Is it digital gold, a 21st century store of value you should envision as another version of the stuff they keep at Fort Knox? Is it currency like the $5 bill in your leather wallet, a means of payment that efficiently replaces USD for buying everything from cars to toothpaste?
Let’s quickly put the latter to bed. Whatever role blockchain technology may play in payment transfer now and going forward, the existing cryptocurrencies fail the most basic tests for a currency, due to extreme volatility.
Certain business icons given to speculative endeavors may be willing to take payment in Bitcoin and that may even work out well, when and if the crypto received appreciates. However, the lion’s share of businesses, which sport the slim-to-moderate profit margins imposed on them by competition, would routinely see their profit margins swallowed by the short-term price movements of these “currencies.” If your profit margins are 10%, you cannot handle a form of payment that routinely moves up or down 10% in a 48-hour period. Taking payment in crypto would turn your average local auto shop or salon into a crypto chart watching station.
At the moment, crypto is not a practical and efficient currency, which places it in the investment category. Observing its price volatility, we can be more specific and call it a high-risk investment. Around 4-6 months ago, depending on your brand of technical analysis, Bitcoin became an incredible momentum trade. The run-up has been steep but if the crypto bulls can impose their narrative on the world, we are probably in the early innings. For example, if you can get global asset managers to allocate 3-5% to crypto, you should fully expect Bitcoin to skyrocket. If asset managers, pension funds and even governments decide en masse they need a real allocation to Bitcoin, which isn’t entirely out of the realm, buckle your seat belts and prepare for takeoff. We are going up!
That said, at the risk of sitting out of a very hot trade, count me in the camp with a negative long-term view of Bitcoin and private crypto.
My quick take in three points:
1. Valuation Issues
It’s imperfect, but I have a detailed methodology for valuing equity in all kinds of for-profit companies ranging from “cigar butt” companies with declining revenues to hypergrowth companies burning through cash. With an equity bias, I can start there and then compare those stocks to other investments, ranging from debt to income producing assets like rental real estate.
What is Bitcoin worth? I can’t get comfortable with any valuation methodology on offer. In fact, I can’t get past “Why is Bitcoin worth anything.” Prove to me this isn’t the next rare tulip bulb or Beanie Baby.
Common arguments go something like, if every pension fund goes to X% crypto …
This strikes me as an inadequate foundation for a valuation model. Even less convincing are the valuation attempts that revolve around the size and scale of black market activity now conducted through crypto.
Blockchain technology? This is valuable tech but in no way does that functional value translate to $50,000 Bitcoin. This is a non sequitur.
2. Which Crypto? 4,500 and counting …
Bitcoin was birthed in obscurity and is backed by no one. The same can be said for the new cryptos emerging from a garage near you every week. There are more than 4,500 cryptocurrencies at this moment, and we should note the multiplication that occurs through forking (see Bitcash).
In fact, as I peruse my unfunded account on Coinbase, here are a couple of findings you might find interesting:
- The red-hot Bitcoin is the 50th best performer of Coinbase-listed cryptos over the last one year.
- In terms of market cap, you have to go all the way down to the 94th largest cryptocurrency to get below $1 billion. There are literally hundreds of these things with huge assigned values and almost no one has never heard of any of them. Mind if I pay you in Stellar Lumens? Stellar Lumens is one of the 10 biggest cryptos. Heard of it? Case in point.
Maybe 4,500 and counting strikes some as beautiful and confidence building as they infer something about the power of “decentralized finance” and the inevitable takeover of payment forms whose time has come. Those people see this as proof of concept. I find this proliferation arbitrary and unsettling.
3. Government Crackdown?
Last week, Turkey followed several other admittedly economic lightweights in banning cryptocurrencies. While Turkey isn’t perhaps the best bellwether, is there is a real risk that governments relying on their own fiat currencies will at some point, in some way, move against these private fiat currencies? By one count, around 40 governments are presently working on central bank digital currencies (CBDCs). It’s easy to imagine a future in which digital currency plays a key role in global finance and my guess is this will happen in digital USD and digital Yuan, and that these early private versions will become an afterthought, the Myspace that spawned the mighty Facebook.
My base case scenario has Bitcoin as an important innovator that actually changes finance, a rare feat indeed. In this base case, tomorrow’s American consumer conducts everyday business with digital USD and Bitcoin isn’t worth much.
USD and other sovereign CBDCs will have value for the same reason their paper money has value. Fiat currencies make sense in a context in which the issuer has the power of the sword and the ability to issue debt and collects taxes.
Looking around, you’ll find really smart people in both the bull and bear camps. In the bear camp, Warren Buffett has called it “rat poison” and he counts fellow billionaires Howard Marks, Ray Dalio and others well known for their ability to value things in his ranks. More to the point being made here, I would key on the perspective of global central bankers, to include Jean-Claude Trichet (ECB), Mark Carney (Bank of England) and former US Federal Reserve Chairman Ben Bernanke, all crypto bears. Here’s Bernanke: “Bitcoin is an attempt to replace fiat currency and evade regulation and government intervention. I don’t think that’s going to be a success.”
I think I agree. I don’t think that’s going to be a success.
I could be wrong. Do I have confidence Bitcoin drops back to $10,000 before hitting $100,000 or even $250,000? Not really. Do I have confidence Bitcoin ever again sees the south side of $10,000? It’s not a high confidence position. Regarding this kind of momentum trade, I would warn every naysayer, you can take a negative view on the long-term prospects, but never get in front of the train. I wouldn’t bet against Bitcoin and I wouldn’t make specific predictions about where it will find a ceiling.
For me, sitting out Bitcoin (at least at the moment) is more about knowing you don’t have to swing at every pitch than it is about having high confidence that Bitcoin crashes in the near term, or ever.
At the moment, count me out, but I appreciate a good trade and I tip my cap to all those who are long crypto. I might change my mind and jump in some day when Bitcoin pulls back to its 50- or 200-day moving average and gives me an outside bullish reversal on high volume. This reminds me that I am the guy bulls love most – today’s bear who they hope becomes tomorrow’s buyer – because they know that once everyone is in on a speculative trade, it’s over.