Investing Vs. Speculating on Cryptocurrencies and Blockchain Tech

In This Post:

There are currently over 1000 cryptocurrencies with market capitalizations above $10 million, and it appears that the terms Blockchain/Crypto/Coin/Token, have become the modern-day equivalent of putting “.com” in a company name in 1999. Speculation is rampant, and if speculation is your goal, this post doesn't aim to stop you from loading up on a cryptocurrency of unlimited supply, started as a joke/warning **cough** Dogecoin **cough**. Instead, the purpose of this post is three-fold:

  • Compare cryptocurrency/coins/tokens to other financial asset classes

  • Highlight why owning any cryptocurrency/coins/tokens is speculation

  • Explain that it is possible to invest in a promising technology if that better aligns with your goals

Quick Compare – Crypto Vs. Metals Vs. Fiat Vs. Stocks

The table below provides a comparison of characteristics often championed as strengths compared to more traditional asset classes:

Ratings Explained:

Scarcity: Defines how limited the supply of the asset category is.

  • Crypto – Rating: Low – Perhaps an unexpected rating as scarcity is often touted as the reason Bitcoin is valuable. However, Bitcoin is only one cryptocurrency of more than a thousand. In fact alternatives like Litecoin are arguably just better clones of Bitcoin, and the number of clones is limitless. Furthermore, Dogecoin has no set limit, and all "stablecoins" (like Tether) are unlimited.

  • Metals – Rating: High – The only category where the limit (at least on Earth) is fixed.

  • Fiat Currency - Rating: Low – With some exceptions, governments can generally issue an unlimited supply of their own debt and currency.

  • Stocks – Rating: Medium - There is no set limit to the number of publicly traded companies, but worthless companies generally cannot go public as no one would buy shares meaning high-quality companies will remain in limited supply.

Portability: As all categories can now be traded digitally, portability is equally high across the board. To clarify, gold is most easily owned through shares of physically backed gold ETFs, which applies in the case of silver, platinum, palladium, etc., as well.

Transactability: Defines how easily and quickly the category can be used to purchase non-financial assets.

  • Crypto – Rating: Medium - Not widely accepted by most vendors, but it could be one day, and is currently used in some transactions for real goods and services. That said, Bitcoin transaction time has been relatively stable over the last 3 years at ~10 minutes. Litecoin by design is about ¼ of Bitcoin’s time, but some Proof-of-Stake coins (think Etherum, Neo) are below one minute.

  • Stocks & Metals – Rating: Low – Your local supermarket isn’t going to take shares of Microsoft or your gold ETF. It takes time to sell and transfer to your local fiat currency for use.

  • Fiat Currency – Rating: High – Accepted just about everywhere with fast transaction times unless you buy something very expensive.

Intrinsic Value: Does it produce a product or service, or can it be used to make a product or service that people will want for any reason other than the sole intent to re-sell it later.

  • Crypto – Rating: Maybe – Bitcoin doesn't produce anything, and it can’t be used to make anything, but when you consider decentralized apps built on the Ethereum blockchain, it is harder to rate. However, if decentralized apps live up to their potential, it is unlikely the governments of the world would allow the underlying platform to be owned privately, just like the internet isn’t strictly owned by anyone today.

  • Stocks - Rating: Has Intrinsic Value – Stocks represent ownership of companies that produce products and services that people want.

  • Metals - Rating: Has Intrinsic Value – Precious metals have industrial uses. Although it is likely, especially with gold, that the price exceeds what supply & demand would dictate, there is some intrinsic value.

  • Fiat Currency – Rating: Essentially Zero Intrinsic Value - Melt down coins for metal? Burn paper currency for warmth?

Programmable: Can the financial asset be programmed with additional uses?

  • Crypto – Rating: Yes – It varies by coin, but by definition, all are programmed to behave a certain way. They might provide for highly secure transactions, anonymity, or countless other possibilities.

