I saved this note until today as a thought experiment even though much of the news on the subject has unfolded over the last few weeks. Circulating at various friend-and-family events through the holiday season I wanted to take inventory of how often Bitcoin and crypto-currencies in general came up since I am usually the “investment guy” in the room. The questions have run along the line of “Should I be getting into this?”, “Am I missing an opportunity?”, and “Are you guys in Bitcoin?”.
The short answers to those questions are no, no, and absolutely not. These market bubbles keep happening, but looking back into history this seems to have the least substance of any of them. At least during Tulip Mania you could end up with some nice perennial bulb flowers. Dot-com companies for the most part had actual businesses, even if many of them were terribly conceived and poorly executed. But with crypto-currencies, somebody wills it into existence out of nothing. One of the counter-arguments goes that the fiat currencies on which the world relies are similarly of no intrinsic value. But, the Euro, the Dollar, the Yen, etc. are backed by the full faith and credit of their issuing governments and citizenries. We can debate how meritorious that is, but it is at least something. Who stands behind Bitcoin?
For a currency to have utility and merit, it needs to be a viable medium of exchange. In the case of the crypto-currencies, their values have been extraordinarily volatile when translated into traditional fiat currencies (Bitcoin traded across a range in USD of $6,000 over the course of a week), which also presents challenges when trying to exchange this crypto-currency for goods and services. How useful is it as money if the price of a carton of milk or a piece of software or a shirt is wildly different from day to day and hour to hour? Now there are Wall Street derivatives trading on crypto-currencies and that provides little solace. Even the rigor and regulation of the derivative markets do not help much when the underlying is trafficked in a completely uncontrolled and unsupervised realm.
Scarcity does not in itself justify a rise in value. An ugly painting by an untalented artist will not go up in value just because there is only one. New crypto-currencies are propagating, so scarcity is not even an attribute. What we are observing is a lot of opportunism and profiteering, and the smart “money” will get out early. Pump-and-dump is an illegal practice in regulated markets and yet there is nothing protecting speculators in the world of crypto (read this Wiki and just substitute “crypto-currency” for “stock”).
In the WCM portfolios, we spend a lot of time wrestling with traditional currencies. Investing across borders requires us to have a view and decide if and how to manage the risk in putting our clients’ US Dollars into investments expressed in Euros, Yen, RMB, Pesos and Francs. That is part of the risk framework of our asset allocations and our benchmarks, and difficult even with all of the controls and supports in global currency markets. We do not engage in speculation even if there is fundamental underlying value in the investment, and certainly will not be putting client capital at risk on a picture of a tulip. Collective fantasy, even a Christmas fantasy, is not an investment thesis.