The Novice Investor: Cryptocurrency

However you get your news, it is almost impossible to not hear murmurings of what’s going on in the financial world. For myself, I receive updates from CBC, Globe and Mail, social media, as well as various investment companies. The problem is that everyone has the same story spun a different way. As a reader, it can be tough to untangle the stories and get a good sense of what’s actually happening. It’s as though the news is a pair of headphones (the kind with wires) that you’ve pulled out of your pocket all tangled. With intense focus and precision, you can unwind the complex mess, only to put them back in your pocket to be tangled once again.

So, what’s the point of this article? I simply want to continue tangling earphones.

In all truth, there are certain topics that have hit the investment market that I’d like to address. I hope that this can clear up some misconceptions or terms that most people recognize but don’t understand.

Our first target is cryptocurrency.

Before we dive too far into what cryptocurrency is, I thought we should put it into context.

Cryptocurrency is considered a “Fad” of the 2000’s. Millennials are all wishing they jumped on the Bitcoin train years ago because they would have seen their fortunes made. But cryptocurrency’s infancy takes us back to the 1980’s, when “Digicash” was invented with the goal of creating a non-traceable and de-centralized form of value transfer (learn more here). Over the years it has evolved through growing pains to become a multi-billion dollar network of currencies that range from Bitcoin (the most recognizable), to Dogecoin. The origins of the modern-day Bitcoin are also very mysterious. The publicized paper which started Bitcoin, Bitcoin – A Peer to Peer Electronic Cash System, was written by an entity known as Satoshi Nakamoto. I say entity because they don’t exist. It’s an alias, the real identity of Satoshi is a mystery.

So, we know that since the 80’s people have been trying to develop a method of transferring wealth without having to go through a major bank or disclose private information. In the early days of Bitcoin, this was an open door for terrorism financing and criminal activity to occur without the ability to trace financial transactions. It’s impossible to know for sure, but it’s suspected that in the earlier days, a large percentage of transactions were related to criminal activity.

But… What is Bitcoin?

It’s a figment. It’s a non-tangible, electronic ‘coin’ that has no internal value. It only has perceived value. You may read that sentence and think, “Man, Garrett must not like Bitcoin!” and you’re not wrong, but you’re not entirely correct. I see two main issues with Bitcoin (and other cryptocurrencies):

1. They have no “real” value.

2. They’re traded as an investment and not a currency.

There are other issues that are attributed to my hesitation toward cryptocurrency, but those are the main two, and I’ll go into more detail.

They have no “real” value

Since, at it’s core, Bitcoin is not a real asset, its true value is $0. There is no tangible asset (company ownership, physical property, ect) associated with Bitcoin. Most other assets have some minimal worth. An investment in gold, even if it went to $0, would still leave you with a physical asset that you can touch and feel. At the very least, a gold bar could be used as a shiny paperweight. With Bitcoin, there is no minimum value, and with it being de-centralized, it is un-regulated, which means there is no institution that maintains its integrity. This manifests itself as a higher chance that a cyber-attack or ‘hack’ could leave the investor with nothing.

They are traded as an investment and not a currency

Traditionally, currencies are not held in investment accounts for the purpose of growth. To clarify, when I say ‘currencies’, I’m referring to cash held in an account outside of your equity or fixed income portfolio. They are held for three primary reasons.

First, they allow for the investor to quickly and easily purchase more investments. For example, investors who held cash in their accounts in March of 2020, when the market crashed, were able to quickly put money into the market when stocks were “on sale”. We would call this an “Opportunity Fund”.

Secondly, they are used to hedge risk against inflation. Holding a different country’s currency can see some growth if the dollar in your own country declined. For example, lets say I converted $5 CAD into $4 US. I could hold the US currency with the hopes that the value of the Canadian dollar fell. When it does, I would convert my $4 US back into CAD, at which time it may be worth $6 or $7 dollars.

The third purpose for currency is wealth transfer. This could be as simple as going to the grocery store to purchase food. Every item on the shelf is assigned a dollar value. How would you feel if you went to buy your favorite ice-cream to find out that overnight, the price had increased by 20%? There would be major distribution issues for non-essential materials, which would only be purchased when the price of Bitcoin dropped, and there would be major financial hardships for people buying essential items when prices were high. Bitcoin can never really be a new form of de-centralized currency until it is regulated to the point where price volatility is managed.