  • Fiat Currency – Rating: Yes – The shift towards a digital monetary system is already underway, i.e. the Fed crediting bank reserves, or China’s digital Yuan. This makes programming possible as already seen with the digital Yuan which allows for “controlled anonymity” and an “expiration date”. The U.S. Federal Reserve is currently working on a purely digital dollar with big decisions to make about programmed features.

  • Stocks & Metals – Rating: No – Would you want them to be?

Decentralized: I’ve yet to see a solid definition of decentralization that doesn’t look like swiss cheese when you put it under a magnifying glass, so I’ll just use a vague definition of a spectrum that ranges from one entity’s complete control over the asset’s creation, destruction, and transferability, to no single entity able to exert any influence on an immutable set of rules governing the asset.

  • Crypto – Rating: It's Complicated – Bitcoin is the classic example of a decentralized currency until companies like Coinbase came along and many people started relying on a centralized platform to trade. Many other FinTech firms have begun popping up to mimic roles of traditional banks in the crypto space as users have ironically demanded more centralization. The complication increases further when considering “stablecoins” like Tether (USDT) and Tether Limited’s role in the creation and destruction of USDT. On top of that, USDT being tied to the dollar obviously makes its value dependent on the centralized forces that influence the dollar like the Fed.

  • Metals – Rating: It Depends – With a large network of private dealers and a price largely based on supply and demand, physical gold in itself is not centralized. If you choose to own gold or other precious metals through an ETF you sacrifice some decentralization for convenience.

  • Stocks – Rating: Not Really – Because stocks are so regulated many centralized agencies, like the SEC and FINRA, the exchanges, the brokerages, it’s nearly impossible for two ordinary people to trade with each other without third party involvement.

  • Fiat Currency – Rating: No - A currency’s “Central Bank” provides the centralization for fiat currency.

Cryptocurrency does have strengths, but it seems that an investment portfolio can easily gain those strengths from a diversified mix of the limited set of traditional financial assets above.

Direct Cryptocurrency Holding is Speculation

An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative - Benjamin Graham

Direct cryptocurrency holding is speculation because no amount of analysis can change the likelihood that your principal is safe or that you will receive a return. The only chance for an individual to profit by owning Bitcoin is to hope that someone else will pay more for it in the future. Contrast that with a company paying out ~7% of its market cap each year in dividends. If no one ever bought those share from you, but the company continued to operate unchanged for the next 14 years, your principal would still be intact and continue to grow into the future. The burden is on the investor to perform the analysis to confirm the health and valuation of the company, but there are many methods available to do so.

Historical Speculative Bubble Signals

An inability to guarantee safety of principal and an adequate return was good enough for Graham to apply the speculation label, but for those that require more convincing, let’s check some boxes on the historical signs of a speculative bubble:

  • The general public talks about it – Can you explain what a blockchain is? Are you reading this anyway? Check this one off.

  • New Jargon Introduced – The dot-com bubble brought about nonsensical valuation metrics like “price-to-eyeballs", and who had heard of mortgage backed securities before the 2008 financial crisis? The crypto boom brought us: ICOs, blockchain, forks, hard forks, distributed ledgers, mining, proof-of-work, proof-of-stake, stablecoin, and don’t forget to HODL

  • Art sales are front page news – NFTs anyone? Count this for “new jargon” as well.

  • Popular leaders need to do almost nothing to convince their followers to take action -

  • “Doge” - Elon Musk tweeted on Feb 4th 2021

  • Followed by a ~1,000% rally over the next three months

  • Extreme Predictions – Historically, these predications have at least taken the form of... numbers, but the more recent predictions in the crypto space appear to be “to the moon”.

  • It’s different this time and doubters just don’t get it - Warren Buffett and Charlie Munger “didn’t get it” during the dot-com bubble and avoided massive losses. When it comes to crypto, they still “don’t get it”, but maybe this time is different.

