Previously I have disclosed that I do not own any positions in cryptocurrency, and I still do not intend to. That being said, I am not opposed to people owning it. However, I do enjoy the crypto investment thesis debate and enjoy poking the bear a bit.
Let’s debunk a few of the arguments as to why one should own Bitcoin.
Bitcoin is Scarce
Only 21 million Bitcoins will ever exist, it’s true. Even better for the scarcity argument is that estimates show about 20% of Bitcoin is lost and unrecoverable. It’s probably fair to say that on a long enough time horizon much more will be lost, as people will fail to do proper digital asset estate planning.
While Bitcoin is scarce, cryptocurrency is not. There are thousands of cryptocurrencies now in existence, and quite a number that also run on a SHA-256 hash algorithm like Bitcoin. At one point in history, Bitcoin did not exist. Man made Bitcoin. Man can make many more currencies, some of which may be improvements to Bitcoin. The scarcity argument does not hold much weight. Ray Dalio agrees with me.
In practical terms, scarcity is not a good attribute for a currency. Under our current monetary system, a bank creates deposits by facilitating a loan (and if they don’t have the reserves available they can go find them afterwards). If a bank could truly only lend out deposits on hand, we may run into trouble meeting loan demand and growing the economy.
The Federal Reserve can expand or contract the money supply by changing reserve requirements for banks, changing the discount rate, and engaging in open market operations (quantitative easing). Bitcoin, being finite, cannot react to money supply issues in the economy.
Bitcoin is a Store of Value
This one is hard to believe people can say with a straight face. Bitcoin fell about 50% during the COVID stock market crash in 2020, which wasn’t its first drop of such magnitude. It fell well over 80% from the end of 2017 through the start of 2019. Yes even if you bought it in 2017 you’d be well ahead today, but it does not come with the day to day price stability of a dollar.
What I believe they mean is that Bitcoin will not be subject to losing purchasing power due to inflation. While it is true that the purchasing power of a dollar has lost over 99% since the Federal Reserve Bank was created in 1913, it is undeniable that all levels of household income are living in better conditions today than in 1913. The world has progressed forward tremendously despite inflation.
The concentration of wealth is a real issue today, but just imagine the concentration of wealth if you had a fixed money supply. This article from Bloomberg in 2020 showed 2% of anonymous ownership accounts control 95% of the digital asset.
The Blockchain and Decentralization is The Future
The blockchain framework is very compelling and could disrupt many industries that exist. Imagine if the title to your house or car was verified on the blockchain, and you wanted to transfer ownership to someone else in exchange for currency. They receive the title in their crypto wallet, you receive the currency. Transaction complete, and verified. Goodbye title company (and title insurance!). The blockchain could disrupt many industries, such as stock exchanges, cloud storage, and banking etc.
BUT, there are significant scalability issues when it comes to the blockchain. Ignore the fact for now that Bitcoin miners consume as much energy as the entire country of Chile. Bitcoin can only process 3.3 to 7 transactions per second, and Visa (a centralized authority) can process 24,000. People are trying to solve this problem, but some of the solutions come with another step towards centralization.
What Should Bitcoin be Worth?
This is my question, and why I have never invested in it. I have never seen a valuation argument for Bitcoin that made sense, and why it should really be worth anything at all. Value is in the eyes of the beholder I suppose, and whether Bitcoin traded at $100 or $100,000 I wouldn’t know which price is closer to the fair value, nor how I would expect it to change over time. Therefore, I do not own it. This is also why I do not own gold.
It’s easier to know that stocks should be worth something. Apple for example produces $55 billion in annual net income. It it were trading at a market valuation of $100, you could buy the entire company and enrich yourself with tens of billions in profits each year. Non-income producing assets are a bit harder to value.
Speaking of non-income producing assets, let’s discuss the recent market mania!
By now most of you have heard about the Gamestop mania, which seemed to have fizzled out the first week of February. Since 2011, Gamestop’s revenue has declined over 30%, operating income declined over 50%, yet the stock reached an all time high of $483 per share on January 28th. This far surpassed the previous high reached in 2007…….of $62. Today it is roughly $52 (still up 300%+ on the year).
Since the market drop last March due to COVID economic shutdowns, there seems to have been a dramatic increase in market speculation. There are plenty of theories as to why, such as the loss of interest in sports has led more gamblers to trade stocks and options. The founder of Barstool Sports (Dave Portnoy) regularly streamed his day trading sessions last summer to his 2 million+ followers, routinely touting that “stocks only go up”.
You begin to wonder how much thoughtful analysis is going into these investment decisions, and how much of it is just pure gambling.
On May 1, 2020 Elon Musk tweeted that Tesla’s stock price was “too high” at the moment. Since then, it has risen over 550%. One business owner friend of mine told me and employee of his received a stimulus check they didn’t need so they bought Tesla stock with it. There are many anecdotal examples of strange market behavior. This chart of the Goldman Sachs Non-Profitable Technology stock index has been making the rounds.
Gamestop was one of the most shorted stocks on the market before it’s run up. A group of Reddit posters (WallStreetBets) decided to band together and go long on Gamestop, and as word started to spread and more people got in, the price went bananas. Hedge fund, Melvin Capital, reported losing over 53% in January as they had a large short position in Gamestop (which has now been covered).
Suddenly the kid that I lent a pen to 16 years ago in high school math class was texting me to ask if he should buy Gamestop. No you shouldn’t, and where is my pen?
The Bizarro Robin Hood
Robin Hood was known for stealing from the rich to give to the poor. The brokerage firm named after the folklore hero is irony in the purest form. Robinhood was the first online brokerage firm I had heard of that offered “free” trading. The reason trades are free, is because the retail trading crowd is Robinhood’s product. The customers are high frequency trading firms like Citadel or Virtu financial, and they pay Robinhood a nice sum for order flow.
Robinhood actually paid a $65 million fine in December to the SEC for failing to disclose its business deals with high-speed trading firms.
Robinhood is not the only firm that does this. Now that all major brokerage firms offer “free” trading, they all receive payment for order flow. BUT, Robinhood received nearly 3 times more in payment for order flow in the first half of 2020 than Charles Schwab, despite Schwab having over $3 trillion in assets compared to Robinhood’s $20 billion.
Robinhood has tried to turn investing into a video game. They encourage using margin and option trading, both of which most investors should steer clear of unless they have extensive experience in financial markets.
It is an established fact that in the aggregate all investors must earn the market return minus costs. For everyone that outperforms there must be someone who underperforms by an equal amount. And if you don’t know who the sucker at the poker table is…….