Why Bitcoin is Uninvestable
“What do you think about investing in Bitcoin?” is a question I am being asked with increasing frequency, as the cryptocurrency mania reaches a fever pitch. Is Bitcoin investable? I would argue that the answer to that question is a resounding “no”. A Bitcoin investment is an oxymoron, with a purchase of bitcoin falling into the domain of speculation.
There are two types of assets that an individual can purchase: (i) an asset that produces cash flows; and (ii) an asset that does not produce any cash flows. Investing refers to purchasing an asset for less than it is worth in the hope of procuring a future profit. For an asset that produces cash flows, it is possible to calculate that asset’s intrinsic value by summing the present value of all future cash flows.
Whilst the intrinsic value is unobservable, and calculating the value of a business requires making forecasts and other judgement calls, there is still a way to arrive at a value estimate which can be compared against the current market price. Investing is buying the proverbial dollar for 50 cents, with a necessary precondition being the ability to estimate that asset’s intrinsic worth. Conversely, assets that produce no cash flow do not lend themselves to the same discounted cash flow analysis.
How does one determine whether they are making a sensible investment if the asset produces no cash flow, and they are unable to derive an estimate of that asset’s intrinsic worth? The classic example of this type of asset is gold. Its price is determined by the rules of supply and demand. Purchasing gold with the aim of generating a profit relies on the greater fool theory – that is, someone else coming along down track and paying more for the asset than you did, given that there is no cash flow derived from a purchase of gold. Bitcoin falls into this category.
There is no obvious way of valuing bitcoin – it is very difficult, if not impossible, to ascertain the valuation goalposts. Is it worth $10 or $10,000? One cannot say with certainty.
Observe the following price chart for bitcoin over the course of 2016.
Those who sold out at the end of 2016 were able to bank a healthy 119 per cent gain! Fantastic! Until they realised that if they had held on for just another year they would have made a 4194 per cent gain if they had sold at the December 2017 peak.
This illustrates the underlying problem with purchasing Bitcoin: without any fundamental yardstick for valuing Bitcoin, how do you know when to sell? Is it $20,000? $30,000? What about $100,000? No one knows.
To clarify, I am not saying that there’s no chance Bitcoin could work out, and achieve its original goal of providing a digital peer-to-peer means of transacting that didn’t rely on a trusted third party (e.g., a bank). However, for those pinning their hopes and dreams on Bitcoin rocketing to the moon, caution is warranted. On the spectrum of gambling and investing, purchasing bitcoin falls much closer to the former.