Here a Bit, There a Bit, Everywhere a Bitcoin

This about sums up my feelings on Bitcoin and the entire cryptocurrency marketplace.   Lately, I’ve had several discussions on the subject.  When people call and tell me how wonderfully easy this investment is, my first instinct is to run the other way. Here is a conversation I had with my own mother, in fact. “Andrew, I’m told you shouldn’t actually buy Bitcoin anymore.”“Oh yea mom, why’s that?”“Because, a guy at the gym told me buying ETF Riot Blockchain is better.  Doing that will invest in all cryptocurrencies.”“Very interesting mom.  Please, tell me what makes this ‘guy-at-the-gym’ so knowledgeable on the subject?”   (Wait for it….) “Andrew, he’s a doctor! ” (I love you mom, if you’re reading this). Sadly, this isn’t a unique conversation.  Bitcoin was up 2,000% last year, true.  But, no one has an actual answer to why. Is everyone using it now?  No! Does it create anything?  Nope! Does it have anything backing it what-so-ever?  Still, no!

What is Bitcoin?

Before I go any further, let’s understand Bitcoin.  To start, Bitcoin is digital currency.  It has no physical backing and can be sent electronically from one user to another.  Unlike conventional payment networks, Bitcoin is not run by a single company, person, or government.  The system is run by a decentralized network of computers around the world which tracks all Bitcoin transactions.  That online ledger is known as the Blockchain and it timestamps every transaction of Bitcoin.  Additionally, this Blockchain is protected by cryptography technology.  It’s presumed to be virtually impossible to break or hack.

Why the recent rise in prices?

So, why are the prices going up astronomically? One word for you “FOMO.” The fear of missing out. You see, Bitcoin is worth what people are willing to pay.  My concern (and why I did not let my mom invest in it) is the speculation.  It doesn’t fit the prerequisites of an investment (stocks, bonds, real estate, etc.).  Bitcoin has no earnings, produces no revenue or dividends, is backed by nothing, and creates no actual product.  Its word of mouth at its best (or worst) – one person convincing another that they can’t miss out on this incredible opportunity.

My three “Cautionary Tale” situations.

Tech Bubble: I had the good fortune to begin my career in some very analogous times (the late 1990’s early 2000’s).  Those days we replaced the word “Bitcoin” with anything technology.  During those times, I knew construction workers who called out sick so they could stay home and buy the latest tech stock.  They reveled in “quick and easy” money. You don’t have to be a historian to know the tech bubble went Kaboom!  And, you want to know what happened to the hard working construction worker? He’s still in construction. But, why did it all come crashing down?  Well, someone, or some people, woke up!  They said, wait!  We are trading stocks of a company in which we know nothing about.  It has no revenue and no logical business plan.   People’s willingness to pay dropped and they stopped purchasing these stocks on speculation.  Instead, they realized what they owned was an unprofitable, worthless company. All of that sounds bit crazy.  It kind of is.

Real Estate: You would think we learned from our mistakes of the tech bubble.  Unfortunately, our memories are short.  It only took a few years for the next get-rich-quick hysteria to rear its ugly, little head.  Real estate! It’s the same story as before, but a different sector of the market.  Everyone wanted to invest in real estate.  Even I bought a place in 2005 on stated income. Why not; you couldn’t lose, right? As it turns out people who knew nothing about real estate were buying properties left and right on credit.  You had blueberry farmers in California buying million-dollar properties on $30,000/year income.  You had financial planners (me) purchasing their first condo in Philly.  Even that doctor at the gym was gobbling up land faster than green grass through a goose. What inevitably happened?  You had this historically slow and steady asset class in real estate with a somewhat limited supply.  One day, the next guy was willing to purchase it for multiples of the last guy.  Thus, the values went through the roof.   Next thing you know, that farmer in California wasn’t able to afford their several mortgages.  Homeowner default rates skyrocketed as the credit markets collapsed. Many people realized these prices are insane and tried to sell when everyone else did. The rest, as they say, is history.

Bitcoin (my fear). If we consider Bitcoin a currency (albeit one no one is actually using), than we must realize it isn’t meant to increase 2,000% in a year.  It actually makes using it virtually impossible.  Imagine walking into the store with one Bitcoin and when you went to checkout it was worth 25% more.  Why would you ever use this currency to buy anything?  Think of buying U.S. dollars as solely an investment, then refusing to actually use them on anything.  Bonkers, right? One of Bitcoin’s big selling points is that it’s unregulated by big government (or anyone to be honest).  While that sounds appealing, it also means governments can’t tax its use.  I can’t see it being adopted at a mass level with no regulation. I also have certain key warning signs I’ve learned to notice regarding ANY investment.  One, which I’ve already mentioned above, is when the doctor at the gym starts telling my mom about a great investment idea.  Or, when my oldest friend, who is a brilliant artist and web developer in California, educates me on why Bitcoin/cryptocurrency is such a great investment.  This concerns me as here is the resume of a currency trader on Wall Street. Want to know my friends Bitcoin resume when I asked him? “Andrew I’ve read a lot of articles on it”. The second warning sign is getting bombarded by spam emails on investing.  Here are two titles from yesterday:

• “Bitcoin investing guide. Learn how Bitcoin is creating millionaires.”
• “Youre (yes, there was no proper punctuation) missing out on the biggest boom ever.”

The third I’ve yet to see (but I promise you will) is seeing infomercials on T.V. advertising some get rich scheme, book, or seminar on how to invest in this new product. Although you won’t see these warning signs in any economic or finance book, I can tell you it is my official sniff test.  I saw it with the tech boom.  I saw it with gold.  I saw it with real estate.  Now, I am seeing it with the crypto-craze.  (If you have 4 minutes, check out this funny video on Bitcoin.)

Disclaimer:

I will admit that I am no expert in Bitcoin or cryptocurrency.  I do read a lot of articles and I try to stay as informed as possible.  What I can tell you is no large institution I deal with, or respect, is investing any money in these currencies.  Some economists are even calling for cryptocurrency to be outlawed.  These are institutions with PHD’s, economists, and CFA’s at their beck and call.     Many do believe in the blockchain technology; however, they aren’t sure how and where the technology will be widely adopted. What you are seeing is some of these large institutions taking the sure bet.  They are creating ways and products that can profit on this mania (like derivatives) regardless if Bitcoin tanks or goes through the roof.  They are betting on people making irrational decisions and that is an investing strategy that stands the test of time.  Now, this is just one man’s opinion.  I realize there are plenty of them on the internet.  Actually if you google why Bitcoin will fail, it comes up with 10,300,000 results.  If you google why it will succeed, it comes up with 8,200,000 results.  At the end of the day, I (and my partners) truly believe in prudent investing and diversification, not speculation. I’ll leave you with a question that I read in a recent article, as I feel it sums up our feelings pretty well: “How much of your life savings do you want to bet on this?”