Bitcoin - It’s a Hustle, Right?
It may have been a joke about dogecoin, but Elon Musk cut to the bone on cryptocurrencies in his Saturday Night Live debut. No one seemed to know enough about dogecoin to make any sense describing it. Falling 40% following the quip, it seems investors also lacked the stomach for the parody coin.
In truth, none of us really understand the investment characteristics due to the speculation-centered coverage. Furthermore, scanning Reddit’s subreddit “WallStreetBets”, one notices a palpable FOMO. This is not a reason to add an asset to your portfolio.
In a post-GameStop world, it is hard to argue that these retail speculators are inconsequential. They are in fact a group of over 10 million speculators discussing their bets. While there is no question their bets are speculative, some seem to think this is investing when it is closer to the opposite.
While we refer to Bitcoin as a currency, it fails the “currency test” as it is far from a stable store of value and, for the most part, is not spendable. Zooming out, what are the questions we should be asking ourselves? It often seems like a new asset class has emerged with so many “experts” ready to opine. In our view, there are still more questions around bitcoin than answers.
Here are some of our questions and concerns:
Will Bitcoin be the cryptocurrency of the future? History is full of early adaptor ideas that are eventually improved on and fade away. NYC taxi medallions seemed impervious, reaching a $1 million price tag until Uber entered the picture. As digital assets become more mainstream, they are being evaluated with a sharper pencil. There are low barriers for competing coins and much of bitcoin’s value is predicated on it being the crypto coin of the future.
Where is the value? Any asset that depends on the “greater fool” theory is speculative and therefore not an investment. The greater fool theory says that prices of an asset can continue to increase as long as people can sell overpriced securities to a "greater fool.” That can work, of course, until there are no fools left. “It” has value only because you know other people think it has value. Evidence based investing does not support owning an asset simply because others are willing to own it at higher and higher prices.
Much of bitcoin’s appeal is that it is not controlled by a government entity and therefore protected from bureaucratic overreach. This concern seems particularly relevant with the massive debt and money printing of late as the world’s central banks responded first to the mortgage crisis and then to Covid. Can digital assets protect investors from inflation and fiat currency devaluation? Eventually, the world may look like a Star Trek universe with a dominant world currency, but in the meantime, governments will likely do anything within their power to keep their own currencies relevant. China recently announced a digital yuan, a version of the Chinese currency based on a blockchain, which is the tamper-proof online ledger technology that underpins bitcoin and other digital currencies. However, China’s blockchain is permissioned, meaning the People's Bank decides who can use it. China is also moving to eliminate mining and trading of other digital assets. The U.S. Federal Reserve just announced its intentions to develop digital currencies as well. Both recognize the threat of currencies outside their control.
There are also opinions that banning cryptocurrency could slow or halt ransomware and other related criminal activity in general (WSJ, May 26, 2021). Will there also be a move to simply make non-government crypto illegal for use? It is not out of the question.
Another risk for cryptocurrencies applies to mining; that is, the process by which new coins are entered into circulation. It is performed using very sophisticated computers, run by electricity, that solve extremely complex computational math problems. This intense energy use is increasingly at odds with a more environmentally sensitive world.
What It All Means
As a speculation, bitcoin and other digital assets could be profitable if one gets lucky on timing purchases. But timing these trades can be frustratingly elusive and generally unprofitable over the long-term. Asset bubbles come and go. Just because a bubble gets bigger does not mean it will not eventually burst. Our advice: if you must own Bitcoin, put it in a personal trading account limited to a preset amount of your portfolio. That way, the risk of being wrong will not irreparably damage your long-term financial plans.
So, are you an investor or a speculator? Long-term investing success comes from consistent exposure to the broad financial markets, participating in economic growth, and profitability of a wide collection of assets with real earnings. Digital assets are not so sexy when viewed through the lens of an investor, which raises the question of whether they have a place in a diversified portfolio. The answer, we believe, is no – at least for now.
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