Warren Buffett, generally a shrewd investor, surely knows the financial definition of intrinsic value, but inexplicably he does not understand Bitcoin. How do I know he does not understand Bitcoin? Because he called it a "mirage," said it had “no intrinsic value,” called it “a joke,” and compared it to a check. A check? Bitcoin, the network, can be compared to the entire banking system that processes a check, which includes the clearing system, the image scanning system, the ATM network, the credit and debit system of the Automated Clearing House, the SWIFT financial messaging system, and ultimately the institutions that we trust to safely track our balances and return our deposited funds upon request.
Buffett’s uninformed and off-the-cuff remark sparked a conversation about the intrinsic value of Bitcoin. We need to begin by defining "intrinsic value," because it has a different definition for a financial investor than it does for most noninvestors. Investors look at the book value and add the discounted cash flow to arrive at the intrinsic value, which is often different from the market value. Most noninvestors think of intrinsic value as the value of a thing itself. Noninvestors often cite the example of gold, or of a knife that can cut, splice, and dice. Gold can be used for industrial purposes. It is extremely malleable, shiny, and contains other unique physical properties. I posit, however, that gold’s real value lies in its scarcity and in its worldwide acceptance as a store of value. Knives, on the other hand, are great tools of utility value.
Mr. Buffett’s ability to calculate the difference between intrinsic (or fundamental) value and market value gives him a real investing edge. I respect his investing acumen and I mean no disrespect for him when I declare he is wrong about Bitcoin.
Perhaps if Buffett thought about Bitcoin differently, he might come to a better conclusion. He regularly purchases stocks, so he understands that market. A stock, based upon the investor's definition of intrinsic value, represents partial ownership in an ongoing business that holds assets (book value) and makes money, which can be included in its value when discounted for time. Once Mr. Buffett learns a bit more about Bitcoin, I hope he will realize that upper-case Bitcoin, the network, holds tremendous value because it can be compared to a banking system, or a worldwide collection of banks and all of their systems. While lower-case bitcoin, the currency, can be compared to an index fund or an exchange-traded fund, which would include all the bitcoin companies in the Bitcoin ecosystem.
Value is subjective and contextual. It is subjective because it depends on the feelings and opinions of the person doing the valuing. It is contextual because it depends on the circumstances and setting of that person.
Let us explore this with a simple example. Imagine you are stranded alone on a desert island with no internet connection. You are hungry, thirsty, and you cannot get off the island. Three things wash ashore -- a laminated-paper bitcoin wallet that gives the private key for an address that holds 100 BTC, a shoebox full of freshly printed US $100 bills, and a crate containing a knife, some flint, nine hens, a rooster, and several large sealed bottles of crystal-clear purified water. Which has the most value -- to you?
Now change the context, and imagine you just polished off a meal at a five-star restaurant and you ate too much dessert. You’re faced with the choice between the same items, but now you might want to count the $100 bills and check the public bitcoin address to decide whether you would rather take the bitcoin or the shoebox full of cash.
OK, one last example. This time you have eaten a nice meal while reading about China and Russia striking a deal to use their native domestic currencies to settle trade and purchase energy in the form of gas, oil, and coal. You are faced with the same choice of food, bitcoin, or dollars. But now you are rattled. You think, “What if the dollar is losing its status as the global-reserve currency? What if dollars come flooding back to the United States as other countries choose not to hold them? What if government numbers for inflation are being blatantly manipulated?” You give it more thought, and you reason that you could take the dollars and buy stock in global companies in order to protect yourself. Then it hits you: “This is why the stock market is doing so well. It is not in recovery at all. People are shifting to stock assets in the face of a manipulated and devalued currency.” Your choice now comes down to buying global stocks, or taking the bitcoin. You look at the history of Bitcoin over the last few years, compare it to the S&P 500, and you make your choice without even needing to count the dollars in the shoebox.