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Importance of remaining rational and why Bitcoin is worthless

A common question from investors is: “What’s your outlook for the next 12 months?” My honest answer these days is: “I don’t know.” That’s because the world confronts its most complex set of economic circumstances for at least 30 years. Charlie Munger, Vice Chairman of Berkshire Hathaway, said at the company’s recent annual general meeting: “If you are not a little confused by what's going on, you don't understand it.”

It's not a time for overconfidence

I admit it is a little confusing and this may not be helpful if you would like clear advice. But it is not the time to be overconfident. As the great economist John Kenneth Galbraith said: “One of the greatest pieces of economic wisdom is to know what you don’t know.” If you hear other investors expressing strong opinions at the moment, it probably means they are either in ‘marketing mode’ or they are unaware of today’s complexities. Our view is that the coming 12 months could see either further gains on share markets or a major correction. Judging which outcome is more likely is difficult, if not impossible.

The case for continued robust market conditions is convincing. Economies are likely to grow, strongly driven by vaccines allowing economies to reopen, unprecedented fiscal expenditure and aggressive monetary policy (zero interest rates and substantial buying of government and other debt). The scale of government spending and central-bank asset buying is historic and breathtaking.

The problem is that the case for a major correction in stock markets (20% or more) in the next 12 months is also convincing. A slump could be triggered by rising interest rates in response to inflation, a mutation of the covid-19 virus that eludes vaccines, a panic in emerging markets sparked by rising interest rates and a stronger US dollar, a spate of corporate debt downgrades and defaults due to rising interest rates, or the bursting of asset bubbles.

It is foreseeable that any of these risks could trigger a major correction, yet almost zero risk is priced into markets, market risk measures are benign and few people appear concerned. This may be due to the euphoria associated with the reopening of the world’s economies. Or it could be the manifestation of our personal experiences as we emerge from covid-19 and maybe a ‘fear of missing out’ when everyone seems to be making easy money.

We have seen similar situations where markets are priced for perfection and know it often ends abruptly and badly. We are not smart enough to leave a great party at one minute to midnight, just before things turn to pumpkin and mice. It is even harder to judge when to leave a party where the clocks have no hands. We are custodians of your money and we will never reach for risk due to a fear of missing out. Our job is to remain rational, make fact-based analytical decisions, and not get caught up with what other people are saying or doing.

In 1965, Warren Buffett wrote in his letter to investors in the Buffett Partnership:

“We derive no comfort because important people, vocal people, or a great number of people agree with us. Nor do we derive comfort if they don’t. A public opinion poll is no substitute for thought.”

We know we will inevitably make investment mistakes and it is important that we objectively recognise mistakes. In the past year, two mistakes stand out.

Our two mistakes

The first was Alibaba Group. After initially outperforming after we invested, Alibaba’s share price fell when the Ant initial public offering was pulled in November 2020 after Alibaba founder Jack Ma criticised Chinese regulators. While we never thought Ma would act so counter to his interests, I made a risk-management mistake in allowing our holding in Alibaba to grow via a higher share price to more than 8% of the portfolio.

There are times when we hold such conviction in a position that such an allocation is entirely sensible. The main reason I didn’t trim the Alibaba holding prior to the Ant IPO was because reducing our holding might have diminished the chance of securing a decent allocation in the listing. At the same time, Alibaba was performing strongly from an operational perspective and we assessed the stock to be undervalued. The plan at the time was to gain a holding in Ant before trimming the Alibaba holding to a more moderately sized position. In hindsight, this was a mistake and was likely due to overconfidence and confirmation bias.

Since then, we have trimmed our holding in Alibaba, notwithstanding our positive view on the prospects of the business and our assessment still that the company is undervalued. To avoid making the same error again, we have instituted risk controls that set a maximum position size for Chinese companies and certain other technology companies.

The second mistake of the past 12 months was being too cautious prior to the announcements about vaccine trials results that were released in November 2020. Our focus, as always, was on wanting to protect our investors from the risk had the vaccine trials failed. Thus, we did not place enough importance on the opportunity that would arise from successful trial results. Our combined risk ratio cap (which is discussed below) makes it expensive from a risk-budgeting perspective to place a meaningful proportion of the portfolio in cyclical stocks such as banks, industrials and travel-related companies. We knew the trial results were coming and prior to November 2020 we evaluated numerous more pro-cyclical opportunities (that have all done well since). But for various reasons I decided not to invest in these cyclicals and the portfolio entered November last year with limited cyclical exposure. In hindsight, this was a mistake. However, we will not chase the market after that horse has bolted.

We are happy with the underlying operating performance of each company in the portfolio (and, in most cases, their operating performance through the pandemic has been exceptional). We judge that the portfolio is well positioned to prosper over the next three to five years, almost irrespective of how events play out in the short term.

