Aswath Damodaran discusses the future of bitcoin

Many discussions of the future of bitcoin are by fervent backers who see its price and importance rising to ever greater heights or by critics such as Jamie Diamond CEO of JP Morgan Chase who considers it a fraud and like a pyramid scheme.

Aswarth Damodaran is a valuations expert who disagrees with many of the critics of bitcoin as well as those who are its most fervent proponents. It is a refreshing and informed viewpoint. This article discusses his views on the possible future paths of the cryptocurrency.

Damodaran is Professor of Finance at the Stern School of Business at New York University where he teaches corporate finance and equity evaluation. He has written several widely used academic texts on Valuation, Corporate Finance, and Investment Management. Before joining NYU Damodaran taught at the University of California Berkeley from 1984 to 1986. He holds MBA and PhD. degrees from the University of California at Los Angeles.

Disagreeing with both prominent critics and ardent supporters of bitcoin,Damodaran wrote in a blog post: “Unlike Jamie Dimon, I don’t believe that bitcoin is a fraud and that people who are ‘stupid enough to buy it’ will pay a price for that stupidity. Unlike its biggest cheerleaders, I don’t believe that cryptocurrencies are now or ever will be an asset class or that these currencies can change fundamental truths about risk, investing and management.”

Damodaain claims that bitcoin is not an asset but a currency. As a currency, he claims, you cannot value it or invest in it. You can only price it and trade in it. This appears a bit contradictory to me in that cash is considered an asset in financial accounting. As Wikipedia says of an asset: "Simply stated, assets represent value of ownership that can be converted into cash (although cash itself is also considered an asset).

Damodaran goes into much more detaiI as to his position in the appended video.

Damodaran see three possible paths that bitcoin could take in the future.

First, it could begin to receive widespread acceptance as a currency globally. For this to happen, it would need to become more stable in its price. However, governments would need to accept its use or at least not actively try to prevent it. He also claims that the air of mystery around the currency would need to fade. Perhaps the air of mystery will begin to fade concurrent with wider acceptance of the coin as payment.

With wider acceptance, the high price of the coin would be justified Damodaran claims. One wonders if the high value of bitcoin in terms of fiat currencies might be a problem. Would other coins of lesser value such as litecoin function better for smaller transactions?

A second path for bitcoin is to take on the function of gold for millennials, and no doubt others as well! Damodaran says:“In this scenario, bitcoin becomes a haven for those who don’t trust central banks, governments and fiat currencies. In short, it takes on the role that gold has, historically, for those who have lost trust in or fear centralized authority.” If this happens Damodaran suggests that the price of bitcoin will follow the price fluctuations of gold.

This is an interesting suggestion especially in the light of the recent hard fork in bitcoin that produced another new coin called bitgold. So far bitgold has not followed gold but has lost over 60 percent of its value.

Bitcoin's price also dropped with the fork but has since recovered to some degree with a recent price of over 5,800 dollars. Damodan does not comment on the fork.

The final path Damodaran describes: “In this, the worst case scenario, Bitcoin is like a shooting star, attracting more money as it soars, from those who see it as a source of easy profits. But just as quickly flares out as these traders move on to something new and different (which could be a different and better designed digital currency), leaving Bitcoin holders with memories of what might have been.”

Damodaran says that he himself is not a good trader so he would not buy the coin at present prices. However, he said that should not stop anyone who is a good trader. He says that traders who have a longer term horizon should be looking at its progress in being adopted as a currency.

Damodoran concludes:“If you have good trading instincts, you should play the pricing game, as long as you recognize that it is a game, where you can win millions or lose millions, based upon your calls on momentum. If you win millions, I wish you the best! If you lose millions, please don’t let paranoia lead you to blame the establishment, banks and governments for why you lost. Come easy, go easy!”

It might not have been paranoia. Governments may make bitcoin illegal for payment or shut down exchanges. Banks may discourage its adoption. It is unfortunate that Damodaran did not have the opportunity to talk of the effects of the recent hard fork.