- Analysts from Bernstein Research compared the recent demand for bitcoin to markets in China’s anti-ageing medicine and high-end liquor.
- Their research considered the characteristics of a Veblen good — a product which gains its appeal from the social status attained by owning it.
- The analysts also said bitcoin’s value is driven partly by limited supply, but uncertainty around underlying demand leaves the market open to manipulation.
The price action of a social status-boosting alcoholic drink popular in China may shed light on the economics of bitcoin, according to Bernstein Research.
To try and add some context to bitcoin’s meteoric rise, the analysts compared the key drivers of demand to that of well-known Chinese products in two distinct fields: Medicine and alcoholic beverages.
“Bitcoins do not provide investors with cash-flows or other benefits, but the maximum supply of bitcoins is fixed and so the price is driven by speculation on the potential demand for bitcoin,” the analysts said.
The market for cryptocurrencies also has a significant degree of uncertainty about what underlying demand actually is. How many people really want cryptocurrencies? Why do they want them? How many will want them in future? Will they want them on an ongoing basis over a long period of time?
This uncertainty about demand contributes to the price volatility.
There are numerous unregulated exchanges around the world, among which the price of bitcoin can vary significantly.
And prices for bitcoin fell overnight, simply because the website coinmarketcap.com removed prices on South Korean exchanges from its listings. Bitcoin prices in South Korea are generally higher than other exchanges.
“In this world, investors vacillate between the holy grail of bitcoin pricing becoming widely adopted and the price ‘going parabolic’ and the risk that actual value is close to zero,” Bernstein analysts said.
They contrasted this situation to demand for a traditional Chinese medicine derived from donkey skin called E.Jiao, used for blood enrichment and anti-ageing.
In 2016, China produced 5,000 tons of E.Jiao, which required 2.5 million donkey skins.
But the population of donkeys in China is falling, which has led to cheap imitations derived from cows or horses.
So the original product’s leading manufacturer — Dong E-E.Jiao — benefits from what Bernstein calls “credible scarcity.”
E.Jiao has limited supply, like bitcoin. But the product also benefits from a higher degree of certainty about underlying demand.
It means Dong E has raised its prices for E.Jiao 18 times over the last decade.
Falling somewhere in between bitcoin and E.Jiao on the demand curve, there’s the Fetien brand of baijiu — a popular Chinese liquor.
Serving baijiu to guests is an important way for Chinese people to convey their status in society, which makes it what economists refer to as a Veblen good.
Basic economic theory suggests that when prices fall, more people will buy a product.
But in the case of Veblen goods — which include high-end fashion brands and luxury cars — raising the price often reinforces the social status attached to the product, making it more desirable and convincing people to pay more.
Bernstein calls this the “snob value” of the product.
Essentially, bitcoin may be displaying some features of a Veblen good now with prices rising for not much other reason than people thinking it’s cool.
“In mid-2017, we conducted a consumer survey of 1,070 Chinese Premium Goods Consumers which showed that Veblen Demand is the third most important motivator of brand choice in Ultra Premium Baijiu brands like Fetien and its key competitor, Wuliangye. 32% of respondents cited ‘serving it shows respect to my guests’ as a key reason for choosing the brand. ‘It is appropriate for people like me to drink this brand’ also came in the top 5 cited by 23% of respondents,” Bernstein said.
“For Fetien, ‘drinking it / serving it shows that I am successful’ was also an important motivator with 27% of respondents citing this as a brand choice motivator.
“This sort of Veblen demand was one of the factors which drove the consumer price of Fetien up by around 400% between 2007 and 2012 and is once again contributing to the 64% rise over the last 12 months.”
Bitcoin, the Dong E-E.Jiao medical formula, and Fetien’s baijiu liquor all derive part of their value from limited supply.
However, Dong E-E.Jiao also benefits from certainty of demand. But demand levels are unclear in the cases of bitcoin and baijiu, and like the world’s leading cryptocurrency, Fetien has been susceptible to a distortion of market fundamentals.
The first occurred in the late 2000s amid a supply deficit, where distributors responded by hoarding excess stock which served to reduce supply even further.
That bears some resemblance to bitcoin, where just 1,000 people are estimated to hold around 40% of all available coins.
Fetien’s price supply then sharply reversed when the Chinese government launched an anti-corruption campaign in 2012 which saw owners flood the market with excess stock.
As a comparison, the cryptocurrency market has already been targeted by Chinese authorities.
It will be interesting to watch whether such volatility will permeate the market for bitcoin and other cryptos in 2018.
For one, the huge increase in the market’s popularity is likely to see it increasingly come under the watch of tax authorities, securities exchanges, and banks.
How such developments impact speculative demand is likely to have some effect in determining ongoing demand for bitcoin and similar digital currencies.