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The price of Bitcoin has risen 64% in 2024 so far.
That’s after rising 156% in 2023!
Last week, a client brought to my attention that the CEO of the largest asset manager in the world, Blackrock, suggested that crypto is a good long-term store of value.
He likened it to digital gold.
This might all seem like good news for crypto investors.
I don’t think it is.
My past musings on crypto
A few years ago, I expressed my reservations about crypto in this blog post.
In essence, I outlined several reasons why I wasn’t enthusiastic about it and didn’t consider it a worthwhile investment.
Since writing that blog, I have dedicated more time to understanding and closely monitoring the crypto market.
Fund managers have jumped on board
In October 2023, the US Securities and Exchange Commission (SEC) approved the first spot Bitcoin Exchange-Traded Fund (ETF) after rejecting similar applications multiple times.
Currently, there are over 10 listed Bitcoin ETFs in the US, with BlackRock, under its iShares brand, offering one of the most widely recognised ones with the code IBIT (listed on the NASDAQ).
After only 2 months, the total investment in IBIT has surpassed $20 billion.
These ETFs provide a simple and cost-effective avenue for investors to invest in Bitcoin.
There aren’t any spot crypto ETFs listed on the ASX, yet.
Asset managers, including BlackRock, have a vested interest in attracting investment dollars because their revenue is directly tied to the assets under management.
Management fees are calculated as a percentage of the ETFs’ assets.
Consequently, there is a commercial incentive for asset managers to promote the advantages of investing in Bitcoin through an ETF.
Therefore, you should maintain a healthy level of scepticism of any commentary that an asset manager makes.
The impact of these Bitcoin ETFs on the asset’s performance is still uncertain.
Some suggest that they could enhance its popularity and demand, potentially leading to a price increase.
On the flip side, other commentators propose that the ease with which investors can buy and sell their holdings through ETFs might also contribute to increased volatility.
10+ years on and still no one’s using it!
For over a decade, crypto has gained considerable attention.
Advocates of crypto have suggested that it could eventually replace traditional currencies.
However, after a decade, it hasn’t been adopted as a means of exchange, rendering it without practical utility except as a speculative investment, to use for criminal activities such as money laundering, and El Salvador has adopted Bitcoin as legal tender.
I do acknowledge that blockchain technology does have a lot of utility and function and believe it holds potential for many applications.
When considering traditional share investments, investors typically evaluate the product or service a business offers and consider whether the demand for that product or service is strong and sustainable.
This fundamental analysis is crucial for understanding investment risks and potential returns.
However, at the moment, crypto, unlike traditional investments, lacks an inherent function or purpose.
Therefore, it presents a high-risk investment, as speculative sentiment has the potential to shift rapidly and vanish entirely in a short period.
The best explanation of crypto I have read is that it’s a social Ponzi scheme.
In this context, the success of the scheme hinges on existing investors convincing new participants to buy into crypto.
This aligns with the ‘greater fool theory,’ which essentially suggests that one can buy overpriced assets with the expectation that someone else will come along and pay even more for them in the future i.e., the greater fool.
Everything is popular until one day, it’s not.
Popularity isn’t perpetual.
Strong fundamentals are.
Storage of value… I think not!
Arguing that crypto serves as a reliable store of value faces two main challenges.
Firstly, there’s the issue of significant and largely unascertainable counterparty risk.
Crypto is often held on exchanges under custody arrangements, and these exchanges and custodians operate without regulation or independent oversight.
In the event of hacks or bankruptcy, there’s a substantial risk to crypto holdings.
A perfect example of this is FTX, operated by Sam Bankman-Fried, who has been convicted of 7 counts of fraud and conspiracy.
It is estimated that investors lost $USD8 billion. I acknowledge that some exchanges have taken significant steps to improve safe custody.
However, an asset class that is worth over $USD1 trillion should not be left to self-regulate.
As I understand it, if crypto is held on the blockchain (not on an exchange), this eliminates any counterparty risk.
Secondly, the highly volatile nature of crypto prices is a major concern.
For instance, Bitcoin’s volatility has typically fluctuated between 20% and 100%, which is very high.
In comparison, the estimated annualised volatility of gold is around 15%.
One potential solution to counteract this high volatility is to use stablecoins, which is a type of crypto.
Stablecoins peg their price to other assets such as the US dollar.
However, they still have the counterparty risk discussed above.
The combination of significant counterparty risk and high volatility makes crypto unappealing to investors seeking a stable means of wealth storage.
If it succeeds, it will be its ultimate undoing
A country’s ability to regulate its own currency is crucial for various reasons.
This control aids in managing inflation, fostering economic growth and investment, enhancing international trade, and safeguarding consumers and businesses from fraudulent activities such as counterfeiting and money laundering, amongst other things.
Hence, if crypto was to gain broader acceptance, it’s highly likely that developed economies would implement regulations to govern its usage.
Consequently, even if crypto were to achieve significant success, it would cease to maintain its decentralised nature – a characteristic often touted by advocates as one of its primary attractions.
How to build it into a portfolio
For all the above reasons, I do not recommend crypto as an investment.
However, I acknowledge that some individuals have made a lot of money through crypto, often gaining media attention.
It’s crucial to bear in mind, though, that markets operate on a zero-sum basis.
While winners may grab headlines, there are corresponding losers on the other side of each transaction, who often go unnoticed in the media.
Despite these considerations, if you still wish to invest in crypto, I recommend allocating only a small portion of your overall wealth to this asset.
In other words, invest only what you can afford to lose.
Your primary investment strategy should remain underpinned by high-quality, fundamentally sound assets.
The chart below suggests that adopting a trading approach for Bitcoin, rather than a buy-and-hold strategy, might be more advantageous, given the considerable variations in Bitcoin returns from year to year.
Just realise that one day the music might stop, and the party may be over.
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