Why I Won’t Be Investing in Bitcoins

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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Damning Treasury Report on Crypto-Assets

Thinking of investing in some Bitcoins or other Crypto-Currencies? Or perhaps I should have said thinking of speculating in them. Best first read the report published today by Parliament’s Treasury Committee. It’s a damning attack on the “wild-west” of this new market and calls for it to be regulated by the FCA as soon as possible.

Their report suggests that most crypto-currencies has used mainly for speculation and they say there is minimal consumer protection.

The report also puts a damper on the alleged wonders of blockchain technology with the Bank of England arguing to the Committee that it does not function well as a means of payment because it cannot handle the payment volumes required, plus it’s too slow and too expensive to meet even current UK payment transaction volumes. It also consumes large amounts of power.

They examine the price volatility of crypto-currencies and the problems associated with them – namely the vulnerability of the exchanges and client holdings to hacking, the potential for market manipulation and the use of crypto-currencies for money laundering and other criminal activities. Crypto-asset markets fall outside the market abuse rules so anything goes in essence, and Initial coin offerings (ICOs) are in a regulatory loophole so are open to abuse.

A bitcoin was worth $20 in January 2013, and reached $19,206 in December 2017 but is now back down to below $7,000. Extreme volatility and even illiquidity seem to be features of crypto-currency markets even in the more widely used ones.

Comment: It is very clear that crypto-currencies and ICOs are promoted as “get rich quick” products mainly to part fools from their money – in other words it’s the same old story of financial innovation being exploited to seduce suckers. There may be some merit in establishing a digital currency that is independent of banks and that cannot be corrupted by Government. But the lack of regulation leaves it wide open to abuse and use for criminal activities. Regulation needs to be introduced as soon as possible to introduce proper controls on those operating exchanges or performing ICOs and there obviously need to be better audit trails and anti-money laundering controls to remove the criminal elements.

The FCA may have been reluctant to take on responsibility for this new area as they barely have the resources to do their job properly at present. But if the resources cannot be made available, or are unjustifiable, then the UK Government should consider banning crypto-currency trading, exchanges and initial coin offerings as in China. If it can’t be regulated it should be banned.

As regards blockchain technology, it might have an advantageous use in some applications but it hardly looks likely to be the wonder drug for electronic accounting as some seem to believe. Too much hype and not enough evidence of real applications where it provides cost benefits as yet.

The Treasury Committee Report is available from here: https://www.parliament.uk/business/committees/committees-a-z/commons-select/treasury-committee/news-parliament-2017/digital-currencies-report-pubished-17-19/

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Revenue Recognition, Patisserie Valerie, Utilitywise and Cryptocurrencies

Revenue recognition is a hot topic at present as folks have come to realise that this is a frequent cause of company accounts misrepresenting the true state of the business. Quindell and Blancco are two examples and I cover Utilitywise below. But first let me report on the Annual General Meeting of Patisserie Valerie (TIDM:CAKE) which I attended this morning (as a shareholder of course).

The company operates a chain of cake+coffee shops under the company name but they also have several other brands. However they seem to be concentrating on the Patisserie Valerie one in terms of new openings. This is a typical “retail roll-out” story where they just open more outlets – fixed costs do not increase in proportion so profits grow rapidly. They plan to open about another 20 stores per year at present. The company is run by Executive Chairman Luke Johnson who owns 38% of the company.

Having read the Annual Report I asked a question on revenue recognition because on page 16 it says “revenue recognition has been identified by the audit team as a significant risk”. Perhaps the auditors are now hedging their bets by putting that in all company reports but I found it rather surprising bearing in mind that I expected most customers would be paying cash in the cafes. Indeed the CFO indicated 80% of revenue is in cash. They do issue promotional vouchers but these are not recognised as revenue until used. However they do have some wholesale customers and franchise deals with companies such as Sainsbury where payments are delayed. This explains why they have significant trade accounts receivable at £12.3 million on revenue of £114 million. So I don’t think revenue recognition is likely to be an issue in this company.

