Bitcoin and its ilk? Opportunity or value trap?
There will be blood on the floor when the crypto mania ends.
It was summer of 2009 when someone using the name “Satoshi Nakamoto” released an open source paper on a peer-to-peer payment system using what is now referred to as “blockchain”, and created the first “Bitcoin”. The idea was elegant in its simplicity and a flood of pundits spent their days trying to identify who was the real “Satoshi Nakamoto”. In the 12 years since, Bitcoin has rocketed in trading price and a sea of copy cat “cryptocurrencies” have emerged with names like “Ethereum” “Dogecoin” “Litecoin” and “Ripple” each touted to “explode” in “value” and precipitating a gold rush into “cryptocurrencies”.
Wall Street has climbed on to the bandwagon, creating Exchange Traded Funds (ETF’s) that are designed to parallel the “peformance” of one or more cryptocurrencies. Fortunes have been made and lost betting on these “assets”. Never mind the fact that any gain comes at the expense of someone else’s loss and that the so-called cryptocurrencies are backed by nothing, not even the “full faith and credit” of a sovereign whose fiat currency has any value.
The number of cryptocurrencies that have evolved is evidence of an important factor in the valuation of any new technology - ease of entry and ability to copy. Basically any high schooler with a basic knowledge of computing can create their own “cryptocurrency”. Any technology so readily copied ultimately has an actual value that decays to zero over time as the number of viable copies approaches infinity or any large number for that matter.
That is not to say no one has made any money. Purchasers of the original Bitcoin’s have seen the trading price of their Bitcoins rise spectacularly with the current price over $47,000 U.S. There are a handful of “Bitcoin billionaires”.
Fortunes have not only been made but also lost, since the purchases and sales of Bitcoins are a truly “zero-sum” gain with the last man standing exposed to the risk of the cumulative gains enjoyed by all former owners. This is a striking example of the “greater fool” theory of investment. The Bitcoin has value only to the extent someone is willing to buy it. When the game of musical chairs ends, there will be blood on the floor.
Bitcoin is touted for two claimed benefits - security and anonymity. Security is a myth. Every purchase of a Bitcoin (or any other cryptocurrency) requires the buyer to pay real money to an “exchange” and to eventually use the Bitcoin to purchase real goods (like groceries, gasoline, cars, homes, furniture, etc.) requires another transaction with an exchange (or finding a vendor willing to take on the risk of the cryptocurrency). I haven’t seen any grocery stores, drug stores, furniture outlets, or car dealerships lining up to receive payment in Bitcoins, but I am sure there are some somewhere. Notwithstanding, both trips to an “exchange” expose the customer to a transaction risk at least as dangerous as using Visa, Mastercard or Interac, but without the fraud guarantee issuers of those payment cards routinely provide their users.
Bitcoin exchanges have failed or been used for fraud with billions of dollars of losses in their wake and the volatility of Bitcoin prices has seen losses of over $1 trillion according to Bloomberg. I have never lost a dollar owing to a fraud on my credit card, debit card or bank or brokerage accounts at a major Canadian bank. The claim of cryptocurrency “security” is nonsense.
Anonymity is another benefit claimed for cryptocurrencies, but that too is specious. The trips to and from the “exchanges” can be tracked and once the beginning and end points are known, the entire “blockchain” is hoist on its own petard of end-to-end verification. While cryptocurrencies have been used for criminal activities based on the belief the transactions will be anonymous, it was only a matter of time before authorities discovered how to use the blockchains to identify the parties to the transactions. A minor cyber war is underway as cryptocurrency promoters seek ways to make their transactions anonymous and authorities seek ways to ensure they are not.
The mania for cryptocurrencies is far from over and will continue to make headlines as the price volatility of each such “currency” sees millions made and lost on a daily basis. Top finance authorities such as JP Morgan CEO Jamie Dimond and famed investor Warren Buffett mince no words in describing cryptocurrency risks and describing them as worthless or in the case of Buffett as “rat poison”.
Every now and then, millions of investors are captured by an idea that sees valuations race to extraordinary levels. The “dot.com” bubble of about the year 2000 saw prices of stocks with little more than a name ending in “.com” and one or two patents valued at billions only to fall from grace with many losing their fortunes on the trade as the NASDAQ index comprising many of those stocks fell 75% in a few months.
Cryptocurrencies have the same characteristics and in my opinion will suffer the same consequences. I avoid them in their entirety.