There isn’t enough fear of Bitcoin (BTC).
Released to the world in 2009, Bitcoin is an open-source form of crypto-currency. It was designed to be a trustworthy means of exchanging value with no need to rely on government or other central repositories. Indeed, many of its earliest (and most vocal) backers are very distrustful of government and very interested in all aspects of privacy.
Blockchain, the digital ledger tech underlying Bitcoin, is very interesting and has a lot of the major players in business and finance looking to use it for various applications. Year-to-date BTC has seen a meteoric rise catching the eye of many an investor and the public in general.
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Recently, my brother’s father-in-law came to me and asked if he should invest in Bitcoin. Such has been the fervor around Bitcoin that even he, a complete financial novice, had heard that buying Bitcoin was an easy slam-dunk method to make money. He had heard about Bitcoin from a friend at work that was very enthusiastic following his own incredible short-term returns. We discussed it in detail and he decided that it probably wasn’t something that he should get into without gaining some knowledge on the both the subject of Bitcoin and Investing itself.
That anecdotal story seems to capture in a small way the growing number of very unsophisticated investors interested in Bitcoin. Hearing of the great returns experienced by acquaintances, friends, and family (often within a relatively short window), they want to find a way to get in on the action… and those that seek… find. Spurred on by their own amazing short-term gains, they invest more and spread the tale of easy money.
Mania
The below are some quotes from the comments on recent Marketwatch articles about Bitcoin that exemplify some of the mania around Bitcoin. Each is from a different user. Sadly, I didn’t need to cherry-pick.
“Why did the founders give BTC 8 decimal places? If that smallest fraction of a coin is worth 1 penny – a comfortable enough amount to trade – it would put one coin’s worth at $1 million. It was intended from the start. Yes, it’s rigged. And it will be lifted to the $1 million by shear will – and by design.”
“…mate If it makes money it makes sense…”
“Housing is equally as speculative these days.”
“You buy bitcoin because it will be worth over Million a coin in next 20 years. Yes it might come back to 1000 or hell even 100 next month or next year or two years later but the trend is up and there are only 21 million of them available. Soon many will not be able to buy a coin and they will have to buy one millionth of a coin…Those idiots do not know the technology behind the block chain and distributed network. This is like buying the Internet in 1990. ”
“1 bitcoin will buy you a small country by the end of the year”
“ I can see 1 BTC going up to way past $250,000 CAD in a few years if that”
“If you guys bought in 3-4 years ago you could tell great stories too or even a year ago.”
“Easy money and there isn’t even any need to pay federal or state income taxes on it.”
“I think the dollar will collapse before Bitcoin will.”
Risks
Now I want to be clear from the start, that I am not certain that Bitcoin isn’t going to be a major currency of the next 10, 20, 30+ years. That said, a prudent investor needs to carefully consider risk before diving in… risk that many investors are currently either discounting substantially or ignoring altogether. The future is not certain, and all we can do is assign rough probabilities to various potential outcomes. One thing, however, is definite, Bitcoin is not risk-less.
So what are some of the risks? The below is an admittedly small sampling.
- The popularity of competing crypto-currencies. What happens if competitors become more ubiquitous? Or governments sanction their own crypto-currency? Bitcoin will still exist but demand for bitcoin may not justify even today’s valuations. Blockchain and distributed network tech can thrive independent of bitcoin itself.
- Government Regulation. With cryptocurrencies being so new, regulations have been running to try and catch up. There is potential for regulation to make using or investing in Bitcoin very inconvenient and/or expensive.
- A financial crisis. Bitcoin has yet to be truly tested during a broad financial crisis. Will people be as eager to exchange Euros and Dollars for Bitcoins during a crisis? Will the relatively few vendors who accept Bitcoin continue to do so in uncertain times? It seems likely to this author that there will be a significant lessening of demand for Bitcoin in favor of currencies people are more trusting of and which can be dependably spent locally.
