Bitcoin and cryptocurrencies: are they a worthwhile investment?
One of the quirks of investment, and the greed and fear which frequently drive short-term price movements, is that rising prices attract more favourable comment (and often more money) and falling ones persuade investors to look elsewhere.
There is no finer example of this than the world of cryptocurrencies in 2017.
Looking at Bitcoin in particular, it’s a digital asset and payments system, a virtual currency, where intermediaries play a very limited role and central banks and governments none at all.
It is encrypted and the creation or transfer of every Bitcoin is kept on a ledger and archived for maximum transparency on how much is in circulation (although the encryption element ensures anonymity for users).
This is all made possible by so-called ‘blockchain’ technology, a database that maintains an ever-growing list of records, called blocks. Each block is linked to its predecessor and bears a time stamp.
Bitcoin has by no means achieved universal acceptance (investors cannot just walk into any shop or restaurant and spend Bitcoin) but its stunning price rise has spawned a host of rivals.
Since 1 January one Bitcoin has surged from $997 to $2,765, according to www.coindesk.com.This is good going for something where the initial coin offering (ICO) came at $0.0001 in 2009, only reaching the $1 mark in 2011.
But there are other cryptocurrencies too. Ethereum has surged from less than $10 to over $225 this year and Ripple has gone from barely half of one US cent to 19 cents in 2017, having been as high as 30 cents.
According to the website www.worldcoinindex.com there are now over 500 cryptocurrencies in circulation, ranging from Bitcoin, ‘valued’ at around $45bn, to Ethereum at $21.3bn and Ripple at $6.6bn, all the way down to the 3.53 million Clevercoins currently valued at just $336.
Here is a selection of cryptocurrencies available, the number of coins in circulation and the value of the coins:
Cryptocurrency: an investable asset?
So are they an investable asset, in the same way as stocks, bonds, commodities, properties or even collectibles, such as vintage cars, art and wine?
Here are the pros and cons.
For: the absence of central bank involvement or government interference means cryptocurrencies are a store of wealth in an era of quantitative easing, monetary policy experimentation and a rampant growth in the supply of money, which could devalue it over time.
Against: the Mt. Gox disaster, the forced shutdown of the Silk Road and now the Alpha Bay websites for their involvement in criminal activity both suggest that the authorities are taking a closer look at some areas where Bitcoin and cryptocurrencies are widely used. In addition, it is thought that one big reason for the surge in prices earlier this year was demand from Chinese nationals who were buying Bitcoins onshore and selling them offshore so they could move money out of the country. Might China move to clamp down? Or even unveil its own cryptocurrency via an ICO?
For: Bitcoin and cryptocurrencies are an even better bet than gold at a time when governments are too happy to print cash to buy votes and too frightened for their own jobs to stick to sound monetary principles. Even gold supply increases every year, whereas Bitcoin supply is designed to be finite.
Against: even if you take such a dim view of central banks and governments, Bitcoin and cryptocurrencies may not be the answer for four reasons:
- The number of alternative currencies has mushroomed.
- The debate over ‘soft’ or ‘hard’ forks for Bitcoin processing development shows that this is not a straightforward topic – and no-one should invest in anything unless they thoroughly understand it.
- US President Franklin D. Roosevelt’s Executive Order 6102 criminalising the possession of gold in 1933 shows that the authorities could still get involved if they wished to do.
- Bitcoin, like gold, offers no yield and generates no interest or cash. As such, investors are buying Bitcoin (or gold) in the view that they can get someone else to pay more for it, not because it has the ability to provide consistent coupons on return. Some would argue this is simply an example of the Greater Fool Theory at work.
For: Bitcoins and cryptocurrencies are now liquid and cheap and easy to trade. Bid-offer spreads are small and there are no pesky intermediaries charging fees, let alone central bank involvement or regulation. A growing number of retail brokerages facilitate Bitcoin trading and some even offer the opportunity to trade derivative instruments based on the cryptocurrency.
Against: investors can’t escape the Bitcoin miners, who create Bitcoins, monitor and record and archive transactions. They will charge a small fee. Just because you can trade derivatives does not mean you have to buy them or even the underlying asset – the Financial Conduct Authority is already cracking down on spread betting and contracts for difference.
The US regulator, the Securities and Exchange Commission, rejected in April an application for approval for the Winklevoss Bitcoin Exchange Traded Fund (ETF), owing to concerns over the volatility in Bitcoin prices and whether the price could be manipulated to the disadvantage of investors, given the lack of regulatory surveillance of the underlying asset.
This third and final point perhaps echoes legendary US investor Warren Buffett’s quote: “If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.”
Anyone determined to start trading Bitcoin or any of its rivals needs to do their research every bit as thoroughly as they would for any individual stock, bond, commodity or fund and ensure that any purchases or sales fit with their overall investment strategy, time horizon, target returns and appetite for risk.
Russ Mould is investment director at AJ Bell