It was only a few short years ago that Bitcoin and its good friends Ethereum & Ripple first showed their head to the mainstream consumer – attracting new buyers who saw it as the next get-rich-quick-scheme. The majority were burnt by the experience after buying Bitcoin at its peak of public interest in December 2017 at a price which peaked at c$20,000 per coin, only for it to fall by 82.5% to around $3,500 by March 2018. We were fairly critical of cryptocurrencies at the time and as they now rise for their second wave of popularity, we are keen to share our thoughts once again.
As the majority of our clients have noticed – it has been relatively easy to build savings over the last year. Graduates have been moving back to their family homes to avoid London rent, mid-career workers have saved on their pricy commute (and coffee!) and our retired clients have been left landlocked. This widespread cut to household expenditure has lead to the majority of the population being able to build savings from surplus income and many now wonder what to do with their ‘extra cash’. This, alongside an unrelenting barrage of unregulated promotion and support from social media ‘influencers’ has seen the number of cryptocurrency investors steadily rise. Like any good self-fulfilling prophecy, the increased number of investors has recently pushed prices up once again as we saw in 2017, meaning that those recent investors have already made some ‘profits’ and are now encouraging their friends and family to join in on the action. This circle will likely continue until it doesn’t. History shows us that these bubbles tend to burst – as they did for Bitcoin in 2017 – and we encourage you to not join in on the ride.
We humans are never lacking in our enthusiasm for the next big ‘investment’ ideas. Around four hundred years ago the Dutch managed to work themselves into a frenzy over tulip bulbs. At the height of the hysteria one bulb of Semper Augustus apparently changed hands in exchange for 12 acres of land (1). In the 1700s the South Sea Company Bubble ruined many as the stock price rose almost ten-fold in 1720, largely on the back of false rumours, and then mercilessly crashed. Even Sir Isaac Newton himself got burnt, losing almost all of his savings.
“I can predict the movement of heavenly bodies, but not the madness of crowds.” Sir Isaac Newton
By all accounts the madness surrounding equity investments was widespread in the early 18th century, with one company supposedly coming to market with the greatest marketing spin ever, describing itself as ‘a company for carrying out an undertaking of great advantage, but nobody to know what it is’ (2).
Today investors face similar sentiment in certain corners of the investment world, from the rise of Tesla’s stock price (now down -36% from high), to GameStop’s ‘to the moon’ rally (now down -51% from high). Shell companies – known as SPACs – raising cash from investors to buy, as yet unidentified companies (sound familiar?) have multiplied in the past 18 months. Cryptocurrencies, such as Bitcoin and the spoof Dogecoin today have ‘market capitalisations’(3) of US$741 billion and US$47 billion. Unfortunately, we as humans seem programmed to suffer from FOMO (fear of missing out), which was likely an advantage in the days of being a hunter gatherer but it can be especially dangerous when it comes to investing and ‘hot’ markets.
Just because something has gone up spectacularly, does not mean that it is a good investment, or even an investment at all. A material risk always exists that latecomers to any speculative game get left holding the hot potato. Knowing what you are getting yourself into is a good place to start.
“When you have difficulty in finding out what the real fundamentals of an investment are, then what you are doing is not a “real investment.” ECB Vice President De Guido, 2021 on cryptocurrencies.
In attempting to understand cryptocurrencies, a good starting point is defining what money actually is. We believe that money can be described in three ways: a store of value, a unit of account, and a medium of exchange. So, do cryptocurrencies – using the popular Bitcoin as an example – have these three characteristics? We believe that an asset which has risen by +36% on one day and fallen by -27% on another is hardly a store of value. The cost of a nice meal out in a restaurant that prices in Bitcoin could change materially by the time you have finished your starter, let alone the rest of your meal and asked for the bill. It is fair to see Bitcoin as a unit of account however it remains a relatively uncommon one. In terms of being considered a medium of exchange, it fails fairly dismally. Pretty much nobody – not even Elon Musk’s firm Tesla – currently accept Bitcoins and few people trust it enough to use in daily transactions. We would suggest this will remain unchanged whilst its price continues to swing wildly.
As an aside, there is an amusing (for us at least) unverified story of a Bitcoin programmer who traded 10,000 bitcoins for two Papa John’s pizzas on May 22, 2010, costing him £280 million in today’s terms. Tomorrow it may be significantly more or less! Those who promote Bitcoin would highlight the phenomenal gains in value made by Bitcoin since May 2010. We would encourage you to realise that currencies for spending need stability. It’s frustrating enough travelling to Europe and finding that your hard earned £’s buy 10% less €’s for your summer trip than they did last year… imagine the struggles of using a currency which fluctuates significantly by the minute!
There are also some other less savoury aspects of cryptocurrencies. The first is that the ‘mining’ of many cryptocurrencies, including Bitcoin, has an extremely poor carbon footprint. Bitcoin is mined by allocating vast computing power to execute extremely complex computational math problems which keep the whole network moving. These Bitcoin miners alone have a carbon footprint equivalent to the Czech Republic (5), as much of it is mined in China where a significant proportion of electricity produced is from coal. A second less savoury aspect is that it has become the favoured unit of exchange for ransomware (blackmail) attacks on governments and companies, such as the recent Colonial Pipeline attack in the US, which was settled, apparently, for 75 Bitcoins or around $4.4 million. Criminals are granted anonymity through the blockchain network – meaning that Bitcoin transactions cannot be tracked.
“Its price volatility makes Bitcoin risky and speculative, while its exorbitant carbon footprint and potential use for illicit purposes are grounds for concern.” ECB Financial Stability Report (2021)
The boosst view is that putting money into cryptocurrencies is not investing, but pure gambling. Combined with the possibility of losing your entire capital invested, either through the failure of the cryptocurrency in question, or your crypto wallet (where your ‘coins’ are stored) being hacked. For us, the moral hazards of dabbling in it make such actions unpalatable. Going crazy and chucking a fiver at it that you are prepared to lose – as you might on a horse in the Grand National – is up to you, but don’t call it investing!
References
(1) Charles Mackay (1841), Extraordinary Popular Delusions and the Madness of Crowds Wordsworth Editions; New edition (5 Jun. 1995)
(2) A good short read can be found here – http://www.dtc.umn.edu/~odlyzko/doc/mania17.pdf
(3) We dislike this term as it implies some form of solid value, such as that built by Apple or AstraZeneca, for example.
(4) https://www.stlouisfed.org/education/economic-lowdown-podcast-series/episode-9-functions-of-money
(5) https://www.nature.com/articles/s41467-021-22256-3