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Bitcoin may just be a ‘dangerous pricing game’, says Aswath Damodaran

If bitcoin does not prove its worth as a usable currency, its massive price surge is a “dangerous” game, according to one respected finance professor.

“If you don’t believe that bitcoin will ever acquire wide acceptance in transactions, it is time that you were honest with yourself and recognized that is just a lucrative, but dangerous, pricing game with no good ending,” Aswath Damodaran, a professor of corporate finance and valuation at New York University’s Stern School of Business, wrote in a blog post late Tuesday.

“Crypto currencies, with bitcoin and ether leading the pack, have succeeded in financial markets by attracting investors, and in the public discourse by garnering attention, but they have not succeeded (yet) as currencies,” he said.

Change in bitcoin price vs. number of transactions between Jan. 2012 and July 2017

Source: Aswath Damodaran

Bitcoin has more than doubled this year to trade near $2,700 Wednesday, while rival digital currency ethereum has leaped more than 2,000 percent to around $200, according to CoinDesk.

As digital currency prices have skyrocketed, some on Wall Street have started disclosing their bitcoin purchases and issuing predictions of double-digit price gains or more. However, Elliott Prechter of The Elliott Wave Theorist newsletter noted in July that the surge in bitcoin’s price and interest in the digital currency has “dwarfed even the Tulip mania of nearly 400 years ago.”

Damodaran, sometimes called Wall Street’s “dean of valuation,” evaluated bitcoin by comparing it to “fiat” currencies like the U.S. dollar based on how fairly the exchange rate reflects their purchasing power.

“The question that you would need to address, if you are paying $2,775 for a bitcoin on August 1, 2017, is whether you can (or even will be able to) buy $2,775 worth of goods and services with that bitcoin,” Damodaran said.

He said bitcoin’s high price can be justified if the digital currency becomes widely accepted as payment, especially since by design only 21 million bitcoins can ever exist. High demand for a limited supply of coins will naturally send prices higher.

So far, bitcoin’s usability is limited.

“Bitcoin acceptance is virtually zero and shrinking,” Morgan Stanley stock analysts said in a July 12 report “The disparity between virtually no merchant acceptance and Bitcoin’s rapid appreciation is striking.”

The analysts said that among the top 500 online merchants, the number that accept bitcoin has fallen from just five last year to three this year.

Part of the reason why few customers and merchants use bitcoin is high transaction cost. Fees have climbed as an increasing number of transactions, which includes investment and trading-related activity, compete for limited processing power on the bitcoin network.

The average bitcoin transaction fee jumped from around 31 cents in December to a high of $5.50 in June, and were still near $2 this week, according to BitInfoCharts.

When CNBC tried to live on bitcoin in New York City for a week, only a handful even accepted the digital currency, while costs went up roughly 40 percent due to conversion rates and additional transaction fees.

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