There is a weekly newspaper in the small city where I live that covers all the local comings and goings. On the last page of the paper is a section called “The Rant.”
It’s a place for people to unload about everything that pisses them off. People rant about everything from a lack of parking downtown to the person in front of them at Starbucks with their face buried in their phone when it’s time to order.
“You, mid-20s guy in a blue checked shirt in front of me at Starbucks Wednesday morning around 8 am. Stop playing Clash of Clans on your iPhone while listening to Nickelback and order your Double Ristretto Venti Half-Soy Nonfat Decaf Organic Chocolate Brownie Iced Vanilla Double-Shot Gingerbread Frappuccino. Some of us actually have to work for a living.”
Most ranters want to blow off steam, but some people want to help others make wiser choices in the future—which brings me to my own rant.
I’ve seen enough cryptocurrency stories over the last few weeks to last me a lifetime, especially about Bitcoin. Bitcoin is not a store of value, and it’s not a reasonable investment candidate. You’ve been warned!
Bitcoin Value Based on Two Flawed Concepts
Due to the fact that it has “currency” in its name, cryptocurrency implies a medium of exchange or a store of value. The idea that Bitcoin and others of its ilk are stores of value is based on two flawed, critical concepts: scarcity and anonymity.
First, investors are attracted to Bitcoin because of its built-in scarcity. It’s commonly believed that only 21 million Bitcoins could ever be brought, or mined, into existence. (Although how someone can “mine” something that isn’t in the ground is beyond me.)
The reality is that developers are attempting a “hard fork,” which would change Bitcoin’s code, split it into two and allow for the creation of more Bitcoins. If you create more U.S. dollars it’s called counterfeiting; if you create more Bitcoin it’s called the hard fork treatment, and there is no one to regulate it. How can Bitcoin be a store of value if any MIT dropout with a laptop can create more of it while sipping a latte in an internet café? (For related reading, see: Bitmain Outlines Bitcoin Hard Fork Plan.)
Second, investors and terrorists like the anonymous aspect of cryptocurrencies for all the obvious reasons. I hate to break it to these guys, but they are probably going to have to find another way to pay for their bombs and Gilmore Girls DVDs. That’s because four U.S. senators, led by Senator Chuck Grassley (R-Iowa), have co-sponsored a bill that, if signed into law, will make using cryptocurrencies to transact anonymously much less attractive. The bill will bring digital wallets, prepaid access devices and other digital currency exchangers into existing anti-money laundering provisions if they contain over $10,000 of cryptocurrency.
Thus, Bitcoin’s façade of scarcity and anonymity is crumbling. For it to retain its allure as a store of value and as a fiat currency alternative in a world run amok with central bankers, Bitcoin depends on this façade. But even if you’re not looking to exchange all your greenbacks for Bitcoins before going off the grid, Bitcoin doesn’t stack up as a pure investment play, either.
Cryptocurrency Investment Too Good to be True
Whenever I’m at a cocktail party and someone with no prior interest in markets asks my opinion about a recent investment fad, I know it’s in a bubble.
Two weeks ago, a buddy asked me if he should invest with a guy who created an algorithm to trade Ripple, the third most popular cryptocurrency. Apparently, for the last three months this engineer-turned-virtual quantitative fund manager has doubled the balance of his “virtual” account every 21 days. (For related reading, see: Ripple Cryptocurrency Aims to Make Global Assets Liquid.)
First off, trading virtual money is not even close to what you can expect from trading real money, in real time in real markets. It’s the difference between the NFL and drone racing. Second, anything that doubles your money every 21 trading days either is too good to be true or will be arbitraged away by the time you’re done reading this sentence.
My friend doesn’t have a plum nickel in financial markets, yet he wants to invest $10,000 with the Ripple genius. Market top, anyone?
There are two primary reasons why Bitcoin shouldn’t be considered as part of your portfolio: liquidity and stability.
On the liquidity front, you can’t short Bitcoin. Short selling, despite what the media and corporate executives would have you believe, is a healthy aspect of any market because it improves both liquidity and, more importantly, price discovery.
I don’t trade any market or stock that isn’t liquid enough for short selling because the price can be too easily manipulated by just a few. (For related reading, see: The Basics of Short Selling.)
A lack of stability is also a big issue with Bitcoin, which is up 99% in the last six weeks, running from $1,365 up to just over $2,700. However, during those six weeks Bitcoin crashed on two separate occasions. A market crash is defined as a peak-to-trough decline of 20% or more. In late May, Bitcoin crashed 29% over two days, and in mid-June it crashed 22% over three days.
Folks, I’m human, so I get the allure of doubling your money in a month. But any potential investment that crashes twice in two weeks isn’t worthy of your hard-earned shekels. It’s downright unstable, like Aunt Kathy when she’s off her meds and drinks a little too much.
In December 2013, Bitcoin took the escalator up to over $900 before taking the window back down to $250. It took over three years before Bitcoin saw $900 again. Three years is a long time for any portion of your portfolio to be underwater and sitting idle.
The Bottom Line
I hate to be the curmudgeonly old man yelling at the kids to get off his lawn, but get off my damn lawn with this cryptocurrency nonsense. Bitcoin isn’t a currency, it’s not a store of value and it’s certainly not worthy of investment. Cryptocurrencies are the 2017 version of Dutch tulips, pure and simple.
People hoping for quick riches and bragging rights at cocktail parties are simply increasing their “cat food risk,” which is the risk that you end up eating cat food in retirement because you’ve decimated your portfolio with bad decisions.
Don’t be the person who exchanged 12 acres of land for a single tulip bulb that was worthless within a few months. Instead, stay focused on minimizing losses and letting the profits stack up. And as always, stay data dependent, process driven and risk conscious, my friends.
(For more from this author, see: Why Investors Shouldn't Ignore Data.)