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Elon Musk and bitcoin’s chicken-and-egg problem

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Elon Musk has made many amazing pronouncements in his storied career. But perhaps the most incredible — and I mean that in the literal sense — was his tweet Wednesday that Tesla would no longer accept bitcoin as payment for its vehicles. The company, he wrote, is concerned about the environmental impact of all the electricity needed to mine cryptocurrency.

Had Musk been on a multiyear news fast that left him unaware that it takes boatloads of power to “mine” digital gold, just like mining the metal kind? Or that the majority of such mining takes place in China, which also burns the majority of the world’s coal?

This seems unlikely. One suspects that Musk simply got caught up in yet another of his futuristic enthusiasms, only to discover, the hard way, why bitcoin is struggling to become the future of payments.

Cast your eyes back to early February, when Tesla filed documents with the Securities and Exchange Commission indicating that the company had bought $1.5 billion worth of bitcoin and planned to accept it as payment. Almost immediately, commentators began pointing out that bitcoin is practically designed to waste power, an odd choice for a company that bills itself as the environmentally friendly future of cars.

If the announcement wasn’t great news for the environment, it was wonderful for bitcoin holders. On Feb. 6, bitcoin had been trading around $39,000. On Feb. 8, after Tesla’s announcement, the price had reached $46,375.90.

On March 24, Musk announced that Americans could now buy a Tesla with bitcoin. More commentators noted the environmental footprint of this decision. Tesla stayed the course, and so did the price of bitcoin, which by April 13 had risen to $63,729.50.

Since that peak, bitcoin has lost almost 20% of its value. And this, in a nutshell, is the problem with bitcoin.

It seems safe to say that most folks who are holding a lot of bitcoin — say, the kind of money you might drop on an $80,000-plus Tesla Model S — are betting that bitcoin will become much more valuable in the future. That is, of course, true of a lot of assets, from urban real estate to Tesla stock. But scarcity is not, in itself, enough to create value. The execrable novel I wrote when I was 23 is very scarce — there is exactly one copy. For a scarce resource to be worth a fortune, you need your scarce thing to someday be in high demand.

For a lot of investors in bitcoin, the hope is that, eventually, bitcoin will displace traditional currencies such as the dollar or traditional payment networks such as Visa. People will have to buy bitcoin to make payments, and since the supply of bitcoin is strictly limited — roughly 98% of all bitcoin that will ever exist will have been mined by the early 2030s — rising demand pushing against a fixed asset base will cause the price to explode.

That’s why the price of a bitcoin rose almost $10,000 as soon as Tesla announced it could be used to buy a whole car. The more bitcoin looks like a regular currency, the better it looks as an investment. Unfortunately, the better bitcoin looks like an investment, the worse it looks as a currency — which in turn makes it look worse as an investment.

Firms generally don’t like to accept payments in currencies that are volatile, since they stand to lose money if the currency declines suddenly. Tesla seems to have realized at some point that bitcoin’s volatility was a problem; reportedly, if you wanted to pay in bitcoin, you had to close the transaction within 30 minutes in order to limit the company’s currency risk.

That’s less of a problem if the volatility is only on the upside — which, as we’ve seen since April, wasn’t the case. Even if it had been, that simply would have created a symmetrical problem for consumers: If you think your bitcoin is going to quadruple in value again, why would you trade it for a car today?

This leaves bitcoin with something of a chicken-and-egg problem: If it ever gets stable enough to function for payments, it will almost certainly stop making money for the people buying it. And since bitcoin investors are the main evangelists for bitcoin payments, who would then push broader adoption?

In the here and now, it turned out that sometimes bitcoin’s value drops a lot, meaning you can exchange an expensive car for cryptocurrency that’s worth 20% less a month later. Maybe the excitement of never knowing quite how much you’ve made on each transaction appeals to Elon Musk, but it probably doesn’t appeal to Tesla’s accountants or investors.

And having belatedly realized the downsides — in every sense of those words — maybe it’s best to tell people you’ve belatedly discovered the environmental costs, and go back to demanding boring traditional dollars in exchange for your cutting-edge cars.

Distributed by The Washington Post Writer’s Group.

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