Readers will know that I’m not usually backward at coming forward on most alternative investment debates. But crypto currencies genuinely leave me speechless. My hunch is that they’re an enormous ponzi scheme BUT I accept that I might be wrong. I am not actively invested in any though, if I am honest, I have thought about putting money into some kind of crypto currency tracker (assuming I could buy one). I’ve also commented before that I have severe misgivings about many of the fan boys and techno-libertarians who are piling into digital currencies en masse as an expression of their own philosophical preferences.
What stops me from regarding the whole thing as a giant scam is the concept of critical mass. In simple terms, enough people now believe that it is important. Thus, it might actually be important. It is, in essence, the perfect example of the momentum trade. I also think that there are enough people out there who have genuine qualms about fiat money that they might make the giant leap into using crypto currencies as a store of value. Personally, I’d rather use gold if I was that worried but I accept that the digital generation might take a different view. I’ve seen a wall of commentary about crypto currencies in the last few weeks and two commentaries stand out.
The first is from Chris Beauchamp, Chief Market Analyst at IG, who addresses the issue of whether crypto currencies is just a bubble. His answer? Possibly not.
“A ‘bubble’ in financial markets is defined as an asset that strongly exceeds its intrinsic value. Famous bubbles in history have included the Dutch Tulip Bubble of the 17th century, the South Sea Bubble in England in the 18th century, and more recently the Dot-com Stocks Bubble that ended in 2000.
So, to establish if there is a bitcoin bubble, we must first derive value for bitcoin, beyond that of a daily moving price. And here we have a problem. Stocks can be valued by their earnings, sales, book value or a host of other metrics. Currencies can find value based on an exchange rate and whether it keeps imports and exports in balance, or whether it allows one to become larger than the other.
Bitcoin, on the other hand, is much harder to value. While the blockchain method of currencies, independent of a central bank, may well be the future, what has driven the price over the past year or so? Bitcoin has caught a narrative, a point picked up by Robert Shiller, the man who created the Shiller CAPE Ratio to value markets.
Rather than an intrinsic value, bitcoin is a story, one that latches on to the angst felt by people in the developed world. Over the past 500 trading days, bitcoin has gone up by over 2000%. Compare that to the tech bubble from 1994 to 2000, which took over 1500 trading days to go above 1000%, before slumping and then only surpassing this gain once 5500 days had elapsed.
Bitcoin may well be a bubble, but that won’t stop the price from going up. Instead, we will need to see a new rival emerge, or see a general disillusionment with cryptocurrencies take hold.
For now, it is tradeable, but it requires iron discipline and risk management. It is certainly not for the faint-hearted.”
Another excellent commentary comes from the US, from deep value investors at Kopernik. This is an excellent firm, jam packed full of contrarian types, who have strong views about most alternatives, including gold. Here’s Mark McKinney a Portfolio Manager, and Principal of the Firm. You can see the full note to investors here: http://kopernikglobal.com/sites/default/files/I%20Dont%20Get%20It%20-%20Mark%20McKinney%20-%20Final%208292017.pdf
According to Mark:
“The mania behind cryptocurrencies has taken Bitcoin to a total market value in excess of $70 billion, which is roughly the same market valuation as Du Pont, Blackrock, Costco or Caterpillar. It’s newest competitor, Ethereum, has a total value of over $30 billion, which is roughly the same as Sherwin Williams, Target or McKesson. The fact that Bitcoin is up more than 850% in the past 18 months and Ethereum is up more than 2,300% just in the past year tells you how crazy the speculation is in these “assets.” Combined all cryptocurrencies have a market value of over $125 billion. The reason so many Bitcoin competitors are coming is the FOMO (fear of missing out) and Initial Coin Offerings (ICOs), which offer smaller investors the chance to “get in” at the ground floor. Two of the biggest “new” cryptocurrencies are Litecoin and NEM, each with market values of roughly $2.3 billion. For that same money you could buy either Rite Aid (big drug store), GATX (largest rail car leasing company), Sotheby’s (one of two dominant auctioneers) or RLJ Lodging Trust (owns over 100 hotels throughout the U.S.). All of these either currently earn or have earned in the very recent past at least $150mm in net income per year.
A couple weeks ago there was an ICO for Filecoin which raised $250mm. To put this in context, this would make it the 25th biggest IPO of 2017 in terms of money raised if it were a real IPO.
Think about that. This is all insanity.
So now that alternative Bitcoin platforms (ie, currencies) are very easy to create, what is each one worth? Blockchain, the underlying technology of Bitcoin, is clearly very real and a critical piece to future secure transactions which will surely have tremendous value in certain applications. But like most clever ideas, as opposed to patented items or processes, it can be copied, changed and augmented infinitely at a very low cost which argues that the platform is a great innovation that is tough to monetize. Companies that were thought to be vulnerable to the blockchain usurping their role in a transaction have created their own private blockchain applications and are turning out to be the first mover with volume and thus seem to be in the best position to win (Visa, investment banks, custody banks, etc.).
On a related note, very recently there have been many discussions within the Bitcoin world that the processing speed is too slow and it is holding back Bitcoin. Bitcoin is an open-source technology so there is no one group in charge leaving its fate to its owners. The solution was to change the software code slightly. Leaving out all the technical details, the Bitcoin developers recently “forked” and created a new (alternative) cryptocurrency, and underlying blockchain named Bitcoin Cash. In the last couple days a third fork was announced and will start trading later in 2017.
An irrefutable store of value cannot be changed.
While today they aren’t saying that the total number of coins needs to expand, but if they can change the code can’t this be possible? With this change might it potentially change the narrative that it is a fixed supply and thus a great store of value? Compared to a cryptocurrency, a country’s currency is backed by the trust in that government.
That said the central banks increase supply every year and sometimes in massive quantities. Virtually all countries around the world overtly say they need at least 2% inflation in order to maintain economic stability, which said another way, they want to guarantee that the average citizen loses at least 2% of their purchasing power a year, combined with punishing savers by reducing interest rates to close to 0%.
That doesn’t seem like they are looking out for the average citizen. John Maynard Keynes famously said that inflation is a way for governments to “confiscate, secretly and unobserved, an important part of the wealth of their citizens.” Why people accept the “inflation is good” narrative is a total mystery. Hopefully someday people will look back and see this as the contemptible act that it is.
As a side note, global inflation has been negative many times throughout history without world ending consequences, so why now is it different? You can answer this, but the answer certainly isn’t about maintaining economic stability.
To sum up our thoughts on cryptocurrencies, we understand the theoretical fixed nature of any one cryptocurrency’s supply and the potential interest based on that. But when so many variants can clearly be created for so little, have such wild price volatility, have a very short history, and can’t be used as a means of transactions, we don’t know what to think other than to be VERY suspicious. Our answer is do nothing and move on looking for better values”