If you’d purchased a $6 sandwich yesterday at 8 am CST, it would have cost you approximately 0.00051 BTC (whatever that is in units). The same $6 sandwich at 12:40 pm would have cost you about 0.00067 BTC (again, units?). That’s 31.37% inflation in 4 hours and 40 minutes. Food for thought. (Pun intended.)
I’ve had multiple questions from clients lately about Bitcoin. So, I decided that this week’s Insight would cover the topic. The most common question I get is “Are you buying Bitcoin?” or the rephrased question “Should I buy Bitcoin?” The answers are “no” and “probably not.” As a Registered Investment Advisor, I am a fiduciary to my clients. This means that I have a legal obligation to act in my clients’ best interest. Besides the question of suitability of an investment there’s also just the question of whether or not it’s a good investment in general. At this time I do not regard Bitcoin as a good investment. You may argue that I’m missing out on an opportunity for upside.
Cryptocurrencies such as Bitcoin look to be a very short-term play. I don’t do short term. I use the longest view possible when selecting investment strategies. That doesn’t mean I believe cryptocurrencies are going away. I think that there’s a place for them and they’re probably here to stay. But, this is the beginning, and in the beginning, there’s always a lot more risk and a lot more uncertainty. I’ll let someone else play in those waves.
Think about it like this: Do you remember when pretty much every computer ran Netscape Navigator? Where’d it go? As with most areas of innovation, there usually emerges a strong front runner and then follows strong competition. Bitcoin is just starting to get some competition from other cryptocurrencies. At this time, no one can say with certainty that Bitcoin will remain the frontrunner. However, the infrastructure has emerged to facilitate transactions using cryptocurrencies, and it’s getting stronger every day.
Besides the lack of certainty around which cryptocurrency will emerge as the standard in the future is the issue of currencies themselves. Prior to cryptocurrencies, people have mostly transacted in and traded in the currencies of different countries or economic zones. What do I know about this? Well, I have a Masters Degree in International Relations, and the focus of my studies was on finance, trade and monetary policies. All governments engage in both fiscal policy and monetary policy. Fiscal policy includes taxes and budgets. Monetary policy includes currency (like the US Dollar) and debt (government issued bonds such as Treasuries). Bitcoin has no government, and this could be good, but is more likely to be bad in the shorter term. Let’s first cover how currencies relate to each other, and then talk about what could happen to Bitcoin.
When we talk about currencies and their strength or weakness (their values), we talk about them in relative terms. For example, you may have heard discussions about a stronger US Dollar. That would mean that the US Dollar can be exchanged for a greater amount of another currency, and usually a statement about a sweeping stronger US Dollar refers to its strength against multiple other major world currencies. I’m going to start by giving you an illustration.
My husband and I lived in the UK from October 2006 to December 2009 (we brought another human back to the US with us). When we first moved to England, the GBP (British Pound) was worth about 1.83 USD (US Dollars). So, if we had $10,000 in savings in USD, and we converted that to a GBP savings account without any exchange fees, we’d have had about 5,465 GBP. That’s 10,000 divided by 1.83. At one point, the GBP reached over 2 USD. I can’t remember the exact exchange rate, but I think it was something like 2.05 USD to 1 GBP. If we’d come home at that point and exchanged our savings account for one in USD without any exchange fees, we’d have had about 11,203 USD. That’s 5,465 x 2.05. However, by the time we left, the exchange rate was about 1.76 USD to 1 GBP. 5,465 x 1.76 equals 9,618.40. We would have lost money on our savings, assuming it had not earned any interest paid by the bank to the savings account (it wouldn’t have earned enough to make up for the difference while we were there). These values fluctuated over a period of roughly 39 months, just a little over three years. That would have been a 12.03% gain if we’d left when the exchange rate was at 2.05 USD, but since we left when the exchange rate was 1.76 USD, we would have actually had a loss of 3.8%.
