Bitcoin, Honesty, and Promise

Bitcoin had an outstanding 2020 that left most everything else in the dust. For perspective, the S&P 500 notched a respectable 16% price gain but looked like a rounding error in comparison.

Figure 1: BTC vs SPY 2020

I last wrote about Bitcoin almost four years ago. As was the case back then I’m still not an expert on cryptocurrency. Also as was the case back then when your landscaper starts giving you advice about crypto-investing the topic is too ostentatious to ignore. My three main points about Bitcoin from 2017 were as follows.

  1. Bitcoin prices were in a bubble that would crash.
  2. Bitcoin was not a complete fraud and would stick around (despite what many financial experts believed).
  3. Bitcoin would eventually mature and “find its place, wherever that may be.”

Bitcoin prices crashed by some -80% in 2018, check mark for point number one. Bitcoin also did not go away and found new highs in the years that followed, check mark for point two. Point three, however, is still undecided. Bitcoin clearly has a spot with speculators, but it still lacks a clear and permanent place within the broader financial landscape.

It is making progress, however, so now seems like a good time to revisit the Bitcoin story. Full disclosure, as I did in 2017 I still own a nominal amount of Bitcoin. And for the record, I still don’t have a crystal ball. I won’t make any price predictions, I’ll just write my honest opinions on a number of issues that usually pop up during heated Bitcoin conversations.

Bitcoin and crypto

I reiterate I think Bitcoin is here to stay, after a decade it should no longer be dismissed as just a fad. To be clear, I’m talking about Bitcoin specifically (BTC). Bitcoin has established itself as the standard and “reserve cryptocurrency” against which all tokens are measured.

In contrast, I think the proliferation of “alt-coins” in crypto space is a tragedy waiting to happen. I expect the vast majority of those tokens to evaporate over time.

At the same time I don’t see Bitcoin serving any real, practical, and economic purpose. Its use still seems relegated to fringe transactions and for purposes of speculation.

Bitcoin and “real investments”

Some may take offense to the characterization above and argue Bitcoin has become a “real investment.” That’s a matter of perspective, so as Ben Inker at GMO recently wrote it helps to be clear on semantics like how we define “investing” versus “speculating.” Right or wrong, my simple definitions are as follows.

  • Investing focuses on fundamentals and intrinsic value.
  • Speculation focuses on market price.

Anyone with a basic understanding of finance knows the fundamental, intrinsic value of an asset can be estimated as the present value of it’s expected future cash flows. That makes perfect logical sense because no rational investor should want to pay more for an investment now than is expected to be returned in the future.

By that definition “real investments” should have real assets, cash flows, and/or other clear economic benefits that can be reasonably approximated and valued. That value can then be compared with market price to make a rational investment decision. Real estate has property and rents, bonds have principal and interest, and stocks have earnings and dividends.

The problem with Bitcoin as an investment is it has no cash flows, no tangible assets, and no clear intrinsic value (or plans to create any). In addition, it has a real cost of carry due to the resources needed to maintain the blockchain. The only identifiable source of value is the expectation that another party may pay an even higher price. To me, that’s what speculation is all about.

Buying Bitcoin is not “investing in the future of decentralized finance,” which sounds good, admittedly. It is simply speculating that price will go higher. That does not make it wrong or bad, we should just be clear and honest about what Bitcoin is and what we’re doing with it.

Bitcoin and fiat currencies

Many BTC advocates argue fiat currencies are printed ad infinitum which devalues them to worthless pieces of paper. Bitcoin is finite and cannot be created at will by central banks which supposedly makes it superior. Yes, BTC’s finite quality is appealing and is one reason I think BTC persists. In addition it’s probably true that BTC is more valuable than some fiat currencies.

However, when it comes to something like the US dollar, claims of BTC dominance are overreaching. Yes, the Fed can “print” dollars (or technically the Treasury can). However those dollars are backed by the taxing authority of the US Government. The authority to tax all the real assets, cash flows, and economic benefits (and yes even Bitcoin) of the largest and most prosperous economy in human history.

Yes, the US government has a lot of debt, but the reality is it can just tax us to repay it. That serves as a backstop to the fundamental value of the USD. BTC is only backed, again, by the expectation that someone may be willing and able to pay more than you did.

As for BTC taking the USD’s place as the world’s “reserve currency,” we’re far from that in terms of practicality or viability. Yes, more vendors are accepting Bitcoin as payment, Tesla did it for a bit (before not doing it). But by and large, everyday people still cannot feed themselves at the grocery store with Bitcoin. Furthermore central banks don’t want to hold reserves in something that so quickly fluctuates 1,000’s of percent in value.

Bitcoin and gold

I do think BTC’s likeness to “digital gold” has valid points. Of course gold is tangible and has more practical utility than BTC. But like BTC, gold has a cost of carry (storage, smelting, etc.), is scarce/finite, and people like to hoard it. That’s about where the similarities end. Bitcoin is not the same as gold and also not a superior version of it.

First, gold does not require a global network of resources operating non-stop to maintain its existence. And second, gold is and has been a universally recognized medium of exchange and store of value long before fiat currencies assumed those honors.

If you think gold’s status has changed then consider the following. In the wake of a catastrophic disaster (think the remnants of a war zone) would you have more success bartering for food and water with Bitcoin or gold coins? How about during a severe power outage?

Yes, there are some similarities, but believing Bitcoin and gold are the same is misunderstanding utility and intrinsic value.

The bottom line

My intention is not to discredit or disparage Bitcoin, again, I own some of it myself. However, I do think it is important to be intellectually honest with ourselves and to differentiate Bitcoin’s fantastic stories from its qualities as an investment.

Promises of disruption and riches are easy to buy into. But just because Bitcoin is “disruptive” doesn’t mean it’s destined for $1,000,000. It’s possible, of course, but so is Bitcoin ending up at $1,000. Unfortunately, many people are too intoxicated by the stories to see the numbers clearly (a hallmark during periods of irrational exuberance).

But I also give credit where it’s due. Regardless of what we think about Bitcoin or what we call it, the reality is BTC HODLers have done well for themselves. Few investments, legitimate or otherwise, have outpaced BTC prices over the past few years. So kudos to the laser eyes who obtained those promised BTC riches.

Just remember there is no shame in booking profits, and just as inflated promises are easy to buy, empty ones are hard to sell.

Victor K. Lai, CFA