Bitcoin: A get rich quick fad or a real investment?

When bitcoin retreated to lows of $3,000 (€2,620) around late 2018, analysts pointed to an overvalued asset that was finally plateauing at fair value. Prescient? Well, during the first half of 2021 its value reached a new high of about $63,700 in mid-April before beginning to slip off.

For both amateur and professional investors alike, the question now is whether this new asset class is merely a passing trend or the future of finance; whatever the answer, cryptocurrencies are clearly becoming too hard to ignore.

“To me, it is like the people who saw the birth of the internet in the mid-‘90s….[ when] everyone could look at the internet and know it’s an arriving force,” explains Emmet Savage, chief executive and co-founder of MyWallSt, a financial technology company which provides advice on what shares to buy and when.

“We’re seeing that exact same pattern emerge now in the year 2021 with crypto. So, personal opinions are absolutely valid, but with your personal opinion you’re either going with or against some of the greatest thinkers in the world.”

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Be that as it may, some of those great thinkers still sit on the fence. Others, like Berkshire Hathaway vice-chairman Charlie Munger have taken clearer views. At Berkshire’s annual shareholder meeting in early May, he said that “the whole damn development is disgusting and contrary to the interests of civilisation”.

“Bitcoin reminds me of what Oscar Wilde said about fox hunting. He said it was the pursuit of the uneatable by the unspeakable,” Munger added.

Hyperbolic though Munger’s language may be, owing to the price volatility of cryptocurrencies it’s not surprising that critics exist. In a March research note, Bank of America analysts said: “The main portfolio argument for holding bitcoin is not diversification, stable returns, or inflation protection, but rather sheer price appreciation.”

‘Get rich quick’

In effect, then, bitcoin in its current guise and at current prices could be viewed as a get rich quick scheme. Of course the corollary of that is buyers should be prepared to lose everything they invest.

Indeed, that warning was made publicly by Central Bank of Ireland governor Gabriel Makhlouf earlier this year. “Personally, I’m not sure why people invest in those sorts of assets, but they see them as assets clearly,” he said. His comments echoed European Central Bank (ECB) scepticism, with ECB president Christine Lagarde referring to cryptocurrency as a “highly speculative asset” in January.

Dave Quinn, managing director of Investwise Financial Planning, says that the price volatility is currently driven particularly by younger investors “seeking super normal returns which history suggests is never that easy”.

“If your goal is to gamble and hope it pays off in a year, then bitcoin might be your answer, but if your goal is to retire in a certain number of years I would suggest the stock market is the way to go because you can value companies and make a call on whether they’ll make future cash flows.”

Another difficulty, particularly for those enviro-conscious investors, is that bitcoin’s environmental score is poor. As it stands, the bitcoin network emits about 60 million tonnes of CO2, equivalent to Greece, according to Bank of America.

It noted that an inflow of just $1 billion in to bitcoin may cause C02 to rise by the equivalent of 1.2 million internal combustion engine cars. If the price of bitcoin rises to $1 million, the currency may turn in to the world’s fifth largest emitter, surpassing Japan. The reason for all of this is because of the centralisation of bitcoin miners in China, which itself relies heavily on coal.

The reality is that the environmental cost of mining bitcoin shows no sign of abating given that bitcoin supply is capped at 21 million coins and designed to become constrained.

As a result, rewards for miners have to halve every four years, making it more difficult and less profitable to mine.

The key attraction, therefore, is the substantial price appreciation that we’ve seen over the past few years. Additionally, it’s a story many of us have been glued to.

“The bitcoin story is an exciting story and looks like a revolution and takes power back from the banking sector,” says Quinn. But, he adds, “it’s the wild west, it really is”.

Bitcoin for transactions

That being the case and, if prices continue to gyrate so wildly, will there ever be a time when bitcoin, or other cryptocurrencies for that matter, are used for big ticket transactions like house purchases?

