Cryptocurrencies: Buy or Buyer Beware?

By Tim Courtney, Chief Investment Officer

Cryptocurrencies have been making headlines again, especially after Tesla’s announcement that it bought $1.5 billion worth of bitcoin and has plans to soon accept the digital currency as payment for its vehicles. This sent bitcoin skyrocketing to $48,000 for the first time ever.¹ We also noticed a survey that asked people what they plan to do with their next government stimulus check, and investing in cryptocurrencies made the list.²

We’ve reviewed cryptocurrencies before but thought now would be a good time to review some basic considerations for this relatively new asset class.

• We classify cryptocurrencies as speculative assets. This is contrasted by investment assets, which create future cash flows like a stock, and use assets, which have some utility like a home. Speculative assets create no cash flows and have little or no utility. Their prices are determined solely by supply and demand. We all own at least some of these assets, which may include the U.S. dollar and other currencies, fine art and antiquities, diamonds and jewelry, and collectibles.³ We also place gold in this category. While gold and cryptocurrency are considered alternatives to common currency, gold obviously has a much longer history of acceptance and does have some industrial applications.

• Cryptocurrencies are not yet viable as money. Money serves as a unit of account, a store of value and a medium of exchange. Because of its high volatility and sporadic acceptance as a payment for goods and services, cryptocurrencies cannot yet function as money.⁴ Some companies have decided to hold some of their assets as cryptocurrencies. High price volatility ensures that for now, most parties will think twice before using cryptocurrency to settle a transaction without properly hedging that risk.

• Blockchain technology may improve and have multiple uses aside from cryptocurrencies. Bitcoin’s creator, known as Satoshi Nakamoto, intended for anyone in the world to open a digital account and hold the cryptocurrency without government intervention. This is done using bitcoin’s blockchain database. Two downsides to this are that it takes a large amount of energy per transaction to keep the blockchain running, and there is no institution to store passwords and send you an email to help you recover it if lost. You may have heard of Stefan Thomas, the crypto investor who only has two more password guesses to recover his wallet containing over $200 million in bitcoin. It’s estimated that roughly 20% of all bitcoin ever mined has been lost to human error.⁵ Future blockchain creators will learn from these problems and may create better blockchains for cryptocurrencies and other database applications.

• Cryptocurrencies attempt to offer owners an easily transferable store of value. While we normally read about the spectacular appreciation of some of these assets, their actual selling point is that they allow individuals to more easily store and efficiently transfer value, especially for those who don’t have traditional bank accounts or live in countries without stable currencies. This, coupled with the fact that many cryptocurrencies have a limited supply (there is no limit on the number of cryptocurrencies – currently there are over 4,000)⁶, may make them a viable asset to hold. However, mainline institutions will also have a say in this. It is the Federal Reserve’s job to maintain the supply of U.S. dollars, and we’ll see if U.S. dollar holders keep their confidence in the Fed’s ability to do this responsibly.⁷ Banks may also come up with better solutions and more efficient ways to transfer value. Nearly all of us use digital currency already in the form of electronic payments and bank deposits.

It is not clear at this point how all of this will play out. There are also likely future regulatory hurdles. The state of New York, for example, is currently looking into potential trading issues with the cryptocurrency Tether in relation to bitcoin pricing.⁸ As such, we recommend proceeding with caution and are not ready to hold these in our portfolios.

Outside of owning these directly, there are few good ways to get exposure currently. There are some daily tradable tickers that investors can use, though these can be priced at fairly large discounts or premiums to the underlying cryptocurrency price. There are some funds that are priced without discounts or premiums but may require minimum balances and for the investor to meet certain criteria. It is likely that more solutions will become available to meet demand.

We’ll continue to closely monitor the space and adjust our investment strategy accordingly. If you have any questions, please contact your Exencial advisor.

Sources:

1. MarketWatch (2/9/21) – Bitcoin blows past $45,000 and reaches as high as $48,000, driven by Tesla’s investment
2. Bloomberg (1/5/21) – Stocks, bitcoin and more: Unusual ways Americans are planning to use their $600 ‘stimmy’
3. Investopedia (12/28/20) – Speculation
4. Investopedia (6/16/20) – Why Bitcoin has a volatile value
5. The New York Times (1/12/21) – Lost passwords lock millionaires out of their Bitcoin fortunes
6. CoinMarketCap (2/10/21) – All cryptocurrencies
7. Investopedia (9/22/20) – Understanding how the Federal Reserve creates money
8. The Financial Times (1/26/21) – New York’s investigation of cryptocurrency Tether hits fresh delay

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