Should I Buy Bitcoin? | Zach Miller
See the full episode notes HERE
As cryptocurrency is back in the media hype cycle; Erik, Brandon, and Justin discuss whether it should be a part of your portfolio. Here are some takeaways and insights into how you should be thinking about crypto and any other speculative investment.
What is cryptocurrency?
Erik defines it as “typically a decentralized digital money designed to be used over the internet. And so Bitcoin is not the only one. There's Ethereum, there's Litecoin. There are, as Brandon will point out, over 3,000 types of cryptocurrencies.”
Coinbase and Robinhood are two popular crypto exchanges that allow trading of their dollars for the cryptocurrencies. Security of the wallet where the cryptocurrency is held is an important consideration and should be well researched and understood. There have been many recent news stories of wallets being hacked and little recourse left for the lost value.
Valuation: Is Bitcoin a currency or something else?
“When it comes to investing, you need to be able to value something. Valuing an asset, generally takes cash flows. Bitcoin doesn't have that. It really, at this stage in the game is speculative, right? It's valued based on an assumption that it will be adopted as some mode of exchange or currency to your point, Brandon, down the road.”
Justin is describing a core tenet of finance which is valuation. What is the expected return and why is there a risk premium associated with owning bitcoin? In order to be considered a currency Bitcoin would need to meet several qualifications. The only criteria it seems to meet is a unit of account. Currency must be a medium of exchange generally accepted everywhere. This is not yet the case but may be in the future. Currency must also be a store of value which Bitcoin is not currently satisfying. The value is extremely volatile when measured against all other currencies. It also fails as a standard of deferred payment as I have not seen yet seen any debt being denominated in Bitcoin.
As was discussed in my blog “Always Ask Why,” an investor must answer the rationale of investing in any asset. Whether it is cryptocurrencies, the red hot IPO market, or speculative real estate, there must be a convincing argument of an expected return. Why will it be worth more in the future than it is today?
“I just have such a hard time trying to figure out what the value is. We talked about gold a few weeks ago and when I look at Bitcoin, I think there's lots of uses. I think the block chain technology it's built on is fascinating, but we're really looking at this, or the only way I can look at it is, is this a currency replacement for maybe the U.S. dollar, the Euro, the Yuan, whatever it might be and I struggle with how to value this stuff.”
Brandon is echoing what many other smart investors know that blockchain technology is valuable. The harder question is how does that translate to valuing cryptocurrencies themselves.
Is the added diversification a good reason to have Bitcoin in my portfolio?
“No, it's a great question. I mean, the math around what you're saying is true, but the uncorrelated asset needs to be really clearly understood. Right. Just because something is uncorrelated doesn't mean it automatically gives you added returns” Justin explains.
An asset may be uncorrelated that doesn’t mean you should allocate to it. There has to be a high confidence in future expected returns that have strong probability to be present in the future. There are many other assets in the investable universe that are also uncorrelated to equities but each must have a highly reliable basis for their allocation.
Should you go buy some Bitcoin?
“I mean, I don't think it's a hard, no. I think it's a situation where if you really understand what you're getting into, you understand the risk that you're willing to take here, then certainly it could open you up. I think we've talked a lot about how we plan for our clients. If you've got that protective reserves set aside, you've got the wealth that's going to provide for your family and your priorities for the rest of your life and you want to take a shot here. I don't think there's anything wrong with that. I think you should still only take a very minor piece of the puzzle and speculate in this case”, Brandon answers.
If the Fear Of Missing Out is too much for you. At least temper your expectations and be okay with whatever cryptocurrency you buy to be worthless in the future. Do not gamble with money that you need for your future. Bitcoin has had some massive declines in the past which can be very tough to hold through.
Brandon elaborates “I mean, I think the thing that people lose sight of in good times, right? 200% returns, that's enticing. I want to participate in that, but then you start to look around and I think most people would probably find it interesting that the Bitcoin’s actually corrected greater than 30%. So declined greater than 30%. Since 2012, it's done so 13 times. There was a three-day period that had actually dropped 87% in three days. I don't care who you are. That's a tough period of time to go through. So I think when you're looking at adding something like this to your portfolio, I think oftentimes we get enticed by the big upside, right? It's sort of the gambler's fallacy.”
It is easy when something is at an all-time high to wish you jumped in earlier but that performance is already in the past. Return chasing has hurt many investors through all market cycles and because of investor amnesia, it will continue to do so for the foreseeable future.
