Morningstar Magazine - February/March 2018 - 55

Jim Sinegal: Why are people buying bitcoin?

Sinegal: Bitcoin was invented as a way of

Evan Morris: People are buying bitcoin because
they've been reading a lot about it in the
news. There's a price feedback loop, where the
more it goes up, the more news it gets,
the more people get into it, and the more they fear
missing out on this revolutionary technology.

conducting transactions. What kinds of transactions
are happening now?

Kai Wu: You can broadly split out the people
buying into bitcoin into three buckets. It
is primarily speculation, where people see these
astronomical returns and want to get a piece
of it. There are a smaller group of people who are
buying into it because of its utility, because
they want to use what it offers. And there are
other groups of people who are buying into
it for the philosophy behind it: It's a currency that's
not in control of a government.

But by and large, speculation is driving a
good deal of the market. There is uninformed
speculation, but there are also folks who
are trying to actually understand the technology
and its potential.

Morris: Bitcoin in the early days had a bad rap,
because it was seen as facilitating illegal
transactions by allowing for anonymous payments
and circumventing governments. The technology
has evolved to enable a wide range of payments. Some companies have developed their own
private blockchains to facilitate internal crossborder transactions in the millions of dollars. It can
be used for micropayments that can facilitate
content monetization. Square SQ recently
announced a technology that would allow people
to use bitcoin in their peer-to-peer payments
app, Square Cash.
Sinegal: A lot of people are looking at bitcoin

as a potential store of value, akin to digital gold. There's
a limited supply of bitcoin, and that's a lot of
the appeal. Unlike fiat currency, which can be printed,
the supply of bitcoins will forever be limited
to 21 million.

Wu: To some extent, this store of value concept
is in its way its own kind of speculation. People
think that because supply is fixed, bitcoin
will somehow retain its value beyond what it costs
to produce those bitcoins as of now.
Morris: To extend that point, yesterday I visited
a large bitcoin mining operation in eastern
Washington state, which has very cheap electricity.
If the price of gold were to go up 10 times
in one year, the supply would increase significantly
due to people investing in miners. Whereas
with bitcoin, how much supply can be created in
any given year is hard-coded. That provides
speculators more justification.

Commodity or Currency?
Sinegal: Bitcoin obviously has gone up dramatically.
How should we value it?

Wu: We're still very much at the early stages
of thinking of how to value these types
of currencies. It comes down to taking existing
valuation models and reconfiguring a bit.

You can either think of bitcoin as a commodity,
or as a currency; each approach has its
pluses and minuses. With a commodity, you'd
normally look at both the supply and demand, but
for bitcoin the supply is fixed. Looking at it
as currency, you'd look at the velocity of money,
among other things, and figure out how
quickly people are turning over bitcoin and then
compare against the supply.
Sinegal: As an equity analyst, it's difficult, because it

is useful, but it produces no cash flow. It's like
commodities, but has a much shorter history than gold
or oil, which have been valued for hundreds of years.
At the same time, there are features about bitcoin
that make it interesting according to our economic
moat framework. Comparing it to companies,
it does have a network effect. Bitcoin has developed
a large network of users, a budding ecosystem.
It has a fairly strong intangible asset. It's the most
well-known of the cryptocurrencies. And some
of the appeal is its potential for processing transactions
at a lower cost than existing payment networks.

Wu: Also, trust in the existing economic systems
is faltering a bit, especially after the most
recent financial crisis. Bitcoin is not owned
by a central government or driven by the policies
that a government might have. It's owned
in a decentralized network.
Sinegal: What are some of the main risks of investing

in bitcoin at this point?

Morris: Current risks, as we've seen in periods
of high volatility, have been regulatory risks. This
summer, China said that it was banning all
sales of new tokens-initial coin offerings-and
we saw the price dip pretty substantially overnight.
Investors have developed somewhat of a
buy-the-dip mentality, and the price rebounded
pretty quickly. But as an investor in this asset
class, you're going to need to learn to stomach
some volatility.
Sinegal: Joseph Stiglitz1 commented the other

day that cryptocurrencies should be outlawed.
What would happen if they were? Can they even
be outlawed?

Kai Wu, a project manager with Morningstar
Data, leads various blockchain initiatives.
1 Stiglitz received the Nobel Memorial Prize in Economic Sciences in 2001 and is a professor at Columbia University.

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55


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Table of Contents for the Digital Edition of Morningstar Magazine - February/March 2018

Contents
Morningstar Magazine - February/March 2018 - Cover1
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Morningstar Magazine - February/March 2018 - 1
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Morningstar Magazine - February/March 2018 - Contents
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