- The Unknown Future. This is a risk with all investments, which is why it’s important to be conservative in estimates of value. The first iPhone was only released 10 years ago in 2007. The internet itself is fairly new having only gained widespread adoption in the 90s. My point here is that it is very difficult to project the future of technology out very far. Likewise, even correctly recognizing a trend does not guarantee investment success. Many “internet” companies failed or had their valuations greatly revised during the dot-com bubble. There were winners as well, but to pick them was not easy. Seeing a trend coming, and capitalizing on it are very different things. Other massive revolutions have been similarly difficult to profit from. Those who are interested can read this famous Fortune Magazine article dated Nov 22, 1999 (another period of excitement and revolution), and written by none other than Warren Buffett. In it, he describes how hard it was to succeed as an investor in previous shifts even if you saw them coming…
If you are invested in Bitcoin (or thinking seriously about it), you need to be sure that you’ve assessed the many risks. Bitcoin’s future success is not a given, the probability of success is not 100%. An honest and conservative assessment probably wouldn’t put it even close.
Value Versus Price
“Hopefully, if I offered to sell you my car, you’d ask the price before saying yes or no. Deciding on an investment without carefully considering the fairness of its price is just as silly. But when people decide without disciplined consideration that they want to own something… that’s just what they’re doing.” -Howard Marks
I would add the following… If you don’t have even a rough conservative estimate of the value (not to be confused with price) of a Bitcoin, then you can’t possibly know, and certainly shouldn’t “feel,” that you are making a good investment. Rather than investing, you are speculating. This is true regardless of it being a “currency.” You must have an idea of value to know that you are getting a good deal. The lack of an intelligent estimate of value is common amongst those who hold Bitcoin as an “investment,” and most, despite what they may claim, are holding it as just that.
Impaired Reasoning
Please also consider that returns (especially short-term ones) are not inseparable from intelligence. A person basing intelligence on short-term returns can seem quite smart one day, and very foolish the next. A record of consistent good returns built over a long career is the mark of the good investor, not a speculator doing well by unknowingly taking on lots of risk during a bull market.
As Buffett has said, “Rising prices are a narcotic that affects the reasoning power up and down the line.”
Try to verify that your reasoning power has not been impaired by the returns you’ve experienced or those you’ve heard that others have experienced. If you are quite enamored with Blockchain tech simply remember that Blockchain as a technology can succeed without Bitcoin. You are buying a “currency,” not a tech company or technology. Remember that, and treat your investment accordingly.
Bubble Talk
Finally, please consider the possibility that Bitcoin is in some stage of a speculative bubble. Only in hindsight can we be sure, but a mania can perhaps be identified now.
There are definitely a lot of Bitcoin investors/speculators who can’t see any downside risk, and associate their short-term returns with their own intelligence. People who are buying on the vague hope that it will go higher in the future, and substantially so. People who, as a consequence of their investment/speculation, feel much wiser and more informed than the “no-coiner” crowd.
“In all speculative episodes there is always an element of pride in discovering what is seemingly new and greatly rewarding in the way of financial instrument or investment opportunity. The individual or institution that does so is thought to be wonderfully ahead of the mob. This insight is then confirmed as others rush to exploit their own, only slightly later vision. This perception of something new and exceptional rewards the ego of the participant, as it is expected also to reward his or her pocketbook. And for a while it does.” –A Short History of Financial Euphoria by John Kenneth Galbraith
So it was with “Internet” companies in the 90s, and Mortgage-backed securities in the 2000s, and so it will be again. John Kenneth Galbraith wrote a list of the common attributes of speculative bubbles in his book “A Short History of Financial Euphoria” of which the above quote is an excerpt. I strongly recommend a reading of the full book and complete list by all investors. It is a short but informative read.
Professor Robert Shiller, (himself famous for identifying the dot-com bubble), when recently asked for a modern example of a bubble, stated, “The best example right now is bitcoin.”
Seasoned and time-tested investors such as Warren Buffett & Howard Marks are avoiding Bitcoin. Both of which, have had excellent track records in publicly identifying previous bubbles.
They may be wrong. It could be that they are all just old fuddy-duddies who are well past the years where they could understand the technology involved, but just remember they were right the last time tech was involved.
Conclusion
Believe it or not, I do believe that intelligent informed people may, after careful consideration, choose to invest in Bitcoin. However, there are definite elements of a speculative bubble, and the future of Bitcoin is definitely very unclear relative to other potential investments.
Cryptocurrencies should be weighted in your portfolio appropriate to either a purely speculative position (if you don’t have a rough conservative estimate of intrinsic value), or as you would any other investment (if you are able to conservatively estimate intrinsic value and assign probabilities to the different potential outcomes.)
In short, I don’t want to deter people from some amazing money-making opportunity… I just want people to consider that it may not be all that they hope, and size their position accordingly. Choose to be an Investor, not a Speculator. Some fear is healthy.
Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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