According to Quinn, for that to happen there’d have to be stability.

Otherwise someone could sell their house of a Tuesday to a bitcoin buyer and see the value fall by Wednesday.

“I’m not sure you’ll see a whole lot of platforms accepting bitcoin without transferring it immediately [to cash] because of the volatility,” agrees James Nagle, co-founder and chief technology officer of Bitcove, a brokerage that allows clients transfer cryptocurrencies into euro and vice versa.

That said, Nagle adds that we’re seeing a “maturing of the industry” with more traditional investors involved.

“I think big swings will start to decrease and it’ll become more stable,” he adds.

And assuming stability does occur, there’s no doubt that bitcoin has its uses - in the area of swift transfer of money.

“You can fly a human being to Sydney faster than you can transfer fiat money government issued currency to someone in Sydney and that fundamentally speaks of the old world,” says Savage.

In an increasingly globalised world, there’s a greater need to ensure that money can be swiftly transferred from one country to another. Cryptocurrencies, which are in effect global currencies, do go some way to solving that problem, although the problem is by no means fixed, given the price gyrations of the currencies involved and the often high transaction costs.

In any event, Quinn suspects that the banking industry could catch up, although “if the banking system stays in the dark ages, then bitcoin has a place and it may take over”.

Blockchain

The underlying technology behind bitcoin, and other cryptocurrencies, is clearly a promising innovation.

Blockchain, as Swiss-bank UBS explained in a 2017 research report, is a “distributed database which is shared and continuously reconciled”. “Traditional databases are run on a masterreplica architecture where a trusted party alone can update the master copy.”

Dull as that may sound, the security and cost efficiencies associated with the technology have the potential to upend many industries reliant on databases, not least finance. Despite bitcoin’s dominant position, challengers are coming up the rear. And they’re not just challenging bitcoin, but modern finance as a whole. Take Ethereum, for example, which the Bank of America analysts “see as more than bitcoin’s smaller sibling”.

In the past year alone, the price of Ethereum has appreciated more than 1,566 per cent. So is it the decentralised blockchain which doesn’t rely on banks or the wild price rises that has so interested investors?

Presumably the latter and, in fact, Bank of America suggests the absence of a centralised, regulated entity could even be part of the problem.

It gives the following example: “If a tech glitch caused my bank to send £1,000 to a random third party, they would not reply to my complaint with ‘that’s on you - you should have realised that our software would do that’, as a DeFi [decentralised finance] application might.

Instead, they would give me the money back. The point simply is that if you decentralise finance, you do away with a clear legal entity to complain about, regulate and sue.”

Even Quinn, who is lukewarm on cryptocurrencies at best, believes that transparent blockchain infrastructure is the future.

But, he adds, “the basis behind it and who controls it is the issue”.

That water has recently gotten murkier with the entrance of exchange traded funds - a type of security that tracks an asset. Quinn warns against cryptocurrency ETFs given their “exorbitant management fees”.

The case for investment

So, given all of these complex risks and tremendous price volatility, why are we all so enchanted with the cryptocurrency story?

Perhaps, posits Savage, because the story isn’t anywhere near completion.

“While the giants of the internet were not apparent in 1995 - because they didn’t exist - I think the giants of the cryptocurrency world may not have been born.”

Does that mean he’s at the point where he would recommend cryptocurrencies as an investment tool?

“I don’t have enough conviction for me to recommend other people do it, but I do believe there’s a movement and I don’t want to be the fool who missed it.”

With the prospect of bonanza profits, few of us are content sitting on the fence. But as Quinn explains, “for every guy that tells you about the huge win there has to be someone who made a huge loss”.

So what’s the answer?

“Don’t get seduced by the latest get rich quick scheme. Just get rich slowly”.

With the growing dominance of cryptocurrency coverage in financial media, and the tales of windfall gains, that might just be easier said than done.

The Top 1000 magazine and listings is published  on Friday 11th with The Irish Times.