We continue to receive numerous inquiries regarding Bitcoin and other crypto-currencies and we have cautiously decided to share our thoughts with you on the subject.
In terms of what Bitcoin is, it is an alternative and 100% digital form of currency whose appeal is that it is not backed by any government and therefore lies outside the manipulation, regulation or trace of any sovereign entity. It is not the only crypto-currency out there, but it is the largest by size and therefore garners the majority of headlines. Bitcoins are “mined” via a computer through a series of complex computations. These grow progressively more difficult to solve the closer you get to the terminal number of Bitcoins, which in its case is approximately 21 million coins.
Just as physical gold miners may find it more difficult to find the next ounce of gold in the mine, Bitcoin miners face the same scarcity value of obtaining future coins. This is perhaps the most ingenious aspect of the Bitcoin’s architecture and is an aspect that champions of the crypto-currency stress as a critical differentiator and potential hedge versus fiat currencies, which can be inflated and devalued by governments and monetary policies.
While there has been widespread focus on the price of Bitcoin and other cryptos, many believe the real breakthrough with digital currencies is the underlying technology, known as blockchain. In its simplest explanation, blockchain technology is a distributed ledger that uses the power of peer to peer computing to track, record and settle digital currency based transactions all over the world and without the requirement of a dedicated network. This open architecture aspect is what many believe is the most powerful and commercially scalable aspect of digital currencies and blockchain in particular. This potential is not lost on the world’s largest financial institutions and technology companies who are actively evaluating the underlying blockchain technology itself for their own use and commercial development.
In terms of how far Bitcoin and other digital currencies can go, the chart shown below puts the current Bitcoin frenzy into historical perspective relative to other famous bubbles. Note the chart is a few months old given the fast-paced pricing environment for Bitcoin, but as you can see, it ranks amongst the highest speculations of all time.
Bitcoin and Past Financial Bubbles
Nevertheless, despite rational, fundamental analysis of the risks associated with Bitcoin, it could still go higher, fueled “by the perfect intersection of ambiguity and animal spirits,” as Robert Shiller described in an article in the New York Times.
The ambiguity, in this case, refers to the uncertain, fundamental value of Bitcoin itself. In contrast to Bitcoin, the value of a company’s stock is essentially the present value of its future cash flows. Within reason, this value can be approximated given assumptions about the business’ future growth, risk and prevailing interest rates. However, neither Bitcoin nor gold, as it is often compared, produce cash flows, or anything else of an operating nature for that matter. Therefore, the value is less certain beyond what the next person in line is willing to pay for it.
When animal spirits take over in an ambiguously valued asset with ingeniously designed scarcity value, there is no telling how high or how far the price will go before the music stops. Eventually, though, it does stop because either the next buyer in line will simply not materialize, or in Bitcoin’s case, governments decide to change the rules of the game in order to protect their interests, such as economic control and taxing authority.
As an additional visual reference, the following is a chart from Hartford Funds overlaying Bitcoin on the classic bubble pattern.
Financial Bubble Pattern
Maybe this time is different and crypto-currencies will escape the fate of past bubbles in terms of price, but we view this as unlikely. Recall that while Bitcoin itself has limitations on the number of coins that can be produced, there is no limitation on the number of crypto currencies themselves that can be launched, which can lead to an oversupply of issues similar to the deluge of new issues that ultimately contributed to the popping of the Internet bubble. The underlying blockchain technology, on the other hand, appears to have an enduring set of potential applications that bears close monitoring.
In closing, without a fundamental way to value the asset, it is virtually impossible to make a recommendation as to whether you should buy or sell Bitcoin or any other crypto currency. The one advice we will give you is that these bubble-like situations typically end badly for late adopters or for those who stick around too long. We would recommend treating any possible capital you are considering committing to digital currencies as pure speculation and as money that you are prepared to lose (potentially all of).
Additionally, if you do choose to speculate, it is imperative to find somebody who can help you with the safekeeping of your digital assets. Unlike gold or cash and securities stored in a regulated institution, Bitcoin and other crypto-currencies exist precisely to remain outside the reach of government, so you are largely without recourse at this point should anything go awry with the custody of your asset.
We hope this was helpful and if you have any additional questions, please feel free to contact your Ancora representative.