Bitcoin: an investment or a coin-toss?

 

Crypto currencies have made headlines from time to time and supporters offer a variety of reasons as to why they are important. Investment is just one of them. But is it valid?

Bitcoin was among the first (if not the first) cryptocurrency and is by far the most famous version. A cryptocurrency is a "digital asset". It exists only in cyberspace. 

The coins are "mined" using extremely powerful computers, and ownership is recorded on a database known as a blockchain. Incidentally the energy consumption involved in the mining process is huge: equivalent to the electricity consumed annually by Switzerland (article)!

So what are the benefits of Bitcoin? 

Purchasing power

One of the main benefits of the currency is that there is a finite number of coins. A total of 21 million coins can be mined. That is all. (the good news for the environment is that we are almost there, with around 90% now in circulation, and once all are extracted, the energy consumed by the sector should reduce dramatically)

This was in response to the endless printing of fiat currency that has taken place since the dollar was taken off the Gold Standard by President Nixon in the 1970s. 

There have been reams of articles written about how much the US dollar has fallen in value as a result of inflation (though as this article points out, that is only really true if you exclude interest payments). The point with Bitcoin is that only 21 million can ever be produced, so no authority (such as a central bank) can debase their value by printing (mining) more.

Record keeping

Probably the indisputable benefit of blockchain technology is its potential for record-keeping.

Ownership of the coin recorded on a block which is indelible and cannot be edited. Then when the coin is sold, a new link in the chain is added with the details of the purchaser. 

This has potential benefits far beyond the coins and the investment opportunity. This could revolutionise areas such as conveyancing and property ownership, particularly in less developed countries where paper records may be lost or incomplete. 

A store of wealth

Having a finite number of coins means that there should be some confidence in their value. Therefore they could be viewed as a modern equivalent of gold, which for centuries has been trusted as a means of preserving and accumulating wealth. 

The coin has similarities to gold in that it pays no interest or dividend and its supply is finite.

According to a recent article in The Economist, Millennials already prefer Bitcoin to gold.

Given all this, what are the risks?

The Risks

1. Security/liquidity

Rather counterintuitively, Bitcoin to date has proven somewhat insecure as a store of wealth. 

Be that from the problems of converting back to the real economy (cash), simply losing your "wallet" that contains the coins, or being locked out of the wallet due to forgetting passwords or even the owner of your bank dying!

Obviously the whole practice was setup to be beyond the reach of Governments and regulators, so there is absolutely no investor protection of any kind.

2. Strong correlation with the stock market

Gold and cash are seen as "safe haven" assets.  In times of trouble, when the stock market falls, the likes of gold and cash appear more attractive and so appreciate in value. They are therefore sometimes termed "fear assets".

The creators and supporters of Bitcoin saw the coin joining this list. 

However history has not borne this out. Bitcoin's value often moves in the same direction as the stock market. So there is little evidence that it can be called a safe haven from economic volatility yet.

3. Regulatory

Arguably the greatest risk to Bitcoin, from an investment perspective at least, comes from the world's financial regulators. If they see it as a genuine risk, they can impede it just as they impede the fledgling cannabis industry in America. They could say "Sure you can invest in it, but you can't convert it back to cash". The potential for it to facilitate organised crime makes this particularly possible.

Of course businesses could increasingly accept Bitcoins as payment, but when one is worth $30,000 that might prove a little tricky in reality.

Should Bitcoin come close to achieving one of its original aims and present a genuine alternative to the regulated fiat money system, then the authorities would surely do all they could to extinguish such a threat.

Summary

So it's nearer to a coin-toss then?

At this stage I would personally say that the answer to that is still yes. However things are changing.

The likes of Larry Fink, head of Blackrock (the world's largest asset manager), and Jamie Dimon, head of JP Morgan, have recently changed from arch critics to tentative admirers.

The traditionally conservative British fund manager, Ruffer, recently made a substantial investment .

The establishment's attitude to the coin could therefore be changing significantly. 

However personally I still see it as pure speculation and the very essence of "greater fool theory". True it may well prove to be the new gold. But it may also prove to be a trap for wealth, in the same way that many commentators are viewing an increasing amount of the oil major's reserves .

If there is one area where investment makes sense to me, it is in the infrastructure of the system. As Mark Twain noted "Whenever I hear of a gold-rush I think it's a great time to be in the pick-and-shovel business". A good example of this is the recent investment by the excellent UK fund manager, Ballie Gifford. Their first foray into crypto investing has seen them invest $100m into the crypto exchange firm: Blockchain.com. This makes sense to me as they don't care what the value of the coin is: they make money when it moves in either direction.

I may well be proved wrong, but personally I'd rather gamble a casino I know far more about and have some confidence in: the world's equity markets.

Dunotter disclosures

Disclaimer: This communication is purely meant as information for general interest. It is in no way to be taken as financial advice or relied upon in any way for investment decisions.