Bitcoin skyrocketed, but is it ‘digital gold’ or ‘fool’s gold?’

Bitcoin was created in 2009 and is the largest (recently valued at more than $900 billion, the same as the market capitalization of Facebook and greater than 494 of the stocks that comprise the S&P 500) and oldest cryptocurrency, a type of digital currency that’s an alternative to the U.S. dollar and other traditional, government-issued fiat currencies.

Interest in cryptocurrencies and other speculative assets like “meme stocks” (think GameStop) and special-purpose acquisition companies (“SPACs”) exploded in the early days of the pandemic-induced economic shutdown as people found themselves bored and isolated, but armed with stimulus checks and access to online communities for traders like Reddit’s WallStreetBets forum and “commission-free” trading platforms like Robinhood.

Sprinkle in a little rebellious, “stick it to ‘The Man’” ethos (think Tesla CEO and crypto cheerleader Elon Musk, who ironically is “The Man” and can make crypto prices jump/plunge in the blink of a Tweet) and an unhealthy dose of “Fear of Missing Out” and you had the total market value of crypto going from $237 billion at the start of the pandemic to $759 billion at the end of 2020 and a recent high of $2.58 trillion.

Are cryptocurrencies “digital gold,” decentralized global currencies, totally free from government oversight/control that will continue to soar as they supplant government-issued currencies as a form of payment and store of value?

Or, are they “fool’s gold” that will crash when the crowd moves on to the next shiny new object? I don’t have a clue, but there are zealots on both sides who are way smarter than me. What I’ve learned in 40 years of investing is 1) it’s hard enough to make money in things you think you understand and 2) it’s critically important to know what you don’t know; a concept Warren Buffett refers to as not venturing outside your “Circle of Competence”(which he credits as a secret to his success).Crypto is clearly outside my admittedly limited circle of competence, so you can decide for yourself.

Look at George Washington on a $1 bill. You can use it to buy something (i.e. it’s a “medium of exchange”). You can deposit and save it at a bank (i.e. it’s a “store of value”). Finally, it’s a “unit of account” (i.e. how businesses price their products, account for income and expenses and keep track of how much they owe/are owed).

Bitcoin traded around $7,000 at the beginning of 2020, peaked at $64,289 in mid-April of 2021 and plunged to $34,259 on May 23, a drop of 47% in just over a month.

In my simple mind, it seems this type of extreme price volatility disqualifies Bitcoin (or any of the other cryptos) as a replacement for the dollar bill. No buyer/seller is going to use/accept Bitcoin if it can rise/fall 30% tomorrow (as it has in the past). In addition, price volatility makes Bitcoin a poor store of value and unit of account.

Bitcoin produces nothing and has no “intrinsic value” (like the U.S. dollar). If you accept Bitcoin fails (unlike the U.S. dollar) the three functions of a currency (“medium of exchange,” “store of value” and “unit of account”), then it has utility only as an instrument for speculators and cybercriminals.

Indeed, the totally anonymous, untraceable nature of Bitcoin makes it a key component of ransomware attacks (a form of malware that encrypts the victim’s computer files and holds them for ransom), like the recent attack that caused the Colonial Pipeline to shut down.

According to The Wall Street Journal, the FBI reported nearly 2,500 cases of ransomware in 2020 (a 66% annual increase), with victims paying $350 million ransom in cryptocurrency to regain use of their computer systems. Indeed, Colonial paid a $4.4 million ransom (in Bitcoin) to DarkSide, the Russia-based ransomware collective that will actually rent you the cyber tools to launch your own attack and collect the ransom, for a cut.

There is a big difference between trading/speculating and investing. Speculators crave the thrill of the “home run” by purchasing assets like Bitcoin that will never produce anything in the hope the pool of like-minded speculators, who also know Bitcoin will never produce anything, will expand and enable them to sell it at a higher price. By contrast, investors are content to stay within their “Circle of Competence” and play the boring “long game,” trying to hit singles and doubles and letting the “miracle of compound interest” put runs on the scoreboard.

Mickey Kim is the chief operating officer and chief compliance officer for Columbus-based investment adviser Kirr Marbach & Co. Kim also writes for the Indianapolis Business Journal. He can be reached at 812-376-9444 or mickey@kirrmar.com.

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