Bitcoin - why now is not the time to invest

John Wyn-Evans, Head of Investment Strategy at Investec Wealth & Investment, discusses why the hype around bitcoin should be tuned out 

All the ingredients for life on earth were available in the primordial soup, but it took some unknown catalyst to create the right combinations. Similarly, all the technology to enable cryptocurrencies was around from the 1990s, but it took the financial crisis to provide the impetus required for Satoshi Nakamoto, whoever (s)he might be, to launch Bitcoin in early 2009. Like all good manias, the enthusiasm for Bitcoin has credible roots.

Bitcoin was born out of the chaos of the financial crisis. With banks going bust, the global financial system seizing up and no counterparty deemed reliable, an alternative currency suddenly had real attractions.

Crucially, it was a currency that could live in its own closed system, using the blockchain distributed ledger technology to authenticate and record transactions made over the internet. It was free from government interference and bypassed the traditional banking system.

Not surprisingly, it initially attracted technology geeks and those of a more anarchic bent, but was quickly adopted by more criminal elements, not least through the Silk Road website, a hub for drug dealing. The Silk Road site’s founder currently languishes in a US prison, sentenced for life with no possibility of parole.

Be that as it may, and despite the ongoing attentions of regulators, Bitcoin has continued to flourish and has spawned a raft of other alternative currencies. At the last count there are more than 1,100 of them, some quite large (Ethereum, Ripple, Litecoin), and many very small.

It is this proliferation of alternative alternatives that is in many ways the most disturbing aspect of the story. It seems inevitable that even if an alternative currency system gains greater traction, only a minority of these upstarts can feasibly survive. It is possible that they could all be acquired for Bitcoins, but it’s more probable that they will be worthless. And there is no impediment to issuing these things through what are known as Initial Coin Offerings (ICOs), which lends them a spurious air of respectability.

Initial Coin Offerings have recently been under scrutiny from the FCA, who described them as “very high-risk, speculative investments.”

The key characteristics of a currency are to be a “store of value” and a “medium of exchange”. On August 21 this year, the price of bitcoin was $3,997. It has since briefly been over $5,000, and last week Friday (August 15) traded in a range between $2,975 and $3,842. That’s difficult to describe as a store of value, and it doesn’t have any sort of yield attached to it, so it’s impossible to value on that basis.

Unless you “mine” your own bitcoins, an activity that takes huge amounts of computing power and energy to extract anything meaningful, you have to buy and sell Bitcoin through an exchange of some sort, and this is the weak link in the system – the so-called “trusted third party”. As was seen, most notably in the hacking of the Mt Gox exchange, when half a billion dollars’ worth of Bitcoins just disappeared, owning Bitcoin is not necessarily risk-free.

 

So who has been buying Bitcoin?

As mentioned, it was initially computer geeks who liked the idea of getting in on the ground floor of a subversive concept.

The big buyers in 2015 and 2016 were the Chinese, as money flooded out of the country when the currency was devaluing. As the government tried to close the official floodgates, the easiest route out was on-line.

Canny Japanese housewives, sometimes described collectively as the world’s biggest currency hedge fund, also latched onto the trade.

Bitcoin is also the currency of choice to subscribe to the afore-mentioned ICOs, which could sound like a pyramid scheme of sorts.

Then the FOMO crowd arrived. If there is one guarantor of speculative mania, it is the Fear Of Missing Out (FOMO), and this is stoked by “clickbait” advertising on otherwise respectable websites.

One advert had the attention-grabbing headline “Kid from Luton becomes a millionaire after buying Bitcoin”, but after clicking through it, there is no mention of the lucky lad, but plenty of exhortations to buy Bitcoin which led to a website where you could unload your hard-earned pounds and buy some Bitcoin. Given the UK consumer’s propensity for on-line shopping, why not stick a few Bitcoin in the cart?

It is understandable why people might want to buy bitcoin as an option against the tail-risk of cryptocurrencies becoming the norm – even if governments, central banks and banks are going to fight it tooth and nail.

A misdirected nuke from Kim Jong-un could be the catalyst. But it is certainly not an asset class in its own right, as some of the more over-excited supporters claim.

Investec has no current intention of adding it to client portfolios, however, it is up to the individual to decide what to do on their own account.

It is inevitable that there will be more stories about people who have made a fortune from bitcoin, just as one hears of people who bought Apple or Amazon for peanuts.

Do you feel visceral regret at having missed those opportunities, and would you have bet the farm on them? I think not.

 

Bitcoin facts:

1. The creator(s) of Bitcoin goes under the pseudonym Satoshi Nakamoto, and is believed to own bitcoins worth around $4.7 billion

2. 5 million bitcoin are believed to be currently in circulation

3. 64 % of bitcoins have never been used

4. Blockchain, the bitcoin wallet, raised $40 million from Google ventures and Richard Branson

5. Bitcoin transactions are measured in Satoshi’s. 1 Satoshi is equivalent to 0.00000001 bitcoin

6. The FBI owns 1.5 % of the world’s bitcoins

7. The first big bitcoin acquisition was SatoshiDice in 2013, with 126,315 bitcoins

8. The Chinese mining pool, Antpool, mined around 20% of all blocks between 2016 and 2017.

9. The 4000^th bitcoin was donated to Wikileaks in 2016

10. Bitcoin has been an accepted form of payment in Japan since April this year.

11. University of Nicosia, Cyprus, was the first university in the world to accept tuition fees in bitcoin.

12. Microsoft, Dell, Expedia and Overstock all accept payment in bitcoin.

13. Falcon, a Swiss private bank, was the first bank to sell bitcoin to its clients

14. Finland, Belgium and Switzerland have made bitcoin exempt from VAT

15. Bitcoin is illegal in Saudi Arabia, Bolivia, Kyrgyzstan, Ecuador and Bangladesh

 

 

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