In the current market manias, investing in Bitcoins or other cryptocurrencies is a popular thing to do. Who could lose money on Bitcoins that seem to be on an unstoppable upward trajectory? Well a lot of people can. It was down 8% yesterday in sterling terms as I was writing this and it has been both very volatile and on a downtrend since the start of the year.
Apart from those folks who like to gamble on a throw of the dice or on the turn of a card, why would anyone “invest” in it? I suggest nobody because there is no fundamental value underlying the asset. That’s apart from the security issues and people just losing their passwords and hence being locked out of the asset.
If you buy shares in a company, you are actually purchasing part ownership of a business. That business will be producing something that people actually want, such as products or services they wish to consume. So long as people, or other businesses, have an urgent need for what a company produces then they will pay for it (typically by exchanging their labour or productive capacity (assets) using currency as a means of exchange). It is possible that Bitcoins might in future be that means of exchange but it is not ideally suited to that purpose.
The value of assets in the modern world is not identified by reference to gold or other physical assets and central Banks can print money whenever they wish. So there is no intrinsic value in cash holdings. The value is not limited by supply, and even with Bitcoins, more can be produced (albeit at enormous environmental cost because of the electricity consumed to do so).
When you buy a share in a company, you are purchasing a small part of a business that produces something useful. When you buy a Bitcoin all you are purchasing is a token to sell to someone else at a higher price – if you are lucky and can persuade them it has some value.
What’s the difference between Bitcoins and Gold you may ask? The majority of gold is not mined for just keeping in a bank vault or converting into coins. Some 50% is used in the production of jewelry and 37% in electronics. In other words, there are applications for it that are well established and consistent demand. Yes there is some speculation in gold and some uses of it as a simple store of value but the mining of gold would be sustained by industrial applications. You can actually wear gold jewelry to impress people with your wealth (just like people buy expensive cars and watches), but you cannot wear Bitcoins. All you can do is to go around boasting about how many you hold but that is not quite as effective as wearing gold.
The Financial Conduct Authority (FCA) has recently warned against speculation in cryptocurrencies by retail investors, and quite rightly. There is no intrinsic value in a Bitcoin. With company shares the intrinsic value may be somewhat uncertain and share prices subject to the emotions of investors but there is at least a way to determine the value by looking at the discounted cash flows generated by a company. The future cash flows help you to determine the current value. But with cryptocurrencies there are no associated cash flows. No dividends paid out and no profits generated directly from the assets as with company shares.
If you buy cryptocurrencies you are simply buying a “pig in a poke”.
Roger Lawson (Twitter: https://twitter.com/RogerWLawson )
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