The price of bitcoin broke $19,000 last week, and traders and speculators are giddy. Fortunes are being made. But in the long run, the smart bet is against bitcoin, for at least four reasons.
First, bitcoin is too volatile to be a reliable store of value. National currencies rest on the real productivity and fiscal capacity of citizens. With bitcoin there is no there there—only some kind of euphoric trust. But this trust is undermined by hackers who have breached bitcoin repositories.
Second, the bitcoin community is using breathtaking amounts of electricity—about as much as all of Denmark, according to one recent estimate. The currency is built so that recording transactions, and thereby generating new bitcoin, requires solving complex mathematical problems. This keeps bitcoin scarce, but it also means that massive server farms are tasked with essentially wasteful calculations. When environmentalists begin to understand this, there will be a firestorm.
Third, the currency is a vehicle for criminal transactions and for avoiding government restrictions on moving capital. This is why bitcoin has been so popular in Venezuela and China, and why such countries are cracking down.
Fourth and most important, bitcoin is on a collision course with sovereign states. Bitcoin was founded on a libertarian ethos, and its proponents zealously resist licensing and regulation. Taken to its logical conclusion, this philosophy would entail the elimination of central banks.
So far, the volume of actual bitcoin transactions has been minuscule. Western governments are dozing. But if bitcoin ever grew to critical mass, politicians around the world would wake up.
King Philip IV of France once could not repay his debts to his bankers, the Knights Templar. So in 1307 he had their leaders arrested on trumped-up charges and then burned at the stake. No modern sovereign will give up the power of the purse without a similar fight, if perhaps a less bloody one.
At the first serious (and likely coordinated) move by governments to regulate or bank the digital currency, bitcoin’s price will crash to zero. Panicked owners will rush to exit and the bubble will burst. Bitcoin futures and options may just as well be based on pixies and fairies. Nothing will be able to save them. Speculators will depart for the next lunacy, leaving behind the greater fools to wonder where their supposed wealth went and demand that government do something about it.
All the same, the bitcoin bubble is doing some good. How can this be? The high price of bitcoin, though wildly fluctuating, is attracting attention to the underlying platform, called blockchain. This technology could revolutionize future transactions of many kinds, providing secure execution of “smart contracts,” as well as fast, efficient claims processing that eliminates expensive middlemen.
Eventually those platforms will be stable and secure. But it will take a lot longer than the frenzied bitcoin market suggests. Before this frontier is reached, bitcoin itself—neither stable nor secure—will have crashed to zero.
Mr. Baxter is a law professor at Duke University, where he also co-directs the Global Financial Markets Center.