By PATRICK CAIRNS
Last month the price of Bitcoin rose above $40 000 for the first time.
Five years ago, at the end of 2015, one Bitcoin was trading at just over $400. Anyone who had bought the cryptocurrency then and sold it at last month’s peak would therefore have made more or less 100 times their money.
They would, however, have had to deal with some stomach-churning ups and downs along the way.
The last time Bitcoin surged like this was in December 2017. Back then, the price of the cryptocurrency briefly went over $20 000, having started the year at around $1 000.
By the end of 2019, however, it was back down under $3 500.
It is important for anyone looking at the current surge in the bitcoin price to bear this in mind. Buying cryptocurrencies has never been a one-way bet. Movements in the price can be very large, and very swift.
This is because the price is primarily driven by one thing: sentiment.
There are many cryptocurrency ‘experts’ who can come up with any number of reasons why bitcoin went up like it did in 2020. A simple internet search will find them.
But one of the most important things to remember about bitcoin is that there is really no way to tell what it is actually worth. Whatever you might think about its benefits or its usefulness of the technology it is based on, there is no economic or financial model that can be used to calculate its value.
Comparisons with gold
Consider that bitcoin doesn’t produce any income. It does not generate a cash flow that can be projected into the future and valued.
It’s true that gold doesn’t do those things either. And like gold, there are a finite number of bitcoin in the world.
There is, however, a very significant difference between an ounce of gold that you can see and touch and appreciate as something that is beautiful, rare and precious, and a bitcoin, which is entirely intangible.
Gold has, for centuries, been recognised as having value, precisely because that value is visible to everybody. Bitcoin does not have that same advantage.
That means that one bitcoin is, very crudely, worth whatever someone is willing to pay for it. Since this is such a subjective measure, the price can swing wildly.
Which isn’t to say that bitcoin has no real value. It might. But, it also might not.
This is what led the Financial Conduct Authority (FCA) to issue the warning it did to investors last month:
“Investing in cryptoassets, or investments and lending linked to them, generally involves taking very high risks with investors’ money. If consumers invest in these types of product, they should be prepared to lose all their money.”
Being taken more seriously
One of the interesting things about the most recent increase in the bitcoin price is that there has been a lot more interest from significant, mainstream investors. Some large asset managers have been adding it to their portfolios. Big banks have been talking about how it could offer investors the same kinds of protection as gold does.
This doesn’t guarantee that the current price is sustainable. It is still quite possible that at some point these investors will decide, for many possible reasons, that bitcoin really isn’t as useful as they thought it was. It is very possible that the real value of bitcoin is, as the FCA warns, nothing.
However, for now at least, their interest does mean that cryptocurrencies are being treated a little more seriously. And some knowledgeable investors are suggesting that it could be worth holding some in your portfolio.
Should you own some?
Even the most positive of them, will nevertheless warn against jumping all-in.
One example is Ric Edelman, who has been named as the top financial adviser in the US three times by Barron’s. He is very positive on bitcoin and recently noted that:
“The stock market makes 10% in a year. #Bitcoin routinely moves up or down 10% in a day. And so it is the potential for outsized returns. It is the number-one-performing asset class of the last one, three, five, and ten-year periods since inception and many people believe it’s still in its infancy. So there’s a tremendous opportunity.’
Even he, however, warns people not to go overboard:
“There still remain massive risks: technological risks, regulatory risks. Governments could get very upset with all of this. We don’t know where it’s going to go, so we want to keep our heads about us, not over-invest, and not subject ourselves to portfolio risks that would harm our personal finances.”
How much does he suggest an investor puts into bitcoin? No more than 1% or 2% of their portfolios.
One of South Africa’s most respected financial journalists, PATRICK CAIRNS is a trusted commentator on the world of investments and the quirks of behavioural finance. Over more than a decade he has built a reputation for keeping the industry honest, and putting the interests of investors first.
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