Otherwise the AGM was fairly routine and we did get some cake at the end. There were about a dozen shareholders present in the City at one of their outlets. Luke Johnson is not a greatly impressive figure physically (first time I had met him) but answered questions openly. He noted profits were up 19% at £16.4 million. He said they opened 20 new stores and all were immediately profitable. Net cash was £25 million at the year end so they are well positioned for acquisitions if they arise, he noted. A couple of interesting questions from shareholders were:

  1. Is there any difficulty in attracting staff, particularly in London and the South-East. Answer: probably as hard as it has ever been, but they expect a lot of foreign staff to stay in the UK after Brexit and many are non-EU citizens anyway.
  2. Media have reported a possible acquisition of Gails, a similar chain (and partly owned by Luke Johnson I believe). Answer: cannot comment.

In summary, Patisserie Valerie is riding on the popularity of cake and coffee of late, but they are differentiated slightly from common coffee shops. They are also vertically integrated which keeps costs of the cakes low and as a result have good profit margins. Defending that position could be tricky but the business seems to be well managed.

Utilitywise (UTW), a reseller of utility power contracts, has had its shares suspended after failing to file accounts within the timescale required by the AIM market rules. To quote from the company’s announcement: “This delay is due to the volume of work still required to be completed by the Company and its auditor to cater for the proposed change in the Company’s revenue recognition policy, as announced on 17 January 2018. This work includes amendments to the Company’s financial reporting systems in order to analyse energy contract data in accordance with that new policy, alongside associated work by the Company’s auditor, for the audit of its results for FY17 to be completed.”

Now I don’t currently hold this company’s shares but I did briefly from December 2013 to July 2014. The more I learned about the way revenue and profits from contracts entered into that covered future periods were recognised, the more concerned I became. Revenue was still reportedly growing rapidly in 2014 but I sold at about 260p. The share price recently was near 40p.

In my book, revenue and the associated profits from long-term contracts should not be recognised until the cash comes in. But that’s not the way accountants like to handle matters at present. Part of the difficulty lies in costs expended in the short term to obtain or develop the contracts so matching costs with revenue, a basic accounting principle, is a problem.

Lastly I think it is worth mentioning cryptocurrencies, initial coin offerings, bitcoin and blockchain technology. These are all hot subjects that I do not think I have covered before which is probably a gross omission.

Blockchain technology is interesting. It’s basically an “open ledger” which might have many applications, although whether it is really any good for really high volume transaction processing seems to be in doubt. Many banks and other financial institutions seem to be looking at it but it is not altogether clear why they need it (are not existing systems and software adequate enough? Perhaps they are just a bit archaic?). It may be lower cost and simplify development but it potentially has great weaknesses.

For example, Coincheck, the “Leading Bitcoin and Cryptocurrency Exchange in Asia” as they style themselves, recently suffered a hack that meant $500 million has disappeared into the hands of the perpetrators. They have promised to reimburse affected customers but it seems highly unlikely that they have the financial backing to do so.

This is not the first such time this has happened. Another case was that of MtGox which became bankrupt after a similar fraud. So it seems bitcoin systems are not as secure as one might have hoped.

One reason internet fraudsters like payments in Bitcoins is allegedly because they cannot be traced. So does that mean there is no audit trail so one cannot trace where the funds come from and where they go to? This is a major defect in any transaction system which suggests to me that Bitcoins and other similar currencies based on blockchain technology should be promptly regulated by all countries as soon as possible. There may be a need to have a “virtual” currency not controlled by any one Government, but unless it is secure with proper audit trails on its movement, it is not fit for purpose.

The Financial Conduct Authority (FCA) should be looking at this area and pronto before the wide boys of the financial world exploit gullible folks and fraudsters take advantage of its defects.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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