Let’s now consider Bitcoin. Bitcoin is a currency, so its value is relative, and it changes based on values of both the dollar or the other currency you’re converting and the value of Bitcoin itself. That is, the changing strength of the USD and the changing strength of Bitcoin will affect the price you’ll pay or receive to buy or sell Bitcoin. If you were purchasing Bitcoin from the UK, you’d be subject to the effects of changes in the relative strength of the GBP and the relative strength of Bitcoin. Bitcoin’s values change much more quickly. 1 Bitcoin was worth 8,204.60 USD at 5 pm last Friday, November 24, 2017. Monday, it was worth 9,728.80. Today is Thursday, November 30, 2017. In less than a week, Bitcoin’s “strength” (not price) surged to a high of 11,427.17 during trading yesterday, November 29, 2017, and dropped back down to 9,001.10 at it’s lowest point during the same day. Let’s say we bought Bitcoin on Monday using our 10,000 USD. We’d have received 1.03 Bitcoin. Now, let’s assume that an emergency came up and we just had to sell our Bitcoin yesterday. It would have been tough because the exchanges that support it went down. But, If we’d managed to sell it at the high (at around 8 am Central) we’d have ended up with $11,769.99. However, if the problems on the exchange had led us to miss the top, or if we’d waited for our lunch break, and we’d sold at about 12:40 pm CST (4 hours and 40 minutes later) we’d have ended up with about $9,271.07. So, you could have had a 17.7% gain since Monday or a 7.3% loss since Monday, depending on whether you sold while you were having your morning coffee at the office or on your lunch break. That’s three days holding period, and a difference in choosing to sell in the morning or at lunch. It’s not three years. That’s instability. Anyone who hit the mark on that gain did it out of pure luck. That’s all there was to it. No one could predict those swings, unless he or she caused them . . . More on that later.
There are a lot of contributing factors to the instability. You may recall that I’ve covered price drivers in a previous post. Buying and selling alone will drive prices up and down. If a lot of people are getting in and demanding to buy, then those who hold the cryptocurrency can offer their shares at a higher price because demand is driving the prices. If a lot of people suddenly freak out because it’s moving down, or some bad headline comes out and they all want to sell, then a lot of supply of the cryptocurrency will hit the market causing the people to offer to sell their Bitcoin at a lower price to make it more attractive to would-be buyers.
Something similar happens with regular currencies and the outcome can be seen in the form of changing domestic and international buying power. That is, inflation or deflation (domestic), trade surpluses or deficits (international), and even in travel (as people choose to go to places where they can stretch their vacation budget based on exchange rates). If a country wishes to devalue its currency, that country might print money and release it to the open market, or buy back its own bonds. If a country wishes to increase the value of its currency, that country might choose to pull money from the open market, and could do so by selling bonds or exercising some other monetary option. When simplified, it’s like supply and demand. China gets accused a lot of currency manipulation, but in America, we are guilty too. Some countries do it to offset trade deficits. And, some countries buy up currencies of their major trading partners in order to have reserves at a specific exchange rate to offset less desirable exchange rates down the road. China owns a lot of US Dollars, and if they wanted, could exercise what some call the “nuclear option” by selling their US Dollar reserves in the open market, causing the US Dollar to fall in relative strength versus other currencies rapidly. This could also cause a rapid rise in inflation domestically in the US. China does not have the motivation to do this because they value the trade relationship with the US since we consume their goods; and, exercising this nuclear option would prevent us from being able to continue to buy Chinese goods.
A rapid rise in inflation of a currency is called hyperinflation, and has been seen in many countries where government has exercised poor judgement in monetary policy. For example, Zimbabwe exercised poor judgement over many years, printing money to try to combat economic problems. They printed money to try to pay for obligations and as a result had inflation numbering in billions percent over very small increments of time. Yes, billions %. Think about the numbers we use for average inflation in the US: 2.5%, 3%? That should put it into perspective. They even printed 100 billion Zimbabwe Dollar bills. When inflation outpaces economic growth by even a little bit it will cause people to suffer, but this caused a crisis.
Currently, there are 21 million Bitcoins outstanding. There are several things that could cause the value of Bitcoin to plummet. One of them would be if one person or group of people who owned a lot of Bitcoin decided to exercise a “nuclear option,” selling massive amounts of it in a very short period of time. Or, if the creator(s) of Bitcoin decided to suddenly make more available. (Note: It would still have to be “mined” but I’m not going to go into Bitcoin “mining” in this paper.) There are other factors too, but I want to just focus on these two.
