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A Letter To My Brother Last December On Crypto

My first (and last) contribution on cryptocurrencies was prompted by an inquiry from an unlikely source.

My older brother, a recent retiree living in the U.K. wrote to me late in December last year with a simple question “Would I buy cryptocurrencies?”

Below is my answer (with some minor edits) which I think covers everything I’ve ever wanted to say on the subject:

“D.

The short answer is, I wouldn’t buy them.

The general rule with investing is stay close to what you know. For that reason dentists are urged to buy stocks related to medicine, oil men should stick with energy and so on and this is, mostly, why to me they’re an avoid i.e. I don’t know much about them.

They are however something of a ‘meme’ at the moment. Everybody has a story about a friend, or a friend of a friend, whose made a ton of money in them; but this is the classic hallmark of a late-phase speculative bubble. Think early internet [1999 or so], tulip bulbs and etcetera.

To be a more specific, first, to describe these assets as ‘investments’ is a misnomer.

An investment is something that will #1 preserve your capital and #2 help that capital to grow. How do you know the capital will be preserved? Well, if it’s a bond issued by a government or top-notch company your answer is right there. How do you know your capital will grow? If it’s a bond you get a regular coupon payment and if it’s a stock of a growing company you usually get a dividend and, over time if the company grows, your investment grows in line with the underlying company’s fortunes.

Here’s the problem with digital ‘currencies’. There’s no guarantee or assumption that your capital can/will be preserved. Moreover, the only ‘growth’ that can occur is if others decide to buy after you. This is known, for obvious reasons in finance, as ‘the greater fool theory’; and it often works for maddeningly long periods of time.

To be clear on this point though, digital currencies cannot be correctly called investments therefore you cannot be said if you buy them to be investing.

Are they currencies though?

Finance Theory-101 defines a currency as having three characteristics: 1) it is a unit of account, 2) a store of value, and 3) a means of exchange. Here digital currencies today (yes, yes in the future and all that) fail all three tests.

So, to call them currencies is also a misnomer. They are not. Sure, they may become so but today they are, 101%, not.

If you buy one then what will you have you bought? We’ve established they’re not investments. Shares in Lloyds Bank and British government bonds are investments for the reasons described above but crypto doesn’t look anything like either of those. Have you bought a currency then? Again, surely not, nobody keeps their books in Ethereum, tries to pay their suppliers with it or is putting it aside for college fees in 20-years’ time.

If you buy one what you’ll have bought is an idea or meme as people prefer to call it because it sounds more scientific. It may be a good idea and it may be an idea that grows in popularity. Christianity seems to be mostly idea-based and has had a 2,000+-year run, so don’t discount the power of ideas to be persistent. However, the idea in this case has to lead somewhere to be of lasting value and here we get into the big problem.

Nobody can predict the future. Who, honestly now, saw Brexit or Trump coming? To say therefore these things won’t, one day, have some real value would be dangerous, they might, who knows?

But to buy any asset on the basis it may in the future have greater utility than today is to go into an orbit of risk I’m not comfortable with; and there’s a shorthand for this use of funds, it’s otherwise known as gambling. 

To wrap up. Buy a Bitcoin, or a bit of a Bitcoin, if you want but be prepared to see it halve [Ahem!], or worse, in value with no chance of recovery. Buy it for the thrill most of all as that’s what most buyers today are really doing.

What I suspect most digital currencies won’t do though, because we’ve probably by now sucked in most of the available fools, is double from current levels [At the time Bitcoin was around U$50,000].

Be clear above all that buying this stuff is not investing and you won’t own a currency either today, nor I suspect most likely, in the future.

Best,”

I believe my brother took the hint to steer clear and having not conflated gambling with investing continues his retirement comfortably.

Many though will be wondering how capital vaporized in these so-called assets can be recovered? A good question I’ve no answer to. But, like other prudent investors, I’ve no need to address it either.

Nial Gooding, May 12th, 2022

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