As bitcoin hit its record highs recently, it began to attract attention again. Its price has increased by more than 200% since the beginning of the year. Without a doubt, this is an amazing growth. Does it make bitcoin a good investment?
We need to think about what investing really is. A common definition of investing is allocation of money in the expectation of some benefit in the future. This definition is too broad from our point of view. A gambler also allocates money to get some benefit. However, gambling is not an investment. We may take the definition from Graham and Dodd’s book Security Analysis: “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative… An investment operation is one that can be justified on both qualitative and quantitative grounds”. Does the purchase of bitcoin fit this definition of investing? We believe it doesn’t. Safety is a really important issue here. Safety based on something which is more tangible than solely the psychology of the buyer.
Bitcoin is referred to as a cryptocurrency and is often compared to fiat money. However, fiat money has an obvious advantage in comparison to a cryptocurrency: fiat money is legal tender and is generally accepted as a means of payment. True, in the case of a cryptocurrency there is no government issuing too much of it and leading to a hyperinflation. But there is also no authority or law that guarantee acceptance of a cryptocurrency, there is no government trying to maintain its value. A serious obstacle to the broad acceptance of bitcoin is its enormous volatility. We’ve been trying hard to find currencies that are more volatile than bitcoin. We examined how the values of the various currencies (expressed in US dollars) have changed over the past 5 years and found only two of such currencies: Venezuelan bolivar and Sudanese pound. All three proved to have significant downside risk. For example, if you purchased Venezuelan bolivar in November of 2018, you lost over 99% of your money a year later. Sudanese Pound lost 86% in value from December 2017 to December 2018. Bitcoin lost 83% between December 16, 2017 and December 16, 2018. To be fair, we would have to mention that bitcoin grew most of the time and provided chances of achieving the highest annual profit.
Bitcoin is sometimes compared to gold. True, like gold, bitcoin is worth what someone else is ready to pay for it. But the supply of bitcoin is not related to its price. As a consequence, bitcoin will probably also remain more volatile. Moreover, gold is a physical asset that has intrinsic value. Bitcoin has none.
Intrinsic value is also the thing which distinguishes stocks from bitcoin. Bitcoin is not backed by tangible assets, nor does it generate dividends or profits. In case the hype supported by fear of missing out, fans and speculators comes to an end, the value of bitcoin may fall to 0 in theory.
Thus, we conclude that operations with bitcoin are speculation rather than investment. Which is ok. We simply believe that it is critical to be aware of the risks and to make deliberate decisions. At this point, we can again refer to Graham and Dodd, who distinguished between intelligent and unintelligent speculation:
- Intelligent speculation is taking of a risk that appears justified after careful weighing of the pros and cons.
- Unintelligent speculation is risk taking without adequate study of the situation.
Those who buy bitcoin should think about whether the speculation they devote themselves to is intelligent or not.
Risk Warning: The information in this article is presented for general information and shall be treated as a marketing communication only. This analysis is not a recommendation to sell or buy any instrument. Investing in financial instruments involves a high degree of risk and may not be suitable for all investors. Trading in financial instruments can result in both an increase and a decrease in capital. Please refer to our Risk Disclosure available on our web site for further information.