One of our favorite investment idioms is that if something seems too good to be true, it usually is. The hype over crypto currency is 2022’s contribution to a long list of examples where investors chased the next big thing, without really understanding it, for fear of missing out (FOMO).
It was just about one-year ago, that Bitcoin, used as an example for all crypto currencies, hit a record intra-day high of $68,513*. Investors were bombarded with messages on how gold was dead, and that crypto currencies were an exciting new appreciating asset class.
We agree that the underlying technology of cryptocurrencies, Blockchain, is an important step forward in market transactions. There are potential exciting changes in how business could work with blockchain technology. For example, will we rent cars in the future, or will we buy them for short periods with ownership verified on a blockchain database?
However, we never understood why the mega-fans of crypto currencies pushed the thesis that the adoption of blockchain in financial transactions would serve to drive up the price of a digital currency. For Bitcoin or any crypto currency to be a financial asset, in our view, it must have a value that can be established by discounting the present value of the cash flow stream it will produce. This is true for stocks, bonds and even fine art – with the view that an eventual sale will be a one-time cash inflow.
Similarly, we never understood the argument that crypto currencies would be a store of value that would outperform the S&P 500 and gold as an investment option, and would hold up well as a non-correlated asset during turbulent markets. The chart below shows bitcoin, gold and the S&P 500 performance since 11/28/2021, which shows the brutal truth of this fallacy.**
It’s Rarely “Different This Time”
In our view, the hype of cryptocurrencies as a price appreciating asset is another in a long line of irrational market exuberances, similar to the housing bubble of 2005-2007 and the internet craze of 1997-2001. Houses and the internet are still here, and important aspects of our economy, but many people lost a lot of money chasing an irrational view that these asset values would grow exponentially, because somehow “it was different this time”. In our view, it’s rarely different this time.
Do Not Confuse Great Technologies with Great Investments
The next time hysteria erupts, and we think there will be a next time, we recommend the following:
1) Understand the asset before you buy. Fear Of Missing Out (FOMO) does not constitute an investment case.
2) Establish the price of any asset by summing the present value of its expected future cash flows. This lesson is taught the first day of Finance 101 and is perpetually true.
3) Do not confuse great technologies with great investments. Every investment must be measured for the potential return it will produce balanced by the risk every investment possesses; not on whether it is an interesting new shiny ball.
4) Invest for the long-term with an eye on downside protection. In our view, the key to winning in investing is playing the long game and benefitting from the value of ‘compounding’ that a good asset will produce. You Only Live Once (YOLO) should not apply to financial assets, for if your capital is destroyed, there is no tomorrow for that investment.
*Bitcoin price 11/28/21 as priced as XBTUSD spot exchange rate – the price of 1 XBT in US dollars, quoted on Bloomberg.
**GLD is SPDR Gold Shares as a proxy for gold, BITO as PROSHARES Strategy E as proxy for bitcoin and SPY as SPDR S&P 500 ETF Trust as proxy for S&P 500 Index, all priced via Bloomberg.