What Is Bitcoin Really Worth? Don’t Even Ask.

This article originally appeared in the New York Times.

Dabbling in Bitcoin lies somewhere between gambling and investing.

After all, true investing requires a rational appraisal of an asset’s value and that is simply not possible at present with Bitcoin. Real understanding of the economic issues underlying the cryptocurrency is almost nonexistent.

It is not just that very few people really comprehend the technology behind Bitcoin. It is that no one can attach objective probabilities to the various possible outcomes of the current Bitcoin enthusiasm.

How can we even start estimating the fundamental value of Bitcoin, with its astonishing market value of more than $275 billion? Any attempt will soon sound silly.

Let’s try for just a moment. It is possible to imagine a future in which Bitcoin eventually replaces some fraction of money as we know it today. Suppose that happens soon. Note that one measure of the United States money supply, M1, is today worth more than $3.6 trillion.

But don’t get too excited.

Will Bitcoin really replace a large fraction of conventional money? There are reasons to be skeptical. Bitcoin is vastly more volatile than conventional money and relatively few people trust it as a store of value. Even if that hurdle is crossed, how much cryptocurrency will people need?

Putting it in economic terms, will the demand for Bitcoin have the same velocity as the demand for money? Will there be the same number of hoarders? And what about all the other cryptocurrencies that exist today, and those that will arise in the future? Bitcoin might well be replaced by something different and better, and end up being worth nothing at all.

I won’t go further down this road. Many people are making analogous attempts to put a fundamental value on Bitcoin—but such efforts will be intrinsically and absurdly inaccurate. The results of a serious attempt to assess the value of Bitcoin can only be ambiguous.

Ambiguity in economics is an important and developing subject.

Many academic economists still embrace the efficient markets theory: the belief that markets generally respond accurately to genuine new information about fundamentals, and react only to such information. But Bitcoin is an example of ambiguity, and the efficient market theory does not capture what is going on in the market for this cryptocurrency. There has not been enough genuine new information coming in day after day to rationally justify Bitcoin’s huge price swings. Something else is afoot.

One narrative that seeks to explain the price increases this year is that they have something to do with the difficulty of betting against—making short sales of—Bitcoin. Absent the opportunity to engage in short sales, “smart money” can only watch from the sidelines while prices soar. Or so the efficient market theory claims.

But pessimistic investors hoping to profit from a Bitcoin price fall actually have had the opportunity to make negative investments for a while. Bitcoin exchanges such as Bitfinex allow shorting of Bitcoins, and it is possible to short Bitcoin-linked exchange-traded notes on online brokerages like the Bitcoin Investment Trust, GBTC. Both of these options suffer from lack of liquidity and of trust in these new institutions; GBTC has not tracked Bitcoin prices accurately, for example. Still, if enough people had managed to take a short position, that might have helped to limit the increases in Bitcoin prices that we have seen.

It is possible that the Bitcoin market will change in a meaningful way now, given the decision of Cboe, the Chicago Board Options Exchange, to start a Bitcoin futures market on December 10 and of the CME Group to do so on December 18. The academic literature tells us that volatility of an underlying asset often falls after the establishment of new futures markets for it. But the ability to short an asset more easily won’t necessarily overcome the power of investor excitement.

In 1936, John Maynard Keynes suggested why. He played down the role of quantitative analysis and probability estimates in human thinking of the assessment of ambiguous future events. People in such situations are vulnerable to a play of emotions and at times a “spontaneous urge to action” that he called “animal spirits.” He argued that much of what happens in financial markets has to do with people learning, from price movements, about each other’s animal spirits.

I believe that Mr. Keynes was correct about animal spirits in general and how they affect markets like the one for Bitcoin. George Akerlof and I expanded on his perspective in our 2009 book Animal Spirits, which argued that the driving force behind human enterprise cannot be reduced to the rational optimization emphasized by traditional economics. Darwinian evolution produced a human species whose behavior sometimes seems to be emotionally driven.

Neuroscientists, psychologists, and economists are leading us toward new models of human decision-making. They may help to explain phenomena like the Bitcoin price rise.

Scott Huettel, a Duke neurologist, and other researchers showed in 2006, for example, that when making decisions involving ambiguity, people do not use the parts of the brain required for calculations of probabilities and expected values. And the economists Anat Bracha of the Boston Federal Reserve and Donald Brown of Yale have provided an alternative to conventional economic theory of human behavior under uncertainty. They define a different kind of rationality—one based on Mr. Keynes’ views, not on calculations of utility—in ambiguous situations.

Furthermore, a paper by neuroscientists including Benjamin Lu that was presented at the Society for Neuroeconomics annual convention in Toronto in October, showed that psychologically stressful experiences can result in changes in neurological processes when ambiguous situations arise.

In short, the Bitcoin market is a marvelous case study in ambiguity and animal spirits. It is providing invaluable information about how millions of human brains process stimuli coming, in this case, from public acceptance, imagination, and innovation surrounding cryptocurrencies.

This is fascinating from a psychological and neurological perspective. But it isn’t grounded in solid economics. No wonder the Bitcoin market has been so chaotic.