When I think about Bitcoin, the best known cryptocurrency right now, I think of a quote from Warren Buffett.
“Price is what you pay; value is what you get,” the ‘Oracle of Omaha’ wrote in a letter to his Berkshire Hathaway shareholders in 2008.
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
The quote highlights a couple of important points about investing.
- 1.The price of an investment doesn’t necessarily reflect its value.
- 2.The lower the price you pay, the better your results.
It’s common sense really. And while Bitcoin and other cryptocurrencies have been around for quite a while, and have made lots of people rich, these two points sum up why I’m staying away.
That is not to say that Bitcoin is going to collapse. It’s just that Bitcoin doesn’t make a lot of sense as an investment to me.
Here are four reasons why.
Bitcoin is not a productive asset
When you invest in the stock market, you become a part-owner of a business.
When they succeed, businesses are productive: they tend to make money, and as a shareholder, you’re entitled to some of it.
It’s the same with property, which can be rented out to generate an income stream for the owner.
You might decide, for example, to accept a certain return from a business or rental property, like 5 per cent. That can help you decide how much you’re willing to value the investment: in this case, 20 times rent or income.
But how do you decide how much to pay for Bitcoin? It doesn’t produce earnings or cash flow like a business or rental property.
It’s really just a token that trades at whatever price people are willing to pay.
I certainly don’t know how much a Bitcoin is worth myself. And that’s one of the reasons I’m steering clear.
Bitcoin interest is not the same as bank interest
Sure, some companies pay interest on Bitcoin, but these arrangements are nothing like a typical savings account.
These interest payments are often generated by lending out holdings to other investors and traders. This introduces counterparty risk: if your company lending your Bitcoin goes bust, you can end up losing money.
It’s far riskier than a bank savings account, because cash deposits of under $250,000 are guaranteed by the Government.
Even in the unlikely situation your bank goes bust, you won’t lose your cash because the Government will bail you out.
There’s also the issue of security. The exchanges where people trade their cash for cryptocurrency are often targeted by hackers and thieves.
Security firm CipherTrace estimates that nearly $US2 billion was lost in cryptocurrency theft, hacks and fraud last year.
Bitcoin is highly speculative
In late 2016, you could buy a single bitcoin for around $1,000. Today, a bitcoin is worth more than 70 times that.
It’s great news for people who held on, but there’s no guarantee the trend will continue.
And while the jury is still out on Bitcoin’s future, it’s clear that there is a lot of speculation going on.
It’s something even Elon Musk, who recently bought $US1.5 billion of bitcoin for his company Tesla earlier this year, can admit.
“It should be considered speculation at this point. So don’t go too far with the crypto speculation front,” Mr Musk said recently.
Another issue to consider is Bitcoin’s volatility.
In December 2017, bitcoin briefly sold for more than $25,000. Shortly afterwards, the price crashed more than 30 per cent. The price continued to decline, falling to less than $5,000 by early 2019.
Even if you were a fervent believer in Bitcoin, it would have been extremely hard to hold on through that period.
It’s not clear if bitcoin will be widely adopted
Some Bitcoin supporters believe that the digital currency will be widely adopted in the future.
It is often used as an argument to buy Bitcoin: buy now, while they’re cheap, before everyone else needs them.
But it’s not entirely clear if this future will eventuate.
As Reserve Bank governor Philip Lowe has argued, cryptocurrencies like Bitcoin are not commonly used for everyday payments, and it’s hard to see that changing.
“The value of Bitcoin is very volatile, the number of payments that can currently be handled is very low, there are governance problems, the transaction cost involved in making a payment with bitcoin is very high and the estimates of the electricity used in the process of mining the coins are staggering,” Dr Lowe said in 2017.
Researchers estimate Bitcoin mining will soon consume more electricity each year than is required to power all of Australia, which is sparking concerns about its climate impact.
In Dr Lowe’s estimation, cryptocurrencies seem “more likely to be attractive to those who want to make transactions in the black or illegal economy, rather than everyday transactions”.
“So the current fascination with these currencies feels more like a speculative mania than it has to do with their use as an efficient and convenient form of electronic payment.”
It’s OK to sit and watch from the sidelines
I don’t know if Bitcoin is going to rule the world, and I don’t want to bet that people will be willing to pay more for bitcoins in future than they do today. So, I’m simply not getting involved.
It’s one of the great things about investing: you can pick and choose the investments that suit you most. And, for me, it’s not Bitcoin and cryptocurrencies.
You may decide differently, and you may be right. I would just say one thing, which is to not get too carried away.
Don’t risk what you can’t afford to lose, don’t put all your eggs in one basket, and have a plan for what you might do if the price falls.
And, finally, keep your bitcoins secure.
You don’t want to end up like James Howell, who accidently threw away a hard drive containing 7,500 bitcoins.
In case you’re wondering, that’s worth more than $500 million at current prices. Ouch!
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