To Bite or Not to Bite?
Key Takeaways
With the recent approval of Bitcoin ETFs, you may be wondering whether it deserves a place in your investment portfolio.
The existing issue is that Bitcoin continues to be very volatile, with its price chart has eerily resembling to a typical asset bubble pattern.
While cryptocurrencies could very well become mainstream over time — for now, there is no enduring economic or investment rationale for them to generate positive long term returns.
To be, or not to be, that is the question
— William Shakespeare
On 10 Jan 2024, the US Securities and Exchange Commission (SEC) approved the listing and trading of several Bitcoin ETFs for US investors. Over the past week, these instruments have attracted over US$2B in inflows from people hoping to make a quick buck. At the moment, Singapore retail investors are unable to access these instruments as the MAS has not given approval just yet.
With greater ease of access, it is likely that more investors are considering whether these deserve a place in their portfolios. It is important to note that cryptocurrencies, such as bitcoin, emerged only in the past decade. Unlike traditional money, no paper notes or metal coins are involved; these currencies are not backed by any assets, unlike traditional currencies created by central banks of countries around the world.
Currencies traditionally have been based upon the value of gold, silver or some form of commodity. Currencies are also backed by the full faith of governments or backed up by sovereign debt.
There is no such backing for cryptocurrencies and there is no clear way to determine the value of these except for demand and supply. Cryptocurrencies are based on pure computing power, where a complex mathematical problem needs to be solved before a unit of cryptocurrency is created. In the case of bitcoin, there is a finite supply of 21 million, of which more than 19.6 million are in circulation.
When considering whether something should be an investment — think of it from a business perspective. An investment should be an avenue for putting your capital to work, in an entity that is able to generate future profits for you. Of course your capital is exposed to business risks — the business could do poorly and shut down and you lose your money. But the return you get is to compensate for the risk you take.
As such, we invest in stocks to get an ownership share in a company, and we also invest in bonds to lend money to a company. The money we use to buy these shares or give loans is meant to participate in the global economy.
Money spent on buying digital currencies does not go towards this same economic purpose. When there is no asset to value behind the cryptocurrency, how can we actually determine what to pay? Is the price quoted on the exchange cheap, fair, or expensive?
The price of cryptocurrencies are determined by pure demand and supply. And at the moment, the only use case for Bitcoin is that it is similar to holding cash; it can be used to pay for some goods and services. However unlike cash, Bitcoin is a whole lot more volatile and a lot of goods and services are not priced in cryptocurrency.
With this in mind, it is not surprising that the Bitcoin price chart has an eerie resemblance to a typical asset bubble pattern.
Can cryptocurrencies evolve and become mainstream over time? It is possible. These instruments and the technology surrounding it may someday prove to be a historic breakthrough. For those who enjoy the thrill of speculation, trading such assets will give them the excitement they crave.
However, there is no enduring economic or investment rationale to expect cryptocurrencies to generate positive long term returns. Allocating a large chunk of your investment portfolio towards it means reducing allocations to traditional asset classes such as stocks, bonds, and cash — the fundamental building blocks of a good investment portfolio — increasing the potential of disastrous losses.
If you would like to find out more about proper portfolio construction, come and have a chat with us.
