The currency isn’t going to work. You can’t have a business where people can invent a currency out of thin air and think that people who are buying it are really smart. –Jamie Dimon, CEO of JP Morgan, on BitCoin
The BitCoin investing craze has created much controversy among “traditional investors,” as can be seen in the Jamie Dimon quote above. While we wouldn’t necessarily drive a stake in the ground as strongly as he did there, we do share his concerns over the future of cryptocurrencies as an investment vehicle.
BitCoin Soared in 2017
Last year turned out to be a fantastic year for stock markets across the world, both here at home and overseas. U.S. stocks climbed over 20% for the year, while international stocks surpassed 25% and emerging markets outpaced even those stellar returns with gains of over 30%. All of those returns, however, paled in comparison to the year’s surprise starlet — BitCoin. Beginning the year trading at around $1000, the crypto-currency yielded a whopping 1,518% increase, and even topped out at over $19,000 at one point in December. However, like every new investment fad, BitCoin found itself flying too close to the sun, and dropped suddenly the week before Christmas by about 30%. Ever since then, the price has drifted slowly downward, dropping below $7,000 at one point in early February!
So while the BitCoin investing craze has rightfully faded into the background, we still get questions about BitCoin investing from time to time. For that reason, we dedicated several paragraphs in our last investment newsletter to the topic of cryptocurrency in an attempt to explain our viewpoint, and would like to elaborate even further on it here.
Is BitCoin a Good Investment?
So, does BitCoin have a place in an investment portfolio? Should it even be called an investment?
First, let me clarify that we do not own cryptocurrencies of any kind in client portfolios, nor do we have any inclination to start. As we will discuss, BitCoin as an investment is speculative in nature, and we simply do not need to fiddle with speculative investments in order to reach our clients’ investment goals. However, the underlying technology, known as blockchain, does have some advantages over conventional recordkeeping systems, and we have no doubt that it will play some important role in the future. Even Jamie Dimon, the CEO of JP Morgan and famous BitCoin critic who once called it “a fraud,” has always maintained that the blockchain technology “is real.”
But while the blockchain innovation may eventually change the world, and BitCoin is built on blockchain, it doesn’t necessarily follow that BitCoin will clearly be the currency of the future. It could be usurped by a lesser known cryptocurrency rival, or perhaps currency is not the right implementation for blockchain technology at all. Only the future will tell, but the bottom line is that (as we’ve seen lately) BitCoin’s price simply cannot surge forever based solely on the speculation of technophiles and casual investors. To continue to rise, BitCoin will have to become a legitimate currency upon which a major portion of globe trade is based. Only then will it compete with the dollar, euro, yen, renminbi, and other major currencies.
So, should you invest in BitCoin? Will it make a rebound and continue to go up, or has the bubble permanently popped? We don’t claim to know the future, so that’s not a question we’ll attempt to answer. However, one thing we can look at is how volatile the currency is. It has been extremely volatile when compared to other currencies on a daily basis. Over the last two months, the price of BitCoin has fluctuated about seven times more wildly than other major currencies! And, for BitCoin to become a major currency it has to act as a store of value, which can’t happen for practical reasons with that much volatility. (Imagine, for example, your checking account dropping by 30% in value over the course of a month…)
What Drives the Value of BitCoin?
But more importantly, the fundamental reason we invest in any investment class is that there’s an identifiable underlying causal factor behind the investment’s future expected return. For stocks, we expect well-managed companies to produce profits, which can then be paid out to investors as dividends or re-invested back into the business for growth. For bonds, we expect governments and companies to pay their interest payments (and ultimately their loan principal) over time. For alternative assets, we expect managers to add value based on their unique expertise, and assets to appreciate based on well-understood economic factors. These expectations then become the basis for an informed valuation of each asset, which along with our client’s risk profiles, then guides our decisions on the investments we own.
But what is the driving force behind the surge in the price of BitCoin, other than the “greater fool theory”? If speculation is the only driver, then how can such an investment be valued? What is the true intrinsic value of something that more people want today, simply because more people wanted it yesterday than the day before?
Ultimately, as we wrote in our newsletter, “we are confident that investors currently buying Bitcoin (or other cryptocurrency) today will be disappointed with their future investment return.” Although the currency is down slightly from that writing, it could just as easily have been up 20% over the short-term as well. We don’t claim to know what it will do over the short-term. However, over the long-term, it’s not an asset that can be valued, it’s not part of our expertise, and it’s largely based on speculations. For these reasons, we don’t want to own it.
However, if you want to invest a little money in Bitcoin, go ahead. Just think about it like you do when entering a Vegas casino — don’t invest any money you can’t afford to lose. At the famous economist Paul Samuelson taught us, “investing should be more like watching paint dry or watching grass grow.” When it becomes too exciting, you might be doing it wrong.