal online payment systems as well.

Winklevoss' defense of bitcoin has nothing to do with this: "Gold is scarce, bitcoin is actually fixed. Bitcoin is way more portable and way more divisible," he said, before descending into outright tech-jargon gobbledygook: "Social networks grow in value exponentially based on the number of users and participants. The difference between one and 100 is dramatic — 100 and a million is that much more dramatic and exciting. As more people join it gains more value."

None of this escapes the charge that bitcoin is just a particularly bad case of irrational exuberance. In fact, it turns out about 40 percent of all bitcoins are held by around 1,000 people. And they're clearly holding them purely in anticipation of a big payday. This is a relatively small subculture of enthusiasts who talk amongst themselves, are probably all looking at the same information, and thinking about that information in the same way. So when they sell, they'll probably all sell in rapid succession. And boom: The price will plunge as supply shoots up and demand falls.

Investors can and have bid gold into bubbles that popped; just look at the run-up to the 2013 bust. But ultimately the productive uses for gold mean there's some floor for demand. But with bitcoin, there's no bottom: Demand for bitcoin is based solely on the belief that bitcoin's price will keep rising. Sooner or later, something will happen to trigger a major sell-off, and then all the bitcoin investors will realize they built their fortunes on sand.

I've given bitcoin the benefit of the doubt before, because the world is complex and predicting the future is hard. Maybe some real-world uses for it will eventually emerge. But so far, bitcoin just looks like fool's gold.