Over the past 5 years, the world has begun to be inundated with news on the concept of cryptocurrencies. A new way to transact, invest, and conduct commerce in the modern age. It doesn’t matter where you hear about it, everyone seems to be intrigued and confused at the same time.
I remember vividly in 2016, starting to hear rumblings of Bitcoin climbing to new highs. From $300 to $600, the price of Bitcoin started climbing rapidly. Eric and I ran out over a weekend, bought a few books on understanding Crypto, and tried to get a decent baseline on how we could explain what we learned to our clients.
As we entered 2017, the market for cryptocurrencies exploded. We saw Bitcoin hit a new high of almost $20,000 and hundreds of new “alt-coins” came into existence. Every news channel, every media outlet, and every UBER driver was all sold on the concept and recommended it to anyone they could.
That seems like so long ago. When Bitcoin was on the backburner of our investment landscape. Today, as I write this, the price of Bitcoin is $56,363. Why is it that price? Who the heck knows.
I don’t want this post to be misconstrued as a recommendation for or against Bitcoin, but rather what I see when I really take a hard look at it.
Below, you will find an amazing chart from Gartner that explains the lifecycle of some new technology. It starts with a massive explosion of innovation, followed by a huge contraction in the market. Then, out of the crash, comes the slope of enlightenment and eventually some productivity from this technology.
I think about this chart often when you take a look at the smartphone industry. The original smartphone industry was the cellphone industry. Palm, Nokia, and Blackberry dominated the stage. As the technology shifted and the industry converted from cellphones to smartphones, the market crashed. Out of that crash came innovations from Apple and Google that restructured the entire market. This lead to immense productivity growth as almost everything can be done from the smartphone in your pocket.
I kind of look at this like Bitcoin today. Nobody really knows what will come from Bitcoin or cryptocurrencies in general. You hear every possibility because nobody is entirely sure. I’ve heard Bitcoin is the new gold, Bitcoin will replace the US Dollar as the reserve currency, Bitcoin protects against inflation, and Bitcoin is the best method of payment in the world. But, my question with any of these answers is what happens AFTER the Trough of Disillusionment. I think we have a LONG way to go before this really becomes something amazing.
What really intrigues me is not Bitcoin itself, but rather the blockchain that it’s built on. For those who are completely clueless about a blockchain, think of it simply as an accounting ledger. A digital record of transactions. If you still don’t understand it, check Investopedia’s write-up on Blockchain Explained.
Bitcoin is simply the means of exchange but the Blockchain is the platform that provides validity to the entire system. It records every purchase, every sale, and every transfer, in a publically visible fashion that is reviewed and verified by “Bitcoin miners”. Since the entire world is tracking this, you have thousands of these “miners” making sure each transaction is accounted for.
Think of this as your bank statement. Imagine if someone was paid a few cents to verify every charge on all your accounts. If we instead had thousands of individuals reviewing your account transactions, the likelihood of fraud goes down dramatically.
The Blockchain really has a lot of potential use cases. Just yesterday, a digital artwork was sold for $69,000,000. That price sounds absolutely insane but the concept of allowing artists to be compensated on every resell of their work is incredible. By using the Blockchain to track transactions and ownership, one commissioned piece can compensate an artist for a lifetime.
Could this technology be rolled into insurance claim verification, Social Security payments, home purchases, etc? I would assume that almost every industry is planning on using this concept in the future to help better track transactions like this.
So, here is where I see the value. Not so much on the existing blockchain networks but instead applying the concept of a blockchain to different aspects of the economy. Using this efficient blockchain accounting framework, we can streamline a lot of very old industries.
Bitcoin as Digital Gold
When I was a kid, I grew up playing video games. Even today, I still put some time aside for a mental break to play. The reason I bring this up, is most games have a digital economy inside of them. Whether the World of Warcraft, Fortnite, even Call of Duty, every platform has a micro-economy inside with some “digital currency” you can spend throughout the game. There are also gamers out there that have amassed a small fortune inside of these economies. Maybe these fortunes are irrelevant for most people today but this concept almost exactly mirrors the Bitcoin economy in my mind.
Bitcoin in my mind is a more confusing version of World of Warcraft gold. It’s limited in availability, it’s generally accepted by everyone “playing the game”, and it seems to be accepted as a means to transact business. All of those statements also hold true for World of Warcraft gold, or credit card reward points. It’s simply a means of commerce within a specific economy, and in this case, the digital economy.
Sure, arguments can be made about countries like Venezuela or Argentina, or corrupt governments around the world. Bitcoin may be a safer store of value for individuals living in those countries but wouldn’t US Dollars be a safer alternative? Some put their trust in Satoshi Nakamoto, a completely anonymous individual, but I’d prefer to put my wealth along with the US Federal Reserve. Even today, the Federal Reserve is working on a digital dollar to allow money to flow more easily in a new digital world.
I would also guess that 99% of people have no idea how to access Bitcoin on an actual blockchain. Yes, we can all download Coinbase and purchase Bitcoin but please try to explain to yourself how to actually access the Blockchain on your own. How am I supposed to trust the longevity and safety of a platform created by an unknown individual? For me, that’s a bit of a stretch I don’t want to make.
Know Your Risk
Finally, I’d like to bring this back to your own investment portfolio. Some clients prefer to have a more “bottle rocket” style portfolio. Take a bunch of bets, some go boom, some go bust, and hopefully, more go boom than bust. In these circumstances, we find a lot of high-risk investments on their books. From cutting-edge medical technologies to extremely new biotechnology therapies a lot of investments can seem like Bitcoin. In a sense, they are grand slam swings. We are either going to crush it and make massive returns or lose our entire bet.
This is how I would approach Bitcoin for investors. It’s a grand slam swing. You are either going to make a bunch of money or strikeout. Nobody really knows what this technology will or will not do. Half the pundits on the news pitching to buy Bitcoin, turn around and market their hedge fund charging investors massive fees to invest with them in Bitcoin. While the other half of pundits have no idea what Bitcoin actually is and argue against it. It’s a twisted world and you can’t rely on the news media for your investment recommendations.
My advice for investors is to understand their own risk tolerance.
If you are an investor that likes lighting your money on fire, then it won’t hurt to throw a little money at some new technology. If you are already doing this with biotech startups or other risky stocks, what’s a small exposure to Bitcoin going to hurt?
However, if you are not the investor that takes an excessive risk, you do not need to rush into anything. Take your time and let markets determine the effectiveness of this technology. The stock market has a great way of ironing out what technology works and what does not work overtime. As with the technology bubble in the 1990s, it took a strong crash to build the technology industry of the 2010s. This may hold true for cryptocurrencies as well.
Csenge Advisory Group, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, asset class, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.