<\/p>\n
I\u2019ve been asked about Bitcoin a lot lately. I\u2019 haven\u2019t written anything about it because I find myself in an uncomfortable place in agreeing with the mainstream media: It\u2019s a bubble. Bitcoin started out as what I\u2019d call \u201cmillennial gold\u201d \u2013 the young (digital) generation looked at it as their gold substitute.<\/p>\n
Bitcoin is really two things: a blockchain technology and a (perceived) currency. The blockchain element of Bitcoin may have enormous future applications: It may be used for electronic contracts, voting, money transfers \u2013 and the list goes on. But there is a very important misconception about Bitcoin: Ownership of Bitcoin doesn\u2019t give you ownership of the technology. I, without owning a single bitcoin, own as much Bitcoin technology as someone who owns a million bitcoins; that is, exactly none. It\u2019s just like when you have $1,000 on a Visa debit card: That $1,000 doesn\u2019t give you part ownership of the Visa network unless you actually own some Visa\u2019 stock.<\/p>\n
Owning Bitcoin gives you a right to \u2026 what, actually? Digital bits?<\/p>\n
I can understand gold bugs and the original Bitcoin aficionados. The global economy is living beyond its means and financing its lifestyle by issuing a lot of debt. Normally this behavior would cause higher interest rates and inflation. But not when you have central banks. Our local central bankers simply bought this newly issued debt and brought global interest rates down to near-zero levels (and in many cases to what would have been previously unthinkable negative levels). If you think investing today is difficult, being a parent is even more difficult. I tried to explain the above to my sixteen-year-old son, Jonah. I saw the same puzzled look in his eyes as when he found out where babies come from. I also felt embarrassed, for my inability to explain how governments can buy the debt they just issued. The concept of negative interest rates goes against every logical fiber in my body and is as confusing to this forty-four-year-old parent as it is to my sixteen-year-old.<\/p>\n
The logical inconsistencies and internal sickness of the global economy have manifested themselves into a digital creature: Bitcoin. The core argument for Bitcoin is not much different from the argument for gold: Central banks cannot print it. However, the shininess of gold has less appeal to millennials than Bitcoin does. They are not into jewelry as much as previous generations; they don\u2019t wear watches (unless they track your heartbeat and steps). Unlike with gold, where transporting a million dollars requires an armored track and a few body builders, a nearly weightless thumb drive will store a dollar or a billion dollars of Bitcoin. Gold bugs would of course argue that gold has a tradition that goes back centuries. To which digital millennials would probably say, gold is analog and Bitcoin is digital. And they\u2019d add, in today\u2019s world the past is not a predictor of the future \u2013 Sears was around for 125 years and now it is almost dead.<\/p>\n
A client jokingly told me that his biggest gripe with me in 2016 and 2017 was that I didn\u2019t buy him any Bitcoin. I told him not so jokingly that if I bought him Bitcoin, he\u2019d be right to fire me. Maybe I\u2019m a dinosaur; but, like gold, Bitcoin is impossible to value. What is it worth? It has no cash flows. Is a coin worth $2, $200, or $20,000? But Wall Street strategists have already figured out how to model and value this creature. Their models sound like this: \u201cIf only X percent of the global population buys Y amount of Bitcoin, then due to its scarcity it will be worth Z\u201d. On the surface, these types of models bring apparent rationality and an almost businesslike valuation to an asset that has no inherent value. You can let your imagination run wild with X\u2019s and Y\u2019s, but the simple truth is this: Bitcoin is un-valuable.<\/p>\n
In 1997, when Coke\u2019s valuation started to rival some dotcoms, bulls used this math: \u201cThe average consumer of Coke in developed markets drinks 296 ounces of Coke a year. These markets represent only 20% of the global population.\u201d And then the punchline: \u201cCan you imagine what Coke\u2019s sales would be if only X% of the rest of the world consumed 296 ounces of Coke a year?\u201d Somehow, the rest of the world still doesn\u2019t consume 296 ounce of Coke. Twenty years later, Coke\u2019s stock price is not far from where it was then \u2013 but on the way it declined 60% and stayed there for a decade. Coke, however, was a real company with a real product, real sales, a real brand and real tangible, dividend-producing cash flows.<\/p>\n
