If you're wondering about bitcoin, read this insight from wine investing

By Joseph L. Breeden and Sisi Liang,

Bitcoin is a fascinating concept, attempting to solve many vexing problems, but it is currently a poor currency. This was the conclusion of an expert panel at the World Economics Forum this year in Davos, Switzerland. The panelists are all luminaries in finance and economics. They were not, however, Bitcoin millionaires. That might cause some Bitcoin enthusiasts to dismiss their complaints, but they made some good points, and some of those points relate to other types of alternative investments, such as fine wines.

Price stability is a key element of a useful currently. If someone receives their salary in Bitcoin and can buy groceries and pay taxes with Bitcoin, then they do not incur exchange rate risk. If either side of this income - outflow relationship is in a different currency, then the consumer bears exchange rate risk. Consumers don’t like exchange rate risk when buying groceries or paying for housing, as seen in Argentina and a number of countries that lived through hyperinflationary events.

Until Bitcoin solves the income – outflow problem, it is an asset, not a currency. Unlike gold or land, Bitcoin has no tangible value. It’s only value is through demand. Yes, it has rarity (only 21 million Bitcoins will ever exist), but it is substitutable with Etherium or 1000 other “coins” as well as future developments. If demand goes to 0, then Bitcoin’s value goes to 0. There is no floor.

This is not unlike baseball cards. Baseball cards are nothing but a bit of paper and ink. Their value is a combination of rarity and popularity of the player. Although rarity cannot change (as with Bitcoin), they could become unpopular (as with Bitcoin). Baseball cards are a collectible, which for an individual can be substitutable with many other collectibles. Interestingly, baseball cards have not been a very safe investment over the last 20 years [1].   

Wine is an interesting middle ground. It has physical, tangible value as a consumable, but the investment value of a wine is not entirely in the bottle or juice. Rarity and perceived quality drive demand, which drives price. The example of the “Lafite Bubble” in 2011 (shown in our analysis to really be a bubble in all Bordeaux wines) was a case where Chinese enthusiasts drove up demand and prices for Bordeaux wine. When the Chinese stock markets struggled (shown in our analysis), their demand eased and prices fell back to their floor in 2015. 

Prof. Robert Shiller said at the World Economics Forum [2], “If something is not shortable, it can be taken over by enthusiasts.” That is exactly what we saw with wine in the Bordeaux bubble, and the best way to explain the current Bitcoin Bubble.

As a consumable with a long history, wine clearly has a demand and therefore price floor. Our analysis called a bottom in 2015 and the market is up over 40% since then. With climate change and increasing global demand, wine prices will probably maintain a reliable floor, but buying near the top can still be devastating to an investor, as in any market. The wine market appears to be driven by perceived wealth, so until a sustained stock market correction occurs, we do not expect a wine market correction.

Another argument in favor of Bitcoin is that it cannot be stolen the way paper currency can. A private key is required to authorize a Bitcoin transaction. However, other points in the steps needed for a transaction have proven vulnerable to hacking. As a physical good, wine can be stolen, but it cannot be hacked. Whether physical theft or hacking is a greater danger seems to be an open question.

For Bitcoin, the fundamental question is, is there a floor? At present, it is not usable as a true currency. Even if one could buy a pizza (or a bottle of wine) with Bitcoins, if the Bitcoin / USD conversion rate falls to zero, all 21 million Bitcoins won’t get you dinner. Value comes from demand, and there is not yet an ecosystem around Bitcoin that creates such a demand floor. Until then, investors are trading the whims and emotions of others. Such volatility can be profitable, but very difficult to predict. Investors should probably view Bitcoin like trading stock in a high tech startup until an ecosystem exists to establish a value floor.

 

Reference: 

[1] Jeff Hwang, "Have Baseball Card Value Risen in 20 Years? Actually...", https://www.fool.com/investing/general/2013/02/25/have-baseball-card-values-risen-in-20-years-actual.aspx, The Motley Fool, Feb 25th, 2013.

[2] Professor Robert Shiller at the World Economic Forum: https://www.youtube.com/watch?v=5MZv9fLLfa4&t=2977s

Joseph L Breeden, PhD has been building forecasting models for over 20 years for such areas as currency futures, sporting events, agricultural commodities, and loans. The methods he pioneered in his book, Reinventing Retail Lending Analytics (2014) are considered are considered best practice in the industry and performed well through the US mortgage crisis and many other international economic crises over the last 20 years. His love of wine and data analysis led to his participation in auctionforecast.com.

Email: breeden@auctionforecast.com

 

Sisi Liang loves to find connections between seemingly unrelated ideas. Her curious mind has taken her to places from business strategy to entrepreneurship, from angel investing to marketing strategy, from metals mining equity research to regulatory stress test modeling in the largest financial institutions. She's a trailblazer and a ruckus maker.

Sisi holds a BA in English and Mathematics double major, with Honors, from Washington and Lee University, and an MS in Quantitative Finance. She is also an alumna from Seth Godin's altMBA program. Her passions for forecast modeling, the poetic and commodity elements in wine, yoga, along with her curiosity in the interconnectedness in diverse fields have drawn her to the collaboration of auctionforecast.com.

Email: sisi.liang@auctionforecast.com