For those who don’t understand the concern around centralized currency, you’re not alone. A centralized currency is simply a currency that is controlled by the government (or a ‘higher power’). In Canada, our currency is centralized and controlled by the Bank of Canada. They are responsible for controlling interest rates and money supply, among other things. One of their major mandates is to control inflation, and two major tools they possess to control inflation is interest rates and the ability to print and recall money (money supply).  Bitcoin and other cryptocurrencies have tried to de-centralize this process with the hopes of creating a currency that is controlled by the users, and not by the government. Extreme crypto-fans will go a step further and say that they support Bitcoin because it resets the value of currency. They see the Canadian dollar (or US dollar) as a value of power. For example, in today’s economy, 1% of the population controls a vast amount of the wealth. Some of these crypto-fans support de-centralization because they believe that it will spread out the wealth.

How wrong they are…

This brings me to a THIRD big pet-peeve with cryptocurrency (and bitcoin specifically). It is not uncommon that a fanatic of Bitcoin is also a semi-socialist (specifically in terms of spreading out wealth). The problem with Bitcoin is that it has created a new market. Bitcoin mining is a brand new industry which has become extremely expensive. As a PC gamer in my free time, I saw a huge price jump in the cost of GPUs (graphic processing units) due to people buying all of the supply to build ‘mines’. If you go onto Kijiji, you can search “cryptocurrency mining rigs’ and find lots of different options that have price tags that reach into the ten’s of thousands. In that model, where it costs thousands of dollars to gain access to a production method, how does that differ from capitalism? If the skeptics of capitalism say that its main goal is to separate the worker from the means of production, how is charging thousands of dollars to have access to currency any different? In this world, the top 1% still get to hold all the wealth. In fact, the top cryptocurrency holders are banks and bank owners, specifically owners who got into cryptocurrency exchanges, such as Micree Zhan, who founded the cryptocurrency mining company “Bitman”, or Chris Larson, who co-founded Ripple, which is a new currency of its own. Both of these men were rich well before they got into the crypto market.

So, where does this leave cryptocurrency, and how does it fit into the future?

That’s the million dollar question. It seems like people are ‘betting’ on whether cryptocurrency will either replace or be integrated into the currency our future society. Others believe it is too fragile in its current state to be a real contender to something strong like the US dollar. We could dive into the weaknesses of the US (or Canadian) dollar, but the reality is that our whole economic system is built on the US dollar, regardless of how weak or strong it is.

Since having started writing this article, the CBC posted a story about the international banking system and how it is pushing back against cryptocurrencies for some of the same reasons we’ve discussed. They did however, propose an alternative: “Central bank-issued digital money” (or CBDCs). The advantage of this form of digital currency is that it is supported by the current banking system. This seems like a bad compromise for crypto-fanatics who may see this as another form of centralized currency (which would be correct), but the CBDCs could maintain a transaction’s privacy. For the everyday individual, this alternative would be much more stable, because it’s backed by one of the world’s mega-institutions. At the end of the day, Bitcoin is unstable because there is so much trading. If one entity (or a group of entities) owned a major portion of the currency, individual traders would have a much smaller impact on the ongoing value. It’s the same reason the US and CAD dollar don’t fluctuate drastically on a daily basis.

In My Opinion:

It’s not as easy as saying “yes” or “no” to cryptocurrency. Since the eruption of Bitcoin, there have been a multitude of different variations of cryptocurrency, and there are even more that are in development that haven’t hit the marketplace yet. I believe that cryptocurrency is here to stay, but I don’t foresee it being a major “currency” in the same way as the dollar. As of right now, there are only a limited number of retailers who are accepting various forms of cryptocurrency in exchange for goods. As a business owner, the risk is that you’ll accept the bitcoins right as the value drops. This would cause many stores unnecessary financial hardship, especially while the alternative (US/Canadian dollar) is relatively stable. So, if you’re interested in holding cryptocurrency, the same ‘rules’ apply as with the rest of an investment portfolio.

Diversify.

With hindsight being 20/20, how would you feel if you had bought Bitcoin in March or April of 2021 during it’s huge expansion knowing where it is now? Here’s a reference:

I would safely presume that cryptocurrency will be part of the future, but who knows which version will be the main form in 10 years time? If you want to have crypto as part of your portfolio, I’d recommend spreading your investment over various cryptocurrencies instead of one or two. You may not see the drastic increases in value in comparison to just holding Bitcoin, but you also won’t experience the dramatic fall in value if Bitcoin itself falls. Either way, it’s a bit of a gamble. If you’re going to hold it, don’t put all of your eggs in that basket. Trend-setting investment options often don’t last long. Bitcoin will continue to be a thing until it’s not, sort of like bell-bottom jeans. Somehow they were extremely popular, but now they’re only used as the bottom half of my Elvis Presley Halloween costume. There will always be a new trend, and once the focus is taken off of Bitcoin, it’s anyone’s guess what will happen next.

 

Amendment: My wife, as she read this over for me, told me that Bell Bottom jeans are apparently coming back into style. Now I get to wear my Elvis costume all year round!