The fear of missing out (FOMO) is a powerful force. I remember being at a middle school dance and a “slow song” started to play. Every middle schooler started to get anxious because we feared we would be one of the few left without a dance partner. So what would the guys do? We would ask the closest girl to us to dance whether we knew them or not. It was similar to the fear you experience in musical chairs!
Over the past year, investing in crypto currencies has been a similar phenomenon. Investors look with envy at these spectacular returns over the past few years, and they are amazed and somewhat frustrated they are missing out. Are these crypto currencies going to be around for the long haul? Are they a valid and worthwhile investment? Is Bitcoin a fad or a new asset class? Will the federal government allow these currencies to replace the use of the dollar? These are all great questions. Let’s explore this interesting topic in more detail.
What is Bitcoin?
Bitcoin is the most popular digital currency. Other popular cryptocurrencies include Ethereum, Ripple, and Litecoin. Unlike traditional currencies, Bitcoin operates without any governing body (or bank) and is not backed by any government.
If you read about Bitcoin, you will come across the concept of “mining.” Mining creates the new supply for bitcoin. Bitcoins are mined using computer algorithms that solve a series of complex calculations. These time-consuming computations verify bitcoins and allow for the creation of new ones. Only 21 million bitcoins can be mined, and they become more time consuming to create as the supply grows.
It’s Like Riding A Rollercoaster
Warren Buffet has many famous phrases that are frequently repeated by investors and one of his most prominent phrases is “know what you own.” We are not telling you to NOT own a cryptocurrency, but we are adamant that you need to understand what you own prior to investing in Bitcoin. The risk of investing in a digital currency is much greater than a traditional stock or bond investment.
The talking heads on TV are talking about Bitcoin on a daily basis. Why? You can call us a pessimistic, but the main goal of a news program is not to deliver the news or to better educate their public. The #1 goal is always to produce better ratings… Have more eyeballs glued to the screen. Bitcoin is getting that done for a lot of these news outlets. Bitcoin seems to attract more attention during and after a steep increase in price. In fact, on April 17th of this year, Bitcoin fell nearly 14% in one hour.
Are you comfortable owning something that can lose 14% of its value in one hour? Most of our clients would emphatically say “no.” If you do choose to place your money in cryptocurrency, you must be okay with this type of volatility.
Risks of Cryptocurrency
Risk #1: Bitcoin is NOT practical: Bitcoin supply is very limited, and it is very expensive to mine additional bitcoins based on the amount of electricity that is needed to run the high-powered computers. A prominent research firm, Capital Group, estimates that cryptocurrency mining consumes about 0.6% of the world’s electricity which is more electricity than the entire country of Argentina used last year!
Risk #2: Governments WILL Intervene: Some will argue that the most powerful man in the world is not the U.S. president but the Chairman of the Federal Reserve. Why? Because the Federal Reserve bank controls monetary policy and can print as much money as needed/wanted. So this begs the question… why would the U.S. government bank that controls the money supply and also serves as the world’s reserve currency be okay with its citizens fully adopting a currency that they have no control over? If the government lost control of its currency, it would lose most of its control over monetary policy. We know one thing about world history…. governments LOVE control.
Risk #3: No Stability of Value: Elon Musk (the founder of Tesla) has been very vocal about his views on Bitcoin. For a short period of time, Tesla accepted Bitcoin as a form of payment for their cars. However, what if you converted American dollars to bitcoin on a Monday and purchased the car on Wednesday? There have been two-day trading periods where the value of bitcoin can fluctuate up/down 30%+. This can be the difference in affording the car and not!
Risk #4: No Flight To Safety: Bitcoin has historically had some type of correlation to the U.S. stock market. When stocks are going down and people want to “run to safety,” what do they do? They park money in their bank where the funds are FDIC insured. Bitcoin does not offer the same safe haven that cash currently offers.
Powerful Technology
We have detailed a few of the top risks to cryptocurrency above. To be fair, we need to also explain how powerful the technology that they are using has become. The technology that bitcoin (and other crypto currencies) uses is called blockchain. Think of bitcoin as the first application of blockchain. Blockchain powers digital ledgers that can be shared over public or private networks and track transactions. This allows people to provide an easier and more efficient way to handle financial transactions. This technology is already being used by many large financial institutions. Regardless of the future of Bitcoin, the blockchain technology is here to stay.
Our Thoughts
When asked by clients and friends about bitcoin, we will always go back to our investment philosophy. We are looking for profitable companies that have the ability to not only pay dividends but also increase dividends. Any company we own has earnings and a stream of reoccurring cash-flow. We are firm believers that the stock market will continue to move higher if companies can continue to make more money each year.
Since bitcoin does not produce a product, does not have earnings, and does not pay dividends, it would by definition be something one could speculate on. We are not in the business of speculation because of the serious risk that comes with this type of “wild west” investing philosophy.
So, if you are really interested in this “new technology,” consider investment in blockchain technology or companies in the financial arena that are poised to benefit from this potential transformation change in how business is done. A high risk/speculative investment should only be considered for the more sophisticated investors who are prepared to experience greater volatility.
In summary, we continue to believe that fundamentals matter if one desires long-term success while investing.
About the Author
Matt Price serves as a Partner and Senior Vice President for The Price Group of Steward Partners. He resides in Houston with his wife, Emily, their three children and the family golden retriever. Matt studied at the University of Pennsylvania – Wharton School of Business for his Certified Investment Management Analyst (CIMA®) designation after receiving his undergraduate degree from the University of Tennessee - Knoxville. Over the past 10 years, Matt has helped families make high quality, common sense decisions regarding their wealth and their legacy. Matt firmly believes that everyone needs a wealth coach!
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Prior to making an investment decision, please consult with your financial advisor about your individual situation. The prominent underlying risk of using bitcoin or other cryptocurrencies as a medium of exchange is that they are not authorized or regulated by any central bank. Bitcoin issuers are not registered with the SEC, and the bitcoin marketplace is currently unregulated. Bitcoin and other cryptocurrencies are a very speculative investment and involves a high degree of risk. Investors must have the financial ability, sophistication/experience and willingness to bear the risks of an investment, and a potential total loss of their investment. 3611610.