Cryptocurrencies: Signed Pieces of Paper in Search of the “Greater Fool”

by Ron A. Rhoades, JD, CFP(r)

Does Bitcoin, or do many other “cryptocurrencies,” possess any true value?

A recent news article reported that Berkshire Hathaway invested over $1 billion in Nubank, a bank headquartered in Brazil.[1] Did one of the world’s greatest investors, Warren Buffet, who in 2018 referred to cryptocurrencies as “rat poison squared,” change his mind about cryptocurrencies?[2] This is doubtful, as Nubank (a highly diversified financial services bank) has an investment unit that permits customers to invest in crypto exchange traded funds (ETFs) – but not in cryptocurrencies directly.[3]

In my introductory Personal Finance class, several students mentioned how they could make a great deal of money by investing in cryptocurrencies. Hearing this, I asked my students, “What is Bitcoin?”

A student replied, “It is a cryptocurrency.”

“What’s that?” I asked.

“It is a digital currency to make payments.”

“What backs this digital currency?” I inquired.

Another student responded, enthusiastically: “It’s backed by blockchain and mining.”

“Really?”, I replied. “The fact is Bitcoin transactions are verified by, and new Bitcoins are created by, a process known as ‘mining.’ But mining is just a procedure. And blockchain is encryption software, now utilized by many financial institutions to secure transactions. But neither mining, nor blockchain, constitutes the intrinsic value of Bitcoin – they just enable Bitcoin to be created and traded.”

To demonstrate a point, I pulled a ten-dollar bill from my pocket. “What is this?” I asked the class.

“Ten dollars,” several replied.

I elaborated, “At the top, it says, ‘Federal Reserve Note.’ This $10 bill is backed by the ‘full faith and credit of the United States.’ This means that it is backed by all the assets owned by the U.S. – gold, land, buildings, etc. But even more important, it is backed by the taxing power of the United States.”

I continued, “Is Bitcoin backed by a stash of gold, or does it have the ability to tax anyone?”

“No,” said a few students, hesitantly.

“How many Bitcoins will there be?” I asked.

An astute student replied, “About 21 million, and only about 2 million are left to be mined.”

“Great answer,” I replied. “Suppose I take this piece of paper and place my signature on it” as I signed the paper with a flourish, in large letters, “Professor Bear.”

Showing my signature to a student in the front row, I asked “How much will you give me for this piece of paper, if I promise I will create no more than 21 million of similar pieces of paper?”

The student looked uncomfortable. I said, “Be honest … you won’t hurt my feelings.”

The student said, “Nothing.”

“But this piece of paper is scarce. There will only be 21 million of them! That means, this piece of paper could well become valuable,” I replied.

A student from the back row chimed in, “You’re not selling that piece of paper very well.”

“That’s right. I’m not very good at creating hype around this piece of paper. So, let me put it out for bid. The opening bid is one penny. Who will bid?”

No student bid.

I continued. “Unlike Bitcoin, which is hyped by many people, there is no hype about my signed piece of paper. Bitcoin is, in essence, only a signed piece of paper, of which there will only be 21 million.”

I added, “Does Bitcoin make any money? Does it generate revenue, through operations? Does it provide any goods or services that benefit individuals, or society?”

“No,” said the class. I could sense the subsiding enthusiasm fading from the student’s earlier excitement of investing in cryptocurrencies.

“So, in summary, cryptocurrencies have value because investors hype them. In general, they are not backed by anything. They have only the value that someone (foolishly) is willing to pay for them.”

I added, “If you choose to invest in cryptocurrencies, you may make money. But only if, as time goes by, other people are foolish enough to buy the cryptocurrency from you, at an even higher price.”

“In the end, the hype around cryptocurrencies will, inevitably, die down. Charlie Munger, the longtime business partner of Warren Buffet, and the vice chairman at Berkshire Hathaway, recently stated “it is a ‘safe assumption for investors that over the next hundred years the price of Bitcoin would go to zero.’ ”[4]

I concluded, “All that happens in the end, is those who invested at low prices, and fortunate enough to sell at higher prices, were able to transfer wealth from those who were greater fools than themselves.”

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Dr. Ron A. Rhoades serves as Director of the Personal Financial Planning Program at Western Kentucky University, where he is an Associate Professor of Finance within its Gordon Ford College of Business.

Called “Dr. Bear” by his students, Dr. Rhoades is also a financial and investment adviser with Scholar Financial, LLC. To request further information about Scholar Financial, LLC’s fees and services, please email AdvisorINFO@ScholarFinancial.com. Thank you.

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[1] Andrés Engler, “Berkshire Hathaway Invests $1B in Brazilian Digital Bank Nubank, Reduces Mastercard, Visa Positions,” CoinDesk (Feb. 16, 2022).

[2] Id. See also https://fortune.com/2022/02/16/warren-buffett-invested-1-billion-crypto-bank/.

[3] Engler, supra n.1.

[4] Sergei Klebnikov, “Billionaire Investor Charlie Munger Calls Crypto A ‘Disease’ And Praises China For Banning It,” Forbes (Feb. 16, 2022).