Stocks

Bitcoin A Bubble, But Long Term Value?

As I write, the price of bitcoin just smashed through US$10,000, and has pushed up through US$11,000.

That’s amazing when you consider it was just US$300 in January 2015. At the beginning of 2017, it was just under US$1,000.

And it’s not only bitcoin that’s on a tear. Dozens of crypto tokens are up hundreds of percent over the past few weeks.

Now, we’re seeing a lot of self-congratulatory backslapping from crypto investors. Folks talking victory laps, bragging about their returns. Hubris.

This makes me uncomfortable.

It’s easy to feel like a “genius” in a raging bull market. But make no mistake, markets don’t go parabolic forever…

Just take a look at the chart below that shows the crypto market (excluding bitcoin) over the last year.

And now look at the gains in just one week. 45 percent. In a week. This is not sustainable.

Now, nothing has altered my medium-term bullishness on the crypto space. To say the best is yet to come is an understatement. And I still believe everyone should own some bitcoin. However, there will be corrections in the crypto space. Some of them violent…

The crypto froth is forming

Today, we’re seeing the early signs of game-changing technology that has the capacity to not only reinvent existing business models, but to completely upend traditional capital markets and business structures as we know them.

And alongside this promise, we have an army of speculators throwing money at cryptos. Just consider…

Ripple has risen 80-fold… in the past nine months.

Iota is up 5-fold in a month.

Stellar Lumens is up 9-fold in less than two months.

These are crazy returns. And what’s more, these cryptocurrencies are liquid and tradeable for the everyday investor.

These are cryptocurrencies that have been around a while. But there’s a huge amount of money now looking for the next 30 or 100-bagger, and that money is also pouring into initial coin offerings (ICOs).

This is a relatively new form of financing for cryptocurrency startup firms. It ‘s similar to crowdfunding. The company will typically write a whitepaper outlining its project, along with the general terms of the ICO. Early investors can then put money into the ICO, be issued with cryptocurrency tokens which can then be traded in the secondary market.

 

Observations from the front line

Having participated in a few ICOs, I’ll share some observations.

Most crypto companies have open forums for their “investors” to communicate. They use messaging applications like Slack or Telegram. You can see what the general “investor” base is like by keeping an eye on these message groups, which run to thousands of people.

There is a huge number of people who quite simply couldn’t care less about the technology, whitepaper, team, management, or anything technical at all. They are simply looking to buy ICO’s and flip them immediately for profit.

By my estimate, nearly two-thirds of the enquiries on these community channels are either related to the terms of the ICO (i.e., What is this? How do I buy it?), or asking when the particular cryptocurrency will be listed on an exchange (i.e., How quickly can I cash out?).

This is pure, unfettered speculation. It’s gambling, nothing more. And it’s not sustainable in the long run.

Now, I’m not saying that nobody is looking at proper business cases and asking the right questions. I’m just observing that hundreds of millions of dollars are pouring into a very, very wide range of ideas (many that exist solely in a whitepaper) right now.

These kinds of capital raises also represent a massive mismatch of capital versus quality.

Typically, with an unproven business model (i.e., little more than a whitepaper), you would be able to raise angel venture capital (VC), or seed money… a few hundred thousand dollars perhaps.

But now, these same companies, because they are focused on blockchain, are raising tens of millions of dollars or more. In traditional venture capital, these kinds of sums are reserved for proven, fast-growing and revenue-generating operational businesses.

There will be blood…

It doesn’t take a genius to realise that huge sums of capital will be squandered during this speculative boom.

Some blockchain companies will become the next Apple or Microsoft… but most won’t. There will be a bloodletting at some stage. I’m not a bear at all, I’m just rational. It’s better just to accept that fact now and be invested in the better cryptos, than be on the back foot and panic when the correction comes.

Also, there isn’t much in the way of regulatory clarity on many of these cryptocurrencies.

The cryptocurrency industry is now discouraging use of the word “ICO” because of the clear stock market connotations. Because of the lack of regulatory oversight, coupled with speculative mania, I suspect it’s only a matter of time before we witness a largescale incident of fraud.

For example, recently crypto startup called Confido raised hundreds of thousands of dollars in an ICO. But the founder subsequently disappeared with the money. And there’s no regulator to go crying to.

Now when it comes to legal, plenty of companies do adopt best practices, spending a lot of time and money to do so. But plenty do not. And when investors are simply focused on “when’s the ICO?” and “how soon can I dump it afterwards?” then I think you’ll agree that there are incentives for bad actors to take advantage.

So make no mistake, large sums of money will be lost in cryptos in the year ahead. And cryptocurrencies will continue to be one of the most volatile asset classes on earth.

But you should still own bitcoin

Regardless of the incredible volatility and wild west nature of this space, and at the risk of repeating myself, I still believe that if you have a little spare speculative capital standing by, then you should get some cryptocurrencies in your portfolio.

The most appropriate course of action for the majority of investors is simply to buy a little bitcoin – and forget about it. Buy, hold and ignore the volatility. Participate financially, not emotionally. It’s not a one-way ride, and it’s a bumpy one. Be prepared to stomach big declines and sit tight. And “invest” no more than you can absolutely afford to lose.

Bitcoin is an asymmetric bet… if it falls or even goes to zero, your loss is small (assuming you’ve put in only what you can afford to lose). But if over the next few years it continues go up, then gains of 10 to 50 times are entirely possible… and even bigger gains lie outside of bitcoin in the cryptocurrency space. There is no other asset class on earth that offers this kind of return profile.

In short, everyone needs to familiarise themselves with the process of buying, trading and storing cryptocurrencies. They’re here to stay. And being on the outside (and not understanding them) will limit your ability to profit from them.

Good investing,