A walk on investment’s wild side with cryptocurrencies
While many are enamoured with crypto, let's takes a step back and asks whether investors should pause for thought
The title of Lou Reed’s famous 1972 song could easily sum up my thoughts on the current crypto-mania gripping investors and financial markets. The almost 700 percent surge in the value of Bitcoin in the past year is reason enough to want to give up the day job, sell the house, and put everything you have into Bitcoin, Ethereum, Ripple and new entrant Dogecoin (sorry if I missed out any other coin that readers like).
I am keen to provide readers with a framework to think about investments, and try to not be judgmental or project my own biases. But I find this approach especially hard to do with cryptos. Why?
Well, for a start, cryptocurrencies have no intrinsic value. That means you cannot use them to buy goods and services on a daily basis like at your local supermarket, favourite restaurant or petrol pump. “So what” I hear many of the pro-crypto readers shout back at me. Fair enough, but I personally prefer a real currency like the US dollar to hold my hard-earned savings. It has lasted for over 200 years, survived two world wars, several economic depressions and a few bouts of high inflation in the 1970s.
I also often hear people talk about cryptocurrencies and blockchain like they are the same thing. They are not, as far I can tell. I do believe blockchain technology is here to stay and in the coming years it will become a critical part of every industry. Cryptocurrencies, on the other hand, are mined from digital storage and use blockchain technology to get circulated in the ‘real’ world.
What’s the difference? To use a sporting analogy, blockchain is Spain’s tiki-taka style of football which was new at the time and went on to conquer the world. Cryptos are a third division team using this style of play to win games. Maybe they succeed and get promoted all the way to the first division, or maybe they get relegated and go bankrupt.
The world is awash with money right now. The US by all accounts has printed an additional 3-4 trillion dollars in the last 12 months. The total amount of US dollars in circulation has gone up by over 30 percent since the start of 2020. These are astounding statistics. It is only natural that many potential investment assets will go up on the back of such large money printing. The rising tide lifts all boats. You can see it in the prices of branded watches, high-end cars and luxury goods, in addition to cryptocurrencies.
The right question to ask is once this money printing stops, which assets will have the best chance of holding their value. Yes I know Bitcoin has a finite number of coins issued and so in theory can hold its value because of the scarcity factor. But that same logic applied to my apartment in central London and that fell 40 percent in value after the financial crisis of 2008. Scarcity does not mean safety. Safety of an investment comes from a track record in good and bad times, the ability to buy and sell in a crisis (liquidity), and a long-term committed investor base.
Take 2020 as an example. Bitcoin fell by 50 percent in value from its peak in mid-February 2020 until the market lows in mid-March. That’s a 50 percent fall for crypto’s poster child in one month. By comparison gold (I am not a gold bug) fell 15 percent during that time, Microsoft (my version of safety) fell 30 percent and Abu Dhabi’s 10-year sovereign bond fell 13 percent (a good version of safety).
I do not mean to denigrate cryptos as an asset. Bitcoin and Ethereum, in my mind, have the best chance of making it to the First Division. But the road will be very bumpy and full of pitfalls. So, invest only a manageable portion of your savings and tread carefully with your walk on the wild side.
As far as my understanding of cryptos go, real knowledge is to know the extent of one’s ignorance. Stay safe and happy investing.