If you cannot value an asset you cannot be rational. With Bitcoin at $11,000 today, it is crystal clear to me, with the benefit of hindsight, that I should have bought Bitcoin at 28 cents. But you only get hindsight in hindsight. Let\u2019s mentally (only mentally) buy Bitcoin today at $11,000. If it goes up 5% a day like a clock and gets to $110,000 \u2013 you don\u2019t need rationality. Just buy and gloat. But what do you do if the price goes down to $8,000? You\u2019ll probably say, \u201cNo big deal, I believe in cryptocurrencies.\u201d What if it then goes to $5,500? Half of your hard-earned money is gone. Do you buy more? Trust me, at that point in time the celebratory articles you are reading today will have vanished. The awesome stories of a plumber becoming an overnight millionaire with the help of Bitcoin will not be gracing the social media. The moral support \u2013 which is really peer pressure \u2013 that drives you to own Bitcoin will be gone, too.<\/p>\n
Then you\u2019ll be reading stories about other suckers like you who bought it at what \u2013 in hindsight \u2013 turned out to be the all-time high and who got sucked into the potential for future riches. And then Bitcoin will tumble to $2,000 and then to $100. Since you have no idea what this crypto thing is worth, there is no center of gravity to guide you or anyone else to make rational decisions. With Coke or another real business that generates actual cash flows, we can at least have an intelligent conversation about what the company is worth. We can\u2019t have one with Bitcoin. The X times Y = Z math will be reapplied by Wall Street as it moves on to something else.<\/p>\n
People who are buying Bitcoin today are doing it for one simple reason: FOMO \u2013 fear of missing out. Yes, this behavior is so predominant in our society that we even have an acronym for it. Bitcoin is priced today at $11,000 because the fool who bought it for $11,000 is hoping that there is another, greater fool who will pay $12,000 for it tomorrow. This game of greater fools is not new. The Dutch played it with tulips in the 1600s\u2013 it did not end well. Americans took the game to a new level with dotcoms in the late 1990s \u2013 that round ended in tears, too. And now millennials and millennial-wannabes are playing it with Bitcoin and few hundred other competing cryptocurrencies.<\/p>\n
The counterargument to everything I have said so far is that those dollar bills you have in your wallet or that digitally reside in your bank account are as fictional as Bitcoin. True. Currencies, like most things in our lives, are stories that we all have (mostly) unconsciously bought into. (I highly encourage you to read my favorite book of 2015: Sapiens, by Yuval Harari.) Of course, society and, even more importantly, governments have agreed that these fiat currencies are going to be the means of exchange. Also, taxation by the government turns the dollar bill \u201cstory\u201d into a very physical reality: If you don\u2019t pay taxes in dollars, you go to jail. (The US government will not accept Bitcoins, gold, chunks of granite, or even British pounds).<\/p>\n
And finally, governments tend to look at Bitcoin and other cryptocurrencies as a threat to their existence. First, governments are very particular about their monopolistic right to control and print currencies \u2013 this is how they can overpromise and underdeliver. No less important, the anonymity of cryptocurrencies makes them a heaven for tax avoiders \u2013 governments don\u2019t like that. The Chinese government outlawed cryptocurrencies in September 2017. Western governments are most likely not far behind. If you think outlawing a competitor can happen only in a dictatorial regime like China\u2019s, think again. This can and did happen in a democracy like the US. With Executive Order 6102 in 1933, US President Franklin D. Roosevelt made it illegal for the US population to \u201choard gold coin, gold bullion, or gold certificates.\u201d<\/p>\n
However, nothing I have written above will matter until it does. Bitcoin may go up to $110,000 by the end of the 2018 before it comes down to \u2026 earth. That is how bubbles work. Just because I called it a bubble doesn\u2019t mean it will automatically pop.<\/p>\n
So, how does one invest in this overvalued stock market? Our strategy is spelled out\u00a0in this fairly lengthy\u00a0article.<\/a><\/em><\/p>\n Vitaliy Katsenelson is chief investment officer at\u00a0\u00a0Investment Management Associates<\/a>\u00a0\u00a0in Denver, Colo.\u00a0He is the author of\u00a0\u201cActive Value Investing\u201d\u00a0(Wiley) and\u00a0\u201cThe Little Book of Sideways Markets\u201d\u00a0(Wiley). Read more on Katsenelson\u2019s\u00a0\u00a0Contrarian Edge<\/a>\u00a0\u00a0blog.<\/em><\/p>\n