Invest in Bitcoin or Avoid it Like the Plague?

It’s hard to ignore the Bitcoin news lately. So hard, that I just had to jump in on the conversation with my own hot take. I’ll focus on Bitcoin for this article, but the same logic presented here is equally applicable to the next hot cryptocurrency (and I’m sure there will be others).

I’m not a Bitcoin miner. Or investor. Or even an expert observer. You may think that would make me unqualified to write the opinion I’m about to write. I think it’s just the opposite.

Bitcoins started the year valued at just under $1,000 each. This past week, they came close to hitting $20,000 – a more than 20X increase in less than a year. Along the way, many early investors have become billionaires, including the villainous Winklevoss twins (remember them?), and the hype has become difficult to ignore. I’ve had very smart people make a strong pitch for why I should begin investing in Bitcoin and alternative cryptocurrencies like Ethereum.

Despite the allure and peer pressure – I don’t see Bitcoin or other cryptos as “investments”, and have resisted joining the craze for 5 reasons.

Bitcoins Don’t Create Value

Investing icon, Jack Bogle, the founder of Vanguard, recently instructed investors to “avoid Bitcoin like the plague“. Among other reasons, Bogle makes a key fundamental reason to stay away:

“You know bonds have an interest coupon, stocks have earnings and dividends, gold has nothing.”

Jack nailed it. And Warren Buffett has had similar sentiments:

“Stay away from it. It’s a mirage, basically…The idea that it has some huge intrinsic value is a joke in my view.”

Not many investors have bet against Buffett and Bogle and won – but let’s put that aside and listen to what they are saying here.

Both allude to the same fundamental principle. Stocks create value in that there are actual businesses doing the work of creating and providing goods or services that people pay for. That work, ideally, creates profit. And over time, efficiencies can grow that profit, increasing the value of the stock. But even if the valuation for that stock is lower in a few years, you could have still made money if that stock paid dividends to shareholders or bought back shares. Bitcoin doesn’t do that. Or anything. It just… exists.

We’ve Seen this Story Before

Go back and look at any bubble and burst story in history. There are a few key common characteristics you will notice:

  1. A few early investors get rich.
  2. Hype ensues and investors proclaim that this is the next big thing.
  3. The flocks deliriously rush in and those buying far exceeds those selling – causing prices to skyrocket in a short period of time and a bubble to form.
  4. Volatility spikes.
  5. Early Investors cash out, causing a decline.
  6. The flock gets fearful, and starts rushing out.
  7. Bubble bursts and prices crash – usually followed by a long period where the “get rich quickers” eventually exit, after losing a good chunk of their original investment.

The two big recent historical examples are with tech stocks in the year 2000:

nasdaq bubble

And the housing market in 2006:

home price index

A more recent and relevant example that we saw before is none other than… Bitcoin? Yep. Bitcoin believers don’t like it when you point out that we’ve seen this bubble and burst story before with Bitcoin.

On November 25, 2013, Bitcoin hit a price of $975.49. That was a more than 10X increase from just a few months earlier. The hype bubble burst, and a year later, it was worth roughly a third of that. It wouldn’t reach those heights again until 2017.

bitcoin price chart

But I’m sure THIS time is different, right?

Limited Supply Does Not Mean Indefinite Price Increases

One common argument that I hear from proponents of Bitcoin and other cryptos, is that there is a limited supply of coins, so demand is going to continue to outweigh supply, and therefore, the value will keep going up. “Better get in early on”, they proclaim!

For starters, this is not true. Contrary to popular belief, Bitcoins are still being created. And while “rumor has it” that Bitcoins will no longer be created once 21 million are mined and in circulation, what assurances do we truly have that the rules won’t change and additional Bitcoins won’t be added?

Beyond that, it’s also worth noting that stocks also have a limited supply. And nowhere does that guarantee that a stock will only go up in value.

Cryptocurrencies are Not Much Different than Other Currencies – But are Less Regulated, More Volatile, and Uninsured

Two Bitcoin stories, in particular, caught my eye last week: hackers stealing $64 million in Bitcoin and Bitcoin plummeted 18%.

Over the past few years, more than 980,000 bitcoins have been stolen from exchanges, which would be worth more than $15 billion at current exchange rates. Few have been recovered, leaving most investors without any compensation.

Coinbase, one of the largest Bitcoin trading platforms, says that its online funds are insured by the FDIC. However, a full 98% of their funds (which are offline) are not insured. If they pull the plug, you’re screwed, unlike traditional investment brokerages, where funds are fully insured by the SIPC, with much stricter regulations.

Proponents of cryptocurrencies often cite that they are somehow better than other currencies, due to the decentralized nature and lack of government involvement. Perhaps someone can coherently explain to me why lack of oversight and regulation on something as critical as currency is a good thing?

On the volatility point, Bitcoin went up roughly 40% and then down 25% IN JUST THE LAST WEEK. That kind of volatility is incredibly dangerous, and it leads me to my next point…

Joining the Herd to Get in Now is Speculative Market Timing

When it comes down to it, what is Bitcoin “investing” other than speculative market timing?

Jack Bogle alluded to this as well, proclaiming:

“There is nothing to support Bitcoin except the hope that you will sell it to someone for more than you paid for it.”

We may believe in our gut that the value of Bitcoin will go up and we’ll get rich from it. But market pricing dynamics don’t care about your gut. They only care about what people are willing to buy and sell for. And when there is no intrinsic value involved, it’s anyone’s guess what that value will be a decade, year, month, or even day from now. It’s really hard to win at market timing. And if you do, it’s luck more than anything else.

No thanks. I’ll stick to passively investing in things that create value.

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