The news lately has been full of stories about the rapid rise and precipitous fall of the cryptocurrency bitcoin. However, even after falling from a peak near $20,000 to around $11,000 in early 2018, bitcoin is still significantly above the $1,000 level where it hovered at the start of 2017. Does this tremendous runup in the price of the cryptocurrency mean that, recent plunge notwithstanding, bitcoin has suddenly become an investment comparable with time-tested alternatives like stocks and bonds?
While bitcoin has certainly made a lot of money for those who were able to buy it low and sell it high, this fact alone doesn’t make it, or even cryptocurrencies in general, a viable asset class. For example, during the Dutch tulip-bulb mania centuries ago, fortunes were made by those who bought and sold the bulbs at the right time. Eventually, however, the mania faded and those who bought tulips at elevated prices found themselves on the losing end of the trade.
Concerns about a bitcoin “bubble” have led a number of notable financial-market experts to express doubts about bitcoin’s future prospects, including Nobel prize-winning economist Robert Shiller. In a speech at the 2018 World Economic Forum in Davos, Shiller proclaimed that while he found bitcoin to be an “interesting experiment,” he didn’t see it becoming “a permanent feature of our lives.”
A Track Record Offers Evidence of Value
Traditional asset classes such as stocks, bonds and commodities like gold and silver can be volatile too, of course, but in the long run, these assets, considered as a whole, have a track record of consistently bouncing back in value after a downturn. For instance, during the great financial crisis of 2007/2008, the stock market as represented by the S&P 500 fell substantially, as did many individual stocks. While not every stock has recovered in value since that time, the broad-based S&P 500 has erased all its losses and gone on to reach new highs.
In the case of a commodity such as gold, even though the precious metal is not directly linked with any government-backed currency, its innate characteristics as an inherently scarce and attractive object, one that is coveted around the world, has cemented its place as a store of value. While precious metals such as gold and silver are subject to significant price volatility at times, their track record of retaining their value over the long term provides investors with evidence of their worth.
Another asset class that has an extensive track record providing evidence of its value is real estate. As with the other asset classes mentioned, real estate is subject to price volatility over time in response to factors such as economic conditions and interest-rate movements. However, the intrinsic value it represents comes from its function as either a place of shelter or to conduct business – as the demand for real estate has grown over time, its value as an asset, by and large, has risen accordingly.
Bitcoin’s Lack of a Track Record
If we compare bitcoin against these long-standing asset classes, we can see how the cryptocurrency falls short by comparison. When considered in terms of a track record, stocks, bonds, real estate and precious metals have histories going back hundreds of years, while bitcoin has only been in existence for a few years. While having a track record is not a guarantee of future performance, as the saying goes, it can provide investors with a certain level of comfort that an investment’s past behavior can be studied for insights into its potential future behavior.
An investment that doesn’t have a significant track record often brings with it a higher level of risk. The reason for this is not hard to discern: If you can access the history of how an asset has performed during various time periods, you can use this data to learn how that asset behaves during different economic conditions. In the absence of a long-term track record, such analysis is much more difficult to perform. This is not to say that new economic developments don’t occur from time to time, bringing along with them new opportunities. However, when the asset class itself is new, and not just the economic activity, it raises a host of issues.
For instance, if a company introduces a more efficient technology, you can look at the history of how the stock of companies debuting successful innovations have performed to help judge how risky investing in the stock is likely to be. You can access data going as far back as the introduction of the railroad up to more recent innovations such as the development of computers and the Internet to see that the stocks of companies that have innovated successfully have historically done quite well. In the case of a cryptocurrency like bitcoin, the lack of any such track record means that to project how the cryptocurrency will perform going forward, we should try to see if any evidence exists to support bitcoin’s valuation.
Is There Evidence That Bitcoin has Tangible Value?
Even more than the lack of a track record, the contention made by some financial pundits that there is no evidence that bitcoin has any tangible value should be troubling to investors. An innovation such as the computer, for instance, clearly had enormous economic value that benefited the companies using the product. Where is the evidence that bitcoin has similar value as an innovation? In this regard, popularity should not be confused with utility. As mentioned earlier, there have been a number of investment fads and manias throughout history that ended badly for those who bought into them, primarily because the investment they bought, whether tulip bulbs or shares in the South Sea bubble, were worth nowhere near what they paid.
When seeking evidence for the value of an investment, there are a variety of criteria to take into account. First, there is the underlying value of the assets behind the investment. In the case of a real-estate security, for example, the property owned by a Real Estate Investment Trust (REIT) will typically have a stated asset value. In the case of a commodity company, the same generally holds true. Blue chip stocks often have a variety of assets supporting their earning power and hence their stock price. Growth stocks are typically more speculative, with some portion of their value attributed to their potential to grow their earnings in the future. But even in these cases, investors can analyze the industry the company is in and the progress it is making in that industry to formulate a projection for future earnings based on the performance of comparable companies historically.
When it comes to evaluating bitcoin’s value, there is no comparable evidence that can be cited to support its current or projected worth. The lack of a track record of similar investments means that any such projections are likely to be highly speculative, to say the least. In the case of, say, a new technology product, one can look at the addressable market and project a potential market share if the company’s product catches on with buyers. With a cryptocurrency like bitcoin, however, given the unprecedented nature of the product, it’s not clear exactly what the addressable market is. Outside of those who purchase bitcoin simply because it is popular, what is the product’s function?
For those who say it enables the transfer of money from one party to the next, the response could be that this only works if bitcoin is considered to be a form of money. Is there any evidence for this? Does bitcoin work as a currency? If you look at major fiat currencies such as the U.S. dollar, Euro or Japanese Yen, we quickly see that they are supported by the full faith and credit of the governments backing them. In this case, that equates to billions or trillions in taxing power.
Does Bitcoin Have What It Takes to Survive Long Term?
What backs bitcoin? An anonymous group of computer operators who engage in “mining” the cryptocurrency. While the distributed ledger technology behind bitcoin, known as blockchain, seems to have promise, at the end of the day, bitcoin itself does not represent any exclusive ownership of this technology. A large part of its value stems from faith that the operators of the bitcoin network will remain true to their pledge not to expand the number of bitcoins in existence beyond a stated amount.
Unlike major fiat currencies backed by the taxing power of their governments, bitcoin is not backed by a tangible source of revenue generation other than its use to conduct transactions. However, given that this function can easily be duplicated by other cryptocurrencies, there is no compelling evidence to support the claim that bitcoin has significant (some might say any) intrinsic value. Insofar as it can be used to conduct transactions, the debut of numerous competitors demonstrates that there doesn’t seem to be significant barriers to prevent competitors from offering a similar service.
As mentioned above, part of the reason for bitcoin’s success to date has been the pledge that only a limited number of bitcoins will ever be issued. But as there is no physical barrier preventing more bitcoins from being issued, as is the case with a commodity like gold, and given that unlike fiat currencies that are linked to the taxing power of the government and the strength of the economy of the countries that back them, there is no tangible source of value linked to the cryptocurrency, so the value of this pledge is questionable. This absence of a link to any evidence-based source of value casts doubt on bitcoin’s viability as an investment over the long term.
While we see some interesting opportunity arising in the blockchain technology that supports the
function of bitcoin, we still need more time, information and stress tests. Investors considering an investment in the cryptocurrency should proceed with caution. Based on the lack of evidence or a track record to support its price valuation, bitcoin should be considered a highly speculative investment.
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