Bitcoin hit fresh highs in the $44,000 range yesterday when it was revealed that Tesla was holding $1.5 billion in Bitcoin and would begin accepting payments in the crypto currency. Since Bitcoin first started increasing in value and made headlines as it passed certain milestones such as $10,000 or $20,000, I have been fielding questions from friends or family on whether they should buy the cryptocurrency. Usually they want a clear cut, definitive answer to their question. The response of “it depends” is not very satisfying.
The reason it depends is that whether you should buy some or not really depends on your financial situation. If you are a relatively well off, already diversified investor, I would say that yes it may make sense to put a small portion of your assets in Bitcoin if you are willing to risk it. Personally, I wouldn’t want more than 1% of my assets in Bitcoin and even that may make me worried. If you want to get rich quick or speculate on where the price will head next with all your savings, I would say do not buy Bitcoin.
The only argument that makes sense to purchase Bitcoin for me is as an alternative asset class with a correlation factor to other assets of less than 1. This means it can smooth the overall volatility of your portfolio returns. In the long run that doesn’t mean you will achieve a return higher than other investors but you may achieve that return with a bit less volatility. It’s essentially the same argument that has the wealthy buy commodities such as silver or oil or has endowments investing in hedge funds despite the fact that they have underperformed the S&P 500 for over a decade.
I do not own any Bitcoin, furthermore I don’t see any value in Bitcoin. This isn’t a popular stance at the moment because the general public and the media is caught in a trance of the “gains porn” as I like to call it. These are mainly stories of a person that risked their life savings on something extremely risky and it paid off for them: the guy who bought 1,000 Bitcoin when it was worth nothing and held onto it until today, or u/DeepFuckingValue, the Reddit trader who gambled $50,000 on long dated GameStop options which eventually turned into $50 million (of which he didn’t sell) and saw recently drop by as much as $20 million or more.
That being said, I am not opposed to Bitcoin as an alternative asset in someone’s portfolio because well, no one knows what will happen next. For myself, gold also has little value to me, I don’t wear it and I don’t need it’s conductivity for any computer or machine I’m building. Someone else, maybe an Indian family about to marry their son off, may have a vastly different value for gold and would be willing to pay a high price for it. That doesn’t mean I may not want to own a small bit of gold as an investment, it just means I have no use for it myself, and would certainly not devote weeks, months or even years of my hard earned savings towards it.
Yet I have a simple and theoretical reason that I don’t find any value in Bitcoin: it isn’t a currency. Although some would argue it is because the inventors put the word “currency” in the name of the class of asset, Bitcoin defies one of the fundamental rules of a currency: that it’s a stable store of value. Someone may trade their dollars for Bitcoin today but how many would be willing to work for the next 2 years for a payoff of 10 Bitcoin? I’m willing to bet probably not that many people because no one has any idea what Bitcoin will be worth then. Of course there are some risk takers that would take that offer, and maybe in 2 years Bitcoin is worth $200,000 and this seems like a smart bet. But it could also go south and that person ends up working for much less in dollar terms than they could have received if they just accepted dollars. It’s the stable store of value of the dollar that helps make you want to exchange your time and effort for dollars instead of Bitcoin or Ethereum for that matter.
Additionally I ask the question, why Bitcoin? Why not Ethereum? Or Dodgecoin or Litecoin or Ripple or Peercoin for that matter? The blockchain technology underpinning Bitcoin has value in terms of its application but the actual Bitcoins are no different from anything else that is not easily replicated which humans use as currency. On the island of Yap which lies in Micronesia in the South Pacific, Rai stones were used as currency from about 500 A.D. A rai stone was valued based on its history and how difficult it was to move.
The stones are not often transported, people weren’t rolling them all over the island, but they represent a store of value for those that own them because derivatives of them are accepted as payment by others on Yap. If this were not the case, they would just be another stone with a hole it them.
Other things such as seashells, cigarettes and even urine has been used as currency across different cultures over time. If someone asked you about investing in urine or rai stones, you may look at them like they were crazy, but what if I told you urine returned 350% last year? That added factor may have just changed your outlook on the urine market. What if a particular urine was most highly prized such as the urine of Tom Brady? If this was the case, in a hot urine market (no pun intended) someone may pay top dollar for Tom Brady urine. Bitcoin is essentially Tom Brady urine. I don’t care if Tesla starts accepting urine as payment, I’m not going to put my money in urine. As a speculative bet would I? Maybe a small portion, but my hard earned money will stay mostly invested in things I know generate income or maintain a stable source of value over time.
Tulip Mania
All this is reminiscent of the famous “Tulip Mania” that is purported to have gripped Holland in the 17th century. The story was made famous by author Charles Mackay in 1841 and was primarily based off of work from Johann Beckmann which was itself thought to be derived from 3 anti-speculative pamphlets circulated at the time. Although the account of Tulip Mania was later found to be exaggerated, the story has seemed to reverberate through the years, likely because we see so much familiar in it compared to our modern times.
In his depiction of Tulip Mania, Mackay describes a situation where a bubble evolved within the most sophisticated financial system at the time. The Dutch Republic saw the world’s first stock exchange and the world’s first formally listed public company in the Dutch West India Company. The value of this company is estimated to be $7.9 trillion in today’s dollars, more than the combined market cap of all the FAANG stocks currently at around $6.4 trillion. The tulip is not native to Holland and is thought to have arrived from Turkey in the late 1500’s, it quickly became popular as it differed from other plants in Europe due to its intense color. Soon the tulip became a status symbol for the newly wealthy merchants, rich from their maritime trading.
As the tulip bulbs became more popular, professional growers saw ever more demand. Once the price rises started to be known, speculators entered the market and even a futures market in tulips was developed. Prices skyrocketed, fortunes were made and lost by many traders who only traded contracts and never actually saw the bulbs they were trading for.
A characteristic of this mania that is relevant to the present but often looked over is that the price decline is rumored to have started when one party did not show up in the town of Haarlem to collect their bulbs at the end of their tulip contract. This was speculated to have been because of an outbreak of bubonic plague at the time. The prevalence of plague at the time is thought to have contributed to an outpouring of speculative risk taking which fueled the sentiment behind the bubble in the first place and may have led to its downfall.
There’s no doubt that some of this same sentiment may be driving sectors of the market now. Young people, locked down, unemployed and bombarded with materialism have a huge desire to get rich quick and Bitcoin may seem like just to Avenue to achieve this through. Yet just like tulip bulbs, Bitcoin has little or no functional value in it. Yes there are those that have gotten rich but we have seen this before. Bitcoin dropped 81% from its last peak at $19,650. An investor that came in at that price and stuck with Bitcoin has seen massive volatility with 80% losses and around a 123% gain in about a 3 year period. Meanwhile the S&P 500 recorded around a 50% return during that same period with much less volatility. Apple stock (AAPL) returned 236% over this same period from December 2017 to today. Just on a pure risk return basis, Bitcoin hasn’t been a great investment.
If you were to change the frame of reference on that same investment, look at the low reached in 2019 versus the high today, you would say that Bitcoin has delivered 12x over. But no one was hyping Bitcoin then or has get rich quick stories so regular folks likely didn’t notice. Stay on track, don’t get distracted by the shiny new thing, even if others make money off of it and let this round of speculation run its course. Dodgecoin was created as a joke and believe it or not, Tulipcoin is a real thing and yes, if you’re wondering, it is named after the bubble.
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