Over the last several months, I have spent upwards of 50 to 60 hours researching bitcoin, crypto assets and blockchain. I’ve had several questions from clients on bitcoin and blockchain. My research is designed to answer one basic question: Is bitcoin a good investment?
The short answer is “No”
The somewhat longer answer is...
“Not yet, but maybe someday”
When I started my research, I was very skeptical of the technology and thought it was a fad at best, and a scam at worst. After spending time learning more, I realize that I was wrong. The underlying technology for bitcoin is quite revolutionary and could have a profound impact on financial services and many other industries. But the investment prospect remains questionable.
First, a quick background on the technology:
What is Bitcoin?
According to Wikipedia:
“Bitcoin is a worldwide cryptocurrency and digital payment system called the first decentralized digital currency, as the system works without a central repository or single administrator. It was invented by an unknown person or group of people under the name Satoshi Nakamoto and released as open-source software in 2009. The system is peer-to-peer, and transactions take place between users directly, without an intermediary. These transactions are verified by network nodes and recorded in a public distributed ledger called a blockchain.”
There are two attributes of bitcoin that are important and unique. The first is that it is decentralized. Normally, when you have an electronic currency transaction, you must work through a third party intermediary – usually a bank. This trusted third party verifies the transaction and makes sure the sending and receiving accounts are debited and credited correctly and stands ready to take accountability if there is a mistake or fraud. In the case of bitcoin, there is no trusted third party. The blockchain technology allows peer to peer transactions. So when you exchange bitcoin for a good or service, you are dealing directly with your trading partner. The blockchain records the transaction. This allows a host of characteristics such as anonymity (if desired) and the ability to interact regardless of geographical boundaries.
The second is that bitcoin is designed to be a currency. Currencies are thought to be stable sources of value that can be used in exchange. This is an important consideration when you think about investing in bitcoin. Most currencies are not viewed as asset classes for investment, but rather vehicles for trading.
What is Blockchain?
Blockchain is a distributed ledger. It allows transactions to be recorded, time stamped and encrypted. It is designed to be tamper proof, in that you cannot modify any data (or block) without then modifying every subsequent block.
I don’t understand the math and logic behind it enough to say whether the claim of tamper proof is true or not. But many smart people seem to think that it is. So I’ll take that as a default positon.
To me, block chain is an interesting concept. I think the blockchain technology could revolutionize the way we interact with data over time.
Blockchain enables bitcoin – a currency – but it has the ability to do much more. As an example, take ethereum. Ethereum is crypto asset (it is not strictly a currency) that allows smart contracts. The ethereum blockchain is designed to be able to encode smart contracts. From ethereum.org:
“Ethereum is a decentralized platform for applications that run exactly as programmed without any chance of fraud, censorship or third-party interference.”
In other words, ethereum is designed to create tamper proof applications. This could be applied to medical records for example, to maintain a tamper proof record of your medical history. If bitcoin was invented as a currency, then ethereum was invented more as an operating system, or platform on which to build future technologies and protocols. So buying ethereum is more like buying equity in a company than it is in buying a currency.
Are you confused yet?
We haven’t even gotten into blockchain forks, hashing or mining…
Should I Invest?
I answered this question at the beginning. The popularity of crypto assets like bitcoin and ethereum reminds me a lot of the internet bubble. During the late 90’s, everyone knew the internet would change the world. There was no question about it. It was obvious.
I know no one personally from that time frame that invested in internet stocks and came away wealthy from their investments. The destruction of capital was just massive. Do you remember Lycos and Altavista? How about Webvan and Pets.com? All gone. Along with hundreds of other companies that tried to ride the trend.
Did you know that in 1908 there were almost 300 car manufactures? I imagine that people knew that cars were going to change the world at the time. It was obvious. Who wouldn’t want to be a part of that? By 1929, there were 44 auto manufactures and after the great depression, there were three. Identifying a generational trend is no guarantee that you will make money.
If the crypto asset trend follows the historical pattern then massive amounts of capital will come into the space. Companies both good and bad will be funded. Trying to identify the winners in advance will be difficult if not impossible. I just spent dozens of hours researching this, and I am no closer to understanding where it will shake out than I was when I started (and I read the original Satoshi Nakamoto whitepaper). In fact, it seems to me that there are more questions than answers in this space.
The price of bitcoin has increased almost 900% in the last year. These types of gains tend to light the imagination on fire. Willing speculators will be pulled in. When you couple incredible return history with a revolutionary technology in its infancy, you will find many people who are willing to bet their money.
Inevitably there will be a wash out and most of the marginal companies will be gone. Once the excitement dies down and there is some history behind the technology, the winners may be much more clear.
I place crypto currencies and blockchain firmly in the speculative space. Yes, this has the potential to be very disruptive and revolutionary. But that does not mean that you will make lots of money if you invest your life savings in bitcoin. Plus you need to decide to how to invest. Do you buy the coins themselves? Or do you buy into companies that will benefit?
If you are intrigued, and like me, you find that having skin in the game keeps you interested in learning, then, by all means, take some mad money and invest in the space. But make sure that it is a very small amount of your liquid net worth. Smaller than 1%, maybe even smaller that ½% of your liquid assets. Because there is a high probability that you will lose your entire investment.
Full disclosure: I have no investments in the crypto asset or blockchain space. But I may make some in the future - following the same limits that I have set out above.
If you are interested in learning more (and if you are going to risk money, this is absolutely the least amount of research you should do):
The original white paper (it’s only 9 pages and surprisingly readable).
Three podcasts by Patrick O’ Shaughnessy which provide the most comprehensive and understandable overview of crypto that I have found.
Two books that are recommended (I have not read them yet, but they are on my list):
Digital Gold by Nathaniel Popper
The Age of Cryptocurrency by Paul Vigna and Michael J. Casey
A letter by Adam Ludwin responding to Jamie Dimon’s (CEO of JP Morgan) criticism of bitcoin.
A nice article on how to think of bitcoin.
Info on ethereum.
If you are still here, a small bit on the history of the auto.
Note: The contents of this site are general in nature and not intended as specific investment advice. All investments are subject to risk; including loss of investment value. If you have any question regarding investments or concepts in these pages, please consult with an investment professional.