You Say Bitcoin Is Digital Gold? Maybe It’s Digital Pearls

What happened afterward is a cautionary tale for bitcoin advocates who believe the cryptocurrency is the equivalent of digital gold.
What happened afterward is a cautionary tale for bitcoin advocates who believe the cryptocurrency is the equivalent of digital gold.

Summary

Almost every previously disruptive technology has ended up being disrupted. Bitcoin could be too.

In 1917, Maisie Plant, the young wife of a rich businessman, couldn’t stop admiring a magnificent double strand of pearls from Cartier. The Parisian jeweler was looking for a U.S. headquarters in New York. Pierre Cartier offered to swap the necklace, priced at $1 million, for the Plants’ mansion on Fifth Avenue and 52nd Street in Manhattan. Maisie’s husband, Morton, promptly agreed to the trade.

What happened afterward is a cautionary tale for bitcoin advocates who believe the cryptocurrency is the equivalent of digital gold. Instead, it might end up being like digital pearls.

Why would an industrial baron like Morton Plant—with vast holdings in railroads, steamships and hotels—trade his elegant mansion for a few shiny lumps that came out of an oyster?

For millennia, pearls had been prized around the world and were often more valuable than gold or even diamonds. In 1917, the $1 million the Cartier pearls fetched was worth at least $24 million in today’s money.

What neither Plant nor Cartier could know was that just months earlier, Japanese entrepreneur Kokichi Mikimoto had industrialized the technology to create cultured pearls.

Mikimoto was soon mass-producing them. The price of natural pearls began collapsing in the 1920s and stayed down for decades.

In 1957, after Maisie died, her Cartier necklace sold at auction for $151,000.

In recent years prices for the finest natural pearls have rebounded. In 2015, a Cartier pearl necklace comparable to Maisie Plant’s sold at a Sotheby’s auction in Geneva for about $7 million.

Even so, that’s about one-third of the price of the Plant necklace in 1917, adjusted for inflation.

Cartier got the much better end of that pearls-for-real-estate swap. In 2016, a comparably sized, less-renowned property two blocks up Fifth Avenue from the landmark Cartier building sold for $525 million.

Why am I connecting all this with bitcoin? Much of the token’s allure comes from its scarcity, fueling the belief that it is digital gold.

Bitcoin isn’t merely rare, like gold; its supply is finite. The coin’s maximum quantity is effectively fixed at 21 million. Approximately 19 million already exist, and the rate of new issuance is scheduled to decline over time until the last coin is created around the year 2140.

Thanks to that scarcity, bitcoin’s fans believe with religious fervor that its value will rise inevitably and indefinitely. Bitcoin is up 22% so far this year and more than 8,400% over the past decade.

If you’re tempted to buy bitcoin or one of the newly minted exchange-traded funds that hold it, whether it turns out to be digital gold is critically important.

Adjusted for changes in the cost of living, an ounce of gold has approximately the same purchasing power it had in ancient Rome 2,000 years ago. Betting that bitcoin is digital gold implies that it will be as durable a store of value, especially as government-issued currencies lose purchasing power over time.

History shows, however, that what happened to natural pearls happens to technologies, too: They fall victim to what the economist Joseph Schumpeter called “the perennial gale of creative destruction."

From 2009 through 2014, BlackBerry boomed from 25 million to 85 million active users as it made flip phones seem like fossils. Then the iPhone blew BlackBerry away.

Commodore and Atari personal computers were buried by IBM and Apple; pioneering search engines Go.com and Infoseek were crushed by Yahoo, which was itself decimated by Google. In social media, Friendster was supplanted by MySpace, which was obliterated by Facebook.

If, in early 2000, you had correctly forecast that the internet would change the world, the company you likely would have bet on was Cisco Systems. With its hardware forming the backbone of the internet, Cisco had become the world’s largest stock by market value. Yet cloud computing ended up pushing Amazon, Microsoft and others far past Cisco.

Almost every previously disruptive technology has ended up being disrupted. Launched in 2009, the bitcoin network has so far only grown more robust. Is it un-disruptable?

The code that powers bitcoin, like all software, requires periodic updating. It has been prone to bugs in the past, although they never severely impaired it. However, if a programming flaw goes undetected long enough to be widely adopted, that could compromise the stability and security of the bitcoin network—which, in turn, could deal a severe blow to the currency’s value.

“Any [software] update is a potentially damaging vector," says Lyn Alden, author of “Broken Money" and an independent investment strategist who recommends bitcoin to her clients.

As the prospectuses for the new bitcoin ETFs all warn, new digital currencies could come along and reduce demand for—and the value of—bitcoin. That might not happen for years, if ever. Or it might come suddenly out of nowhere.

“We’re never at the end of innovation," says Matt Hougan, chief investment officer at Bitwise Asset Management, which runs the Bitwise Bitcoin ETF, launched on Jan. 10.

“It’s theoretically possible that another digital asset could supplant bitcoin as the apolitical store of value," says Hougan. “If you buy bitcoin, you’re not buying crypto, you’re buying bitcoin: one asset, one piece of software, one part of the ecosystem."

That’s an undiversified bet that bitcoin’s scarcity and uniqueness are unassailable. Learn a lesson from Maisie Plant: If you make that bet, keep it small and hedge it if you can.

Write to Jason Zweig at intelligentinvestor@wsj.com

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