There is a great episode of the American version of The Office in which Dwight Schrute, Assistant to the Regional Manager at Dunder Mifflin’s Scranton branch, creates an incentive program focused around “Schrute bucks”. An exchange with grumpy salesman Stanley Hudson follows:
Dwight: Don’t you want to earn Schrute bucks?
Stanley: No. In fact, I’ll give you a billion Stanley nickels if you never talk to me again.
Dwight: What’s the ratio of Stanley nickels to Schrute bucks?
Stanley: The same as the ratio of unicorns to leprechauns.
The first time I heard the term ‘bitcoin’ I was talking to a client whose million dollar retirement account my firm managed. At his request, I read about the burgeoning crypto-currency for 20 minutes and told him they were a nonsensical fad that were not worthy of an investment. My client wasn’t convinced, and he later bought $10,000 worth at the urging of his millennial son. This was in early-2013. When I saw him 6 months later his investment was up almost 20X. He said something like “my $10k bitcoin investment has made more money than my $1,000,000 retirement account since the last time I saw you.” Of course, I reiterated my skepticism and suggested he take his gains. I took a new position a few months later and don’t know when/if he ever sold his position, but I’ve followed bitcoin ever since.
According to a quick google search, there were 15.2 million bitcoins as of February 2016 and 25 bitcoins were added every 10 minutes or so. The unknown inventor of bitcoins set it up so that the amount of bitcoins created would drop in half every 4 years or so, and eventually would be capped at 21,000,000 bitcoins.
Earlier this year, the price of a bitcoin hit $1,000. At that price, 21 million bitcoins would have a total value of $21 billion. To put that in perspective, bitcoin, when fully mined, would have a market cap in the range of companies like AutoZone (AZO – $21.2 billion) or Campbell’s Soup (CPB – $19.4 billion). In other words, bitcoin is tiny.
The size of bitcoin is the opportunity. Towards the end of 2013 bitcoin trade, previously primarily in US Dollars, came to be dominated by Chinese Yuan. Baidu (NASDAQ:BIDU), the Chinese Google, even announced plans to accept bitcoin for payment.
However, later that year, the People’s Bank of China (PBoC) banned financial institutions from dealing in bitcoin. The PBoC insisted that the Yuan (or Renminbi) be the sole mainland currency in circulation. As you can see in the chart below, bitcoin prices plunged.
The Chinese appear to love the bitcoin, but not for use as money – as one might expect. Instead, the Chinese, like to speculate on bitcoin by day trading. There is also speculation that wealthy Chinese use bitcoin to circumvent capital controls to get money out of China. Despite President Trump’s efforts to label China a “currency manipulator”, China’s foreign currency reserves have declined for six straight months as they’ve had to sell Dollars to buy Yuan to try to prop up the price of Yuan. Barron’s, for one, has argued for the past year that the Yuan is overvalued.
In addition to the Chinese demand for bitcoin, the Winklevoss twins (who, if they had invented Facebook would have invented Facebook) have filed with the SEC to list a bitcoin ETF on the Bats exchange. A decision from the SEC is, at long last, expected by March 11 of this year. Estimates from investment bank Needham Co., which assign a low probability of approval of the ETF, suggest that approval “would attract a flood of investor cash that could hit $300,000,000.”
In financial markets, the marginal buyer sets the price. If the Chinese Yuan continues to decline against the USD, increasing the desire for wealthy Chinese to get capital out of China, or if the bitcoin ETF is approved by the SEC, demand could increase significantly. Since the “market cap” of bitcoin is very small, an increase in demand could significantly move the price higher.
If you are inclined to invest in bitcoin, treat it like money you take to the casino – you should only invest money you can afford to lose. Bitcoin is extremely speculative, and I would suggest limiting your exposure to no more than 5% of your investment portfolio.
I want to emphasize again that it is important for investors to understand that bitcoin is a trade, not a long-term investment. It is unlikely that bitcoin will ever serve as a true “alternative to paper currency”. Bitcoin fails to posses the most important attributes of a valid currency – general acceptability and stability.
1) General Acceptability – This is fundamental to any currency. If I’m selling something, I want to be paid in a currency that I know others will accept. There are several companies that “accept” bitcoin, but they actually require the user to convert the bitcoin to giftcard format first, which is really a different way of saying that they require the user to convert the bitcoin to US Dollars. Of course, all of that is just another way of saying that they don’t accept bitcoin. To be clear, the vast majority of vendors don’t price in bitcoins, they price in Dollars. Dollars are the currency.
2) Stability – A good currency should be a stable, or at least relatively so. That is to say, the value of a material, which is used to measure the value of all other materials, needs to be stable. Bitcoin, after eclipsing $1,100 earlier this year, reverted to a bear market (20% decline) within a week!
Bitcoin bulls might argue that the market for bitcoin justifies itself. I’d remind those folks that just because people are willing to buy something doesn’t mean it has any value. Consider pet rocks from the 1970s. Or more recently, fancy pet rocks from this past holiday season which sold out at a price of $85. Bitcoins are pet rocks without the rocks.
If Warren Buffett hates gold, imagine how he would feel about bitcoin?
An investment in bitcoin could be enriching, but you’re investing based on “The Greater Fool Theory”… that somebody will be willing to pay even more than you paid at some point down the road. If anybody tries to tell you differently, offer them a billion Stanley Nickels to never talk to you again!
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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