Should you invest in Bitcoin?

If you haven’t noticed Bitcoin and other ‘cryptocurrencies’ like Ethereum making headlines recently you may be living under a Bitcoin!

Even Alan Kohler’s nightly finance segment on ABC News now includes a snapshot of the price moves in Bitcoin and other obscure cryptocurrencies.

As far as investment education goes for the average Australian this isn’t particularly useful. However it’s not hard to understand why people are interested. Anything that can rise in value by 100% in a day creates a sense of excitement and the natural reaction is ‘How can I be a part of it???’

Recently many clients have asked if we will add Bitcoin or other cryptocurrencies as an investment to our portfolios or as a Stockspot Themeoption.

Here’s our answer…

First of all, what are cryptocurrencies?

Cryptocurrencies are digital currencies that are secured using complex algorithms, known as cryptography. Bitcoin was the first cryptocurrency powered by a public ledger that records and validates all transactions chronologically, which is known as the Blockchain.

Blockchain refers to public online ledgers that can be used for verifying and recording transactions. Since Bitcoin launched in 2009, many new cryptocurrencies and alternative coins ‘altcoins’ and ‘tokens’ have been created using similar Blockchain technology.

What we like about Blockchain

As big believers in the opportunity for technology to reshape financial services, we’re excited about Blockchain. Blockchain’s potential to transform the asset management industry, reduce trading frictions and make holding investments more secure and cost effective is, to use a much overused term, a real gamechanger.

In the future, online investment advisers (robo-advisers) like Stockspot are likely to use some form of Blockchain technology to transact and administer holdings rather than the current system of Holder Identification Numbers (HINs) on the CHESS subregister system. This could help us further drive down costs which ultimately benefits clients.

However, as an investment adviser assessing if Bitcoin should form part of the Stockspot portfolios as an investment, we are less excited right now and here’s why…

Bitcoin as an investment, two sides of the debate

Since it was created there’s been no shortage of critics to call its rise a bubble and argue that Bitcoin has no intrinsic (measurable) value.

Yet the people actually working in Blockchain say that focusing on the price of Bitcoin is missing the point. Its real value is as ‘proof of concept’ as a new form of payment system not reliant on middle parties like governments, banks or credit-card businesses.

The truth may be somewhere between. Blockchain is starting to be more widely accepted, however the value of the technology and its ‘tokens’ as a store of wealth is very much up in the air.

Ultimately it’s this debate that is driving the price volatility in Bitcoin and other cryptocurrencies.

What’s Stockspot’s view?

When it comes to recommending an investment strategy our job is to provide clients with carefully tested investment strategies based on evidence. We don’t provide opinion on if a new innovation will succeed or how much it could be worth.

That’s the difference between speculation and investment. Could Bitcoin be worth 10 times its current price in the future? Sure. Could be worth one tenth? Absolutely. The nature of any speculative bet is that it could pay off handsomely or be next to worthless.

Or there’s a good chance it could be both at some point.

Take Amazon shares (AMZN) for example…

Today Amazon trades at US$1,200 per share but let’s pretend you predicted it would dominate online shopping back in 1999. In December 1999 Amazon traded at $110 per share and everyone was excited about it.

But in 2000-2001 the share price fell from $110 to $5. That’s a whopping 96% fall. Would you have had the nerve to hold the stock all the way down?

Would you have then continued to hold it from $5 back to $110 in 2009 and to $1,200 in 2017? The chances are, probably not.

Bitcoin has already had several speculative ‘hype cycles’ like Amazon had back in 1999-2000.

In 2011 Bitcoin rose from $1 to $31 before falling to $2. It then rose to $250 in 2013 and fell back to $50. After that it rocketed to $1,100 before falling back to $180. Each time Bitcoin has risen rapidly it has fallen 80% to 95% from its peak before continuing on a longer term journey higher.

If you’re buying Bitcoin at any point in time you should be aware that the value of your investment may fall by more than 80% at some stage.

Many of today’s buyers of Bitcoin aren’t thinking about the value of Bitcoin in 20 years. They’re chasing momentum and hoping to sell to someone else at a higher price. These speculative ‘cycles’ are ultimately what has sent Bitcoin up and down so dramatically.

Feeling Bitcoin FOMO?

This year (2017) the price of Bitcoin has risen from US$1,000 to over US$19,000. The total value of all Bitcoin now exceeds US$300 billion. 2017 was a very good year for those betting it will succeed!

It can be easy to lose sight of what’s smart when you see people making tonnes of money in short periods of time. The same happened in other speculative manias like the tech bubble of 1999-2000 and in the mining boom of 2003-2007. In both periods plenty of shares rose by more than 1,000% before falling or vanishing entirely.

Rapid gains can be exciting, and quickly lead to FOMO if others are making easy money and you’re missing out, but as a general rule, ‘easy money’ is just a mirage.

Even if one Bitcoin is worth $100,000 in 10 years, the odds that you’ll make money are not good. Successful speculation requires you to enter and exit at the right points as well as having nerves of steel to manage your emotions along the way. It’s much harder than you think to get your market timing right and have the discipline to not sell on the way up – or during dips along the way. And that’s just assuming you’re eventually right with your bet.

Want more sound business financial advice? Speak to the team of Sunshine Coast accountants at Bottom Line Control today.