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Written by: Jacob Wolkowitz | Accredited Investors Wealth Management
The railroad, the automobile, the airplane, the internet, gene therapy. All these things have changed our lives or continue to do so. They permanently altered the course of civilization.
They were investment disasters.
The beauty of an investment bubble is the central prediction usually turns out to be accurate. It is too soon to say whether blockchain or distributed computing will have the same impact as the automobile. However, we think investors’ experience with Etherium, Ripple, Dogecoin, and Bitcoin is going to be similar to previous generations experience with Cartecar, Ewing, Elmore or in more recent memory, Ask Jeeves or GeoCities.
Since cryptocurrencies have no natural cash flow (no earnings, no governments issue debt denominated in them, etc.), it is an asset class naturally prone to speculation because it is untethered from any normal method of valuation. Since I don’t have to justify the price by the cash I expect to receive in the future, my valuation is simply what I think the next guy (and yes, it is mostly guys) will pay for it. In investment lingo, this is known as “the greater fool theory”, as the investment really boils down to whether you can find someone more foolish to pay a higher price in the future.
The logic of cryptocurrencies is that they are a “store of value”. However, stores of value are naturally resistant to swings in price. A certain Nobel winning economist pointed out that a 40% drop in value over a six-week period, which is what Bitcoin has recently experienced, is equivalent to an 8000% percent annual inflation rate, which makes Venezuela look good (2,300% expected annual inflation). In comparison, the Hong Kong Dollar is actually a store of value, as the currency has traded in a range of $.06 over the past year. I haven’t checked this thoroughly, but I’m confident that CNBC has not had any “Hong Kong Dollar Millionaires” on the network recently.
The fundamental contradiction is if cryptocurrencies are stores of value, they wouldn’t attract speculation, and if they didn’t attract speculation, they would have very little value.
As with trains, automobiles, the internet, and biotechnology, we expect the blockchain to become an interesting investment idea after the initial bubble bursts. It took decades for GM to become the biggest company in the S&P 500, Apple suffered a near bankruptcy, and Amazon fell 80% from peak to trough.
There is no prize for being first in the investment world and often there is a significant penalty. We’ll continue to watch cryptocurrencies and blockchain with interest, but for the foreseeable future, our feet will be firmly planted on the sidelines. You may want to consider doing the same.