Among the most prominent critics of Bitcoin and cryptocurrencies in general is American billionaire Warren Buffett, who stated in an interview with CNBC years ago: "Cryptocurrencies are essentially worthless. You can't do anything with them except sell them to someone else."
In financial literature, this theory is known as the "Greater Fool Theory." The idea is that you shouldn't invest in something if its value depends solely on someone else selling it at a higher price.
This theory states that stocks, bonds, and real estate assets generate cash flows and can be valued based on them, while Bitcoin produces nothing at all.
A lesson from the history of crude oil
Before the late 19th century, crude oil was mostly a nuisance. Pioneers in the American West drilling for water would sometimes find oil and be disappointed. The problem was that oil had no definite use. On the profit margin, it could be used to make asphalt and was often used as medicine, but it was mostly ignored. Finding oil was as exciting as finding clay.
Things began to change when George Bissell made a breakthrough in the 1850s: he wondered if “rock oil,” as it was called, could be processed and used for lighting (replacing “coal oil” in kerosene lamps) and as a lubricant for machinery.
Thus the oil industry was born: a lone scientist discovered that a viscous, pungent, and unsightly liquid could be used to generate light.
However, demand for oil remained low in the first few years due to its problems. One of these was its unpleasant odor, as crude oil naturally contains a high sulfur content. But subsequent chemical refining processes, such as desulfurization—interestingly financed by oil producers like Standard Oil—created new uses and markets.
The story doesn't end with kerosene lamps, of course. The early 20th century saw engineers experimenting with internal combustion engines. As cars grew from children's toys to necessities, demand for oil soared. By the end of the 1920s, 85% of oil production was used for fuel.
Not many realized the potential of the “new light” early on, but those who did, like John D. Rockefeller, were responsible for some of the greatest examples of value creation to date.
Bitcoin today is like oil after the development of kerosene lamps, but before cars, airplanes, and other things. It is a commodity with limited but meaningful real-world uses. Individuals today use it to store their savings outside of the fiat currency system (“digital gold”), to transfer money across borders, and to settle large transactions quickly and irreversibly. In some countries, it provides a safety valve for citizens concerned about repressive regimes and a way to smuggle money with limited financial risk.
But like oil in the late 19th century, these applications are still in their infancy. Kerosene lamps were a proof of concept; the true value of oil lies in its ability to be easily transported and released in large quantities. Similarly, Bitcoin's current utility is limited; its true value lies in allowing money to move at the speed of the internet and to be held independently.
Investors who buy Bitcoin today are betting that future uses built on these fundamental capabilities will be greater than Bitcoin's current market value.
For example, if Bitcoin significantly penetrates parts of the external wealth markets, escrow, payments, remittances, or other markets, its potential will be much greater.
The "greater fool" theory states that asset prices may rise simply because someone is willing to buy them at inflated prices in the hope of selling them later to a "greater fool," regardless of their true value. However, this game ends once the "fools" willing to pay run out.
According to this theory, investors ignore financial ratings, earnings reports, and all basic investment criteria, relying instead on the hope of a later buyer who will pay more. This is an extremely risky approach, as it can ultimately leave investors with worthless assets when the market collapses.
How does the theory work?
Under this theory, an investor might purchase securities of dubious value, hoping to quickly sell them to a more optimistic investor. However, these securities collapse as speculative bubbles burst, as occurred in the 2008 subprime mortgage crisis, when financial institutions were unable to liquidate securities backed by worthless mortgages.
Theory vs. Real Evaluation
One of the most important lessons from the financial crisis is the importance of fundamental asset valuation. This includes analyzing the asset's intrinsic value, examining earnings data, growth rates, and cash flows, analyzing the industry and competition, and understanding ownership and management structures.
Are cryptocurrencies for fools?
Speaking to TechCrunch, Bill Gates stated that non-fungible tokens (NFTs) and cryptocurrencies are "100% based on the 'Greatest Fool' theory." Or as Warren Buffett said in 2020: "Cryptocurrencies are essentially worthless. You can't do anything with them except sell them to someone else."
The point Gates, Buffett, and many economists are making is that cryptocurrencies offer no "real" value. Therefore, cryptocurrencies are simply a bubble in which people try to outdo each other. They are nothing more than a scheme to make money by buying and selling at higher prices.
When people realize this fact, cryptocurrencies will collapse. But how fair is this analysis of cryptocurrencies? Although cryptocurrencies have few practical applications, it is too early to conclude that Bitcoin or other digital currencies are practically useless. Today, people use cryptocurrencies to transfer money across borders and settle large transactions.
At least a few major retailers accept Bitcoin as they would fiat currency. Matt Hogan, a writer for Forbes, compares Bitcoin to oil in the 1850s. Back then, oil was used only for lamps and lubricating machinery. Of course, with combustion engines and technological advances, oil has become one of the most valuable commodities in the world. Perhaps something similar will happen with cryptocurrencies.
When you think about it, the "greater fool" theory is how many markets work. Prices and value aren't always determined by practical factors like utility, but rather by supply and demand. If people think a Rothko is worth $80 million, then that's how much it's worth. If people are willing to pay a price, then that price is what determines value (at least in economic terms). Of course, the problem is that humans are remarkably fickle. What we consider valuable today, we may consider worthless tomorrow. So, cryptocurrencies are no more of a "bubble" than any other market that often inflates, like art or jewelry.