Speculating on Tether

The most important financial innovation that I have seen in the past 20 years is the automatic teller machine – Paul Volker, 2009

The legendary former chair of the Federal Reserve went on to say that the ATM was really more of a mechanical invention anyway. Most financial innovations aren’t inherently bad, but in practice, most are rarely better than a mixed bag. Credit cards are convenient but led to high-interest credit card debt. Mortgage backed securities played a role in the financial crisis. Long Term Capital Management popularized options contracts, made some mistakes, and nearly blew-up global financial markets. Tether is a “stablecoin” where each tether (USDT) is worth exactly $1 (USD), and in theory it is backed by real assets like cash and cash equivalents. The basic premise is that because it is currently inconvenient to trade cash for any cryptocurrency, USDT is like holding U.S. dollars with the convenience and lower costs of trading crypto for crypto. Is this financial innovation worth investing in? If you have the interest, there is an incredible deep-dive worthy of a read-through here, but it could be distilled down to a few basic points.

  • Tethers are issued by Tether Ltd. and are worth $1 USD each

  • Tether accounted for 70% of daily Bitcoin traded volume at the time of writing

  • Regular people are leveraging up and being offered free Tether to promote Tether.

  • Tether’s bank, Deltec, did not have enough deposits to back the value of Tether.

More recently, the New York Office of the Attorney General (OAG) completed a two-year investigation concluding that, “Tether’s claims that its virtual currency was fully backed by U.S. dollars at all times was a lie”. Furthermore, the OAG revealed in court documents that approximately $850 million had gone missing and that Bitfinex and Tether had been misleading their clients. As a result Bitfinex and Tether will be required to pay $18.5 million in penalties to the state of New York. Note that penalty is paid to the state of New York rather than any potential victims. In other words, don’t rely on regulation or law enforcement to protect you against any fraud based losses in the crypto world.

Investing in Cryptocurrency

Given the enormous risks that come with directly owning cryptocurrency, what’s a non-speculative believer in blockchain technology to do? Simple, identify companies through analysis that not only provide a high likelihood for safety of principal and an adequate return, but also stand to utilize cryptography to their advantage in the future. If your risk tolerance allows, you might start by:

  • Looking for patent leaders in the crypto space

  • Finding diversified businesses that can support blockchain investments from other sources

  • Looking globally, while understanding currency risks

  • Looking for companies that benefit as users, rather than developers of blockchain technology

Applications for blockchain technology extend beyond technology companies, from supply chain management, to advertising, to finance, and beyond.

Benefits of Investing Vs. Speculating in Cryptocurrency

Beyond that improved safety profile, choosing to invest, rather than directly purchasing cryptocurrency has several additional advantages.

Diversification – Investing $1 across the top 1,000 cryptocurrencies isn’t true diversification as there is a high correlation in movement between the coins. By creating a portfolio of diverse assets that can benefit from blockchain technology, risks of total or significant losses can be substantially reduced.

Inflation Protection - Cryptocurrency offers inflation protection the same way gold or any commodity does, by transferring your local fiat currency into some other store of wealth while subjecting you to the volatility of whatever you bought instead. Domestic companies have built-in inflation protection because the value of their products and services keep pace with inflation. For example a new car today may cost more than 20 years ago as a result of inflation, but the value of a new car, reliably getting you from point A to point B, is unchanged. Furthermore, because we have a global market, many large companies have exposure to multiple currencies which provide inflation diversification.

Lower Fees – Many brokerages have commission free trades where Coinbase currently charges a flat or percentage based fee dependent on transaction type and size.

Concluding Thoughts

The dot-com bubble began to burst in 2000, but it wasn't because the internet didn’t eventually deliver on just about every expectation set at the turn of the millennium. In fact with the benefit of hindsight, the hype may not have been high enough, but that didn't prevent many of the 457 IPOs in 1999, primarily in tech, from going bankrupt soon after. With 1000+ cryptocurrencies available, expectations for blockchain technology may be higher than they were for the internet. If you choose to speculate, understand the risk of losing your entire stake, and consider that investing might be the more suitable choice for you.

Author: Andrew Dudar is a registered investment adviser representative at JRW Advisory Services, serving clients in Colorado and across the United States where exclusions apply.

Disclaimer: The article is written for the purpose of general education and information and should not be taken as financial advice or investment recommendations. The author does have a speculative holding in cryptocurrencies purchased years ago.

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