Duke - The Fuqua School of Business

News Release

Is Bitcoin a Bubble?

Bitcoin Analysis by Professor Campbell Harvey

January 21, 2014

Analysis from Professor Campbell Harvey

What is bitcoin really worth? Is it overinflated?

Fifty top financial economists from around the world participated in the 4th Annual Miami Behavioral Finance Conference on December 14 and 15 and discussed answers to the questions and other topics.

Fuqua Finance Professor Campbell R. Harvey served as program chair.  William Goetzmann, the Edwin J. Beinecke Professor of Finance at Yale University, and a world expert in financial history, joined Harvey on the panel.

Harvey began the panel by polling the crowd: “Raise your hand if you own any Bitcoin.” No one raised their hand. “That is a vote of confidence from a group of people that are uniquely qualified to judge its value,” he remarked.

There was a discussion about the difference between Bitcoin and a regular fiat currency, like the U.S. dollar. The dollar became a fiat currency in August 1971 when the President Richard Nixon abandoned the gold standard.

“There are big differences,” Harvey emphasized. “First, the dollar is legal tender and you are required by law to accept the dollar for any transaction. Second, and most importantly, while the dollar isn’t backed by gold any more, it is backed by the U.S. government’s power to tax. In addition, the taxation is enforced by the legal system. Bitcoin is backed by nothing other than beliefs of the people that hold it. There is no backing or collateral, there is no taxation – indeed, it is so mysterious that we don’t even know if Satoshi Nakamoto is the real name of the founder.”

Goetzmann talked about the history of currencies. He remarked that there were very few currencies in history that were not backed either directly or indirectly. He pointed to a stone-age practice of using rocks as currency. There is a more recent example, albeit more than a century ago, of certain South Pacific Islanders using shells as a currency.

Harvey remarked that it was hard to think of Bitcoin as a currency given the wild swings in the value of Bitcoin. He noted that an investment in Bitcoin was almost ten times as volatile as investing either in gold or the stock market (S&P 500). Bitcoin is 20 times riskier than holding the U.S. dollar. “For example, suppose you had a Bitcoin on April 9 of this year and you held it for one week. You would have lost 70%! What kind of currency is that?”

The market capitalization of Bitcoin is approximately $10 billion however there are many other competing crypto currencies. The website, coinmarketcap.com, lists 80 different crypto currencies. While Bitcoin has the largest outstanding value, the second largest, Ripples, is substantial at $2 billion.

Many at the conference argued that Bitcoin had all the characteristics of a classic bubble which means the price at any time could collapse to zero (the current price of one Bitcoin is over $800).

Goetzmann provided some preliminary but very interesting analysis showing that Bitcoin prices were influenced by contemporaneous Google news counts.

One participant argued that interest in Bitcoin was initially seeded by fraudulent transactions. Once capitalization exceeded the critical mass it became more popular for mainstream transactions.

Harvey agreed with analysis.  He argued that very little of the current Bitcoin volume is used for illegal transactions. “One of the unique features of Bitcoin is that every Bitcoin has an identifier that contains the history of the transactions (a block chain). This prevents the same Bitcoin being used twice – it also eliminates counterfeiting.” Harvey added, “I am not sure that the criminals realized this initially. While the transaction history is represented by a secure 'hash', the program was developed by the NSA. Who knows what the NSA knows now -- or what others could know in the future. It seems preferable to use a suitcase of cash for illegal transactions.”

Harvey prefers to view Bitcoin as a disintermediation force rather than a currency. "Visa and Mastercard must be sweating big time," he added. "We are in the waning days of their 2-3% transactions fee duopoly. The crypto currencies are a disruptive force. It is too early to say whether the Bitcoin model will be the winning model. However,  it is obvious that we are headed towards a new era with minimal transactions fees."