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Has the Bitcoin Supply of Greater Fools Finally Been Exhausted?

It’s a bubble fueled by babble

The Declaration of Bitcoin’s Independence, endorsed by numerous celebrities, states that,

We hold these truths to be self-evident. We have been cyclically betrayed, lied to, stolen from, extorted from, taxed, monopolized, spied on, inspected, assessed, authorized, registered, deceived, and reformed. We have been economically disarmed, disabled, held hostage, impoverished, enervated, exhausted, and enslaved. And then there was bitcoin.

Bitcoin and other cryptocurrencies are, in reality, not useful alternatives to cash, checking accounts, debit cards, credit cards, and the other components of the financial system that powers the economies of developed countries. Blockchain technology is slow, expensive, and environmentally unfriendly. In 2021, Cambridge University researchers estimated that bitcoin blockchains consume as much electricity as the entire country of Argentina, with only 29 countries using more electricity than bitcoin. Bitcoin is essentially strip-mining the climate.

In June 2022, a letter to U.S. Congressional leaders signed by 1,700 computer scientists stated that blockchain technology is

poorly suited for just about every purpose currently touted as a present or potential source of public benefit .We strongly disagree with the narrative peddled by those with a financial stake in the crypto-asset industry that these technologies represent a positive financial innovation and are in any way suited to solving the financial problems facing ordinary Americans.

As a speculative investment, however, bitcoin has been spectacularly speculative. I have written frequently (including here, here, and here) that bitcoin is a bubble fueled by babble. True believers have not appreciated my skepticism. Paul Krugman, an economics Nobel Laureate and New York Times columnist, wrote that bitcoin is “something of a cult, whose initiates are given to paranoid fantasies about evil governments stealing all their money Journalists who write skeptically about Bitcoin tell me that no other subject generates as much hate mail.”

Here are a few of many responses from infuriated readers of my op-eds (with spelling mistakes corrected):

Rich people fear Bitcoin as it means their wealth could be shifted over to “peasants” and are scared of becoming irrelevant.

Bitcoin makes cross border payments possible and provides an easy way for people to escape failed government monetary policy.

Nobody believe this orchestrated FUD which is all paid for by American Express and other banking institutions.

FUD is a popular acronym for “fear, uncertainty, and doubt.” Another is HODL. An enthusiast once misspelled HOLD as HODL (there are lots of misspelling on bitcoin forums) and it was misinterpreted as an acronym for “hold on for dear life.” Bitcoin fanatics ignore the FUD and just HODL.

In the long and ignominious history of bubbles, bitcoin doesn’t match the Dutch Tulip Bubble, the British South Sea Bubble, or the U.S. DotCom Bubble. But it shares the common features of all bubbles.

Initially, a genuine innovation excites and titillates. The Tulip Bubble started with the introduction of tulips into Western Europe. The South Sea Bubble started with the granting of exclusive trading rights in South America. The Dot-Com Bubble started with the internet. The bitcoin bubble started with blockchain technology.

As prices rise and some become rich, others rush to become rich too. The torrent of buyers pushes prices higher still, luring even more dreamers not wanting to be left out and also attracting scoundrels selling dreams. At some point, prices stop rising and there is no longer any reason to buy. In the stampede for the exit, the dreams turn into nightmares.

The intrinsic value of an asset is what you would pay to hold the asset forever and receive the cash it generates the interest from bonds, the dividends from stocks, the rents from an apartment complexes, the profits from businesses. What makes a bubble a bubble is that an asset’s price rises far above its intrinsic value. People are not buying the asset for the cash it generates but, rather, with the expectation that they will be able to sell it quickly at a higher price.

This is the Greater Fool Theory: Pay a foolish price because you hope to sell to an even bigger fool.The intrinsic value of bitcoin (and other cryptocurrencies) is a big fat zero because bitcoin generates no cash whatsoever. The only reason for investors to buy bitcoin is the expectation that they will be able to sell their bitcoin to greater fools.

Now the FTX crypto exchange (and dozens, perhaps hundreds) of related companies have crashed and burned. We don’t yet know the details but it seems that they used customer funds to buy and sell cryptocurrencies, thereby creating highly leveraged bets on extremely volatile prices.

The slide in bitcoin prices over the past year, from above $60,000 to below $20,000, and now below $17,000 after the FTX collapse may persuade some that Greater Fools will be harder to find in the future than they were in the past.

Still, the future prices of bitcoin and other cryptocurrencies is very uncertain because of the rampant market manipulation by “whales” that control so much of the market. In 2019 the Wall Street Journal reported that nearly 95 percent of reported bitcoin trades are fake trades intended to manipulate prices. A 2020 study published in the Journal of Finance concluded that nearly all of the rise in bitcoin prices in 2017 was due to trading by one large, unidentified trader using another digital currency, called Tether, to buy bitcoin.

In a 2021 report, Research Affiliates, a widely respected investment management company, concluded that,

perhaps [bitcoin] is just a bubble driven by a frenzy of retail, and some institutional, money eager to get a piece of the action. Alternatively, and far likelier in my opinion, is that this “bubble” is more fraud than frenzy.

On August 3, 2021, the head of the Securities and Exchange Commission said that cryptocurrency markets were “rife with fraud, scams and abuse.” In June 2022 the U.S. Department of Justice charged six individuals with cryptocurrency fraud. As I write this, many people are waiting for more shoes to drop.

When it will end, no one knows. But it will end badly. At some point, the supply of greater fools will dry up, the manipulators will dump their bitcoin, and the bitcoin bubble will end the way all bubbles end. Today, we laugh at the Dutch who paid the price of a house for a tulip bulb. Future generations will laugh at us for paying the price of a fancy car for literally nothing.

Gary N. Smith

Senior Fellow, Walter Bradley Center for Natural and Artificial Intelligence
Gary N. Smith is the Fletcher Jones Professor of Economics at Pomona College. His research on financial markets statistical reasoning, and artificial intelligence, often involves stock market anomalies, statistical fallacies, and the misuse of data have been widely cited. He is the author of dozens of research articles and 16 books, most recently, Distrust: Big Data, Data-Torturing, and the Assault on Science, Oxford University Press, 2023.

Has the Bitcoin Supply of Greater Fools Finally Been Exhausted?