Bitcoin was created by an unknown entity. The only name for the entity is Satoshi Nakamoto. No one knows if that’s Mr. Nakamoto, Miss Nakamoto, Mrs., Ms., a non-binary gender pronoun, the Nakamotos . . . or maybe the plural of Nakamoto is Nakamoto. It could be an organization or an individual. Lots of mystery. I think that’s part of what people find sexy about Bitcoin, besides feeling like they’re Keanu in The Matrix . . . Bitcoin is not run by a government entity. So, in the event of the collapse of part of the world’s financial system, some people feel that having a currency that isn’t tied to a government would be of value and would allow them to still transact business, assuming the internet stays on when the banks turn off. Think about it like digital gold bullion. In fact, some doomsday prepper-types have started buying it, which is just crazy to me.
Bitcoin has also gained in credibility as companies have emerged to create infrastructure for it. You can even use Bitcoin to by a sandwich or pay rent if you are at the right sandwich shop or have a landlord who accepts Bitcoin. If Bitcoin (BTC) is hovering around a value of 9,000, then no, it wouldn’t cost you $9000+ to buy something off the dollar menu. It would cost you 0.0001111111 BTC, or something like that. Think about it like Bitcoin and Bitcoin cents, except the units are similar to the metric system. It uses prefixes like deci-, centi-, milli-, and micro-. When you get down into very small denominations they’re usually referred to as bits, and really very small ones are “Satoshi.” Cute. I don’t know the exact denominations at which these become bits or Satoshi or how to abbreviate the units. Nor do I care. I don’t need to know. I’m not going to use them. All I need to know is that they have a lot of decimal places.
Let’s say though, that someone manages to buy up a substantial portion of the supply of Bitcoin and just hold on to it for a while. Bitcoin is not really regulated. There’s nothing to stop them from doing it and nothing to require reporting ownership of it (sort of, except for tax purposes in the US and only for some users). This hypothetical person is an activist with a bad agenda, or just an asshole. Suddenly, after some time, major Bitcoin owner-activist decides to dump tons of Bitcoin all over the cryptocurrency markets, causing the value to plummet. We need to do some calculations and comparisons. Then, we’ll return to this person dumping their BTCs.
There are over 16.7 million Bitcoin currently in circulation. (There are 21 million total available. The others still have to be “mined” or could be lost in the World Wide Web. Yes, that’s a thing.) Let’s just say it’s worth 9,000. It’s up. It’s down. It’s all over the place. But, let’s just use 9,000. 16,700,000 x 9,000 = 150.3 billion US Dollars-worth of BTC being traded, Give or take a $10-$20 billion since the price fluctuates so much. Let’s just say $150 billion for the sake of round numbers. Trust me, we need them for the next part.
From top to bottom in the Global Financial Crisis, 2007-2009, during which time the idea of Bitcoin was conceived, the US Stock Market lost a little more than half its value. Let’s just call it 50%. If the asshole activist or whomever, decided to dump a ton of Bitcoin on the market, and the unregulated cryptocurrency fell by 50%, it would happen more rapidly than it did with stocks. It could happen in a day or a matter of days. That would wipe out $75 billion (that’s US dollars) of wealth. That’s not that much when you think about global markets on the whole and all the other things people trade. However, to put it into perspective, the World Bank issues an annual report of the GDPs of 214 economies. Only 65 of 214 countries had a GDP higher than $75 billion in 2016. So, there’s that.
Once that happens, there will be global talks about regulating and monitoring Bitcoin. Trust me. And, a lot of people will be mad about it because that’s part of what they like so much about Bitcoin in the first place, it’s unregulated and isn’t tied to any country’s policies.
In a rapidly integrating digital, global economy, there’s certainly a place for Bitcoin or cryptocurrencies. However, its relative instability does not make it attractive to me right now. So much irrational buying surrounds the currency that a concept called the Satoshi Cycle has been developed, and it says that Bitcoin’s price is highly correlated to its search popularity on Google. I haven’t researched it. I’ve only heard about it. However, I did find this article that says “Bitcoin” has officially surpassed “Kardashian” in popularity in online searches.