Risks hiding in plain sight

There is considerable debate and uncertainty on whether inflation will re-emerge as a threat and whether central banks will be forced to tighten monetary policy. It is clear that the reopening of economies and pent-up demand fuelled by expansive fiscal and monetary policies are resulting in constraints along supply chains and in labour markets. This has placed upward pressure on various goods and services such as building materials, certain commodities and transportation costs. It is likely these inflationary pressures will persist for some time.

The big question is whether these pressures will prove to be transitory – that is to say, disappear once supply chains normalise – or lead to more permanent inflationary pressures. Most central bankers say they think inflationary pressures will subside next year and they feel comfortable with their loose monetary policies. While we agree that this is the more likely outcome, we don’t think people should be complacent about inflation risks.

There is a meaningful risk that we may enter a period of inflation that troubles markets. Even if you believe that inflationary pressures are more likely to be temporary, the most important question to ask is what happens if inflation pressures are not temporary. If central banks were forced to tighten monetary policy by reducing, or ending, asset purchases and increasing interest rates, we could witness a major correction in equity and other asset markets.

Other risks hiding in plain sight include some worrying asset price bubbles. It would be fair to say that we are witnessing one of the most extreme delusions in modern history, measured by the breadth of participation and size. This delusion has some powerful attributes: cult-like behaviour, rebellion against authorities, gambling, break-out technology, a fear of missing out and the madness of crowds.

You have probably guessed that the prime example of bubbles are cryptocurrencies with Bitcoin being the pin-up. To put Bitcoin into context, if it were a listed company it would be the seventh or eighth most valuable company in the world (depending on the day).

Devoted followers accuse doubters of not understanding blockchain or the role of cryptocurrencies. Calling out a cult is not popular, particularly when people are making ‘easy’ money. But in times of cult-like behaviour, the most important thing is to stay rational and not be afraid of being unpopular with the crowd.

Let's look at crypto gold

Perhaps the best way to show how weird all this is, is to imagine if someone were to create crypto gold.

Imagine this journey starts via a proposal to launch a gold exchange-traded fund backed by one metric tonne of gold (35,274 ounces). At market prices, the assets of the new gold ETF are worth US$65 million. The gold ETF has one million units on issue so the initial price per unit is US$65, which should move in line with the gold price. The new gold ETF is named GOLDCOIN and listed on a reputable stock exchange. There is nothing revolutionary about GOLDCOIN other than it offers an easy way for investors to trade in gold.

A genius colleague, Hideyoshi Son (excellent, virtuous, good and respectable), proposes some enhancements to GOLDCOIN:

  • The total amount of gold in the ETF is fixed at one metric tonne
  • The total maximum number of units that can be issued is capped at 20 million units (rising from one million to a maximum of 20 million over time)
  • New units are issued to people who solve a complex mathematical riddle.

On review, we run into a problem: that the rules of the reputable stock exchange ban the issuing of units to new investors for no consideration. Not to be deterred, Hideyoshi Son says we need to create a mechanism to trade our product outside the system so we won’t be constrained by stock exchange rules or, for that matter, laws or regulations. He suggests that units in GOLDCOIN be recorded on a new fully distributed ledger known as the blockchain.

This form of ledger changes everything, he argues. Most importantly, a blockchain ledger gives reliable proof of ownership but also total privacy – no one can find out who owns units in GOLDCOIN. Our new product is outside the constraints of the current system and doesn’t have to comply with any anti-money-laundering laws, exchange rules, consumer-protection laws, etc. This provides GOLDCOIN with an enormous potential market.

We launch GOLDCOIN on the new blockchain but things don’t go as planned. Each time we issue a unit to a person who solves the riddle, the value of a unit of GOLDCOIN falls. We are so stupid. Obviously when we create units for no consideration the value per unit falls. In fact, once the total number of units reaches the maximum 20 million allowed, the value of GOLDCOIN will fall by 95% on a per-unit basis.

Hideyoshi Son sees the flaw in our product. The problem, he says, is that the asset backing of GOLDCOIN is fixed at one metric tonne of gold. The solution, I suggest, is to increase the asset backing up to a maximum 20 metric tonnes of gold, in line with the maximum number of units we can issue. If we do this, each unit will always be backed by 0.035 ounces of gold. We now have the perfect product, a digital form of gold where each unit is always backed by the same quantity of gold, that can be traded anonymously on the blockchain outside of the reach of authorities.

Hideyoshi Son says so far so good but we need to do something more radical. He says the proposal to fully back the product with gold won’t work under the magic he is proposing where crypto mining and the solving of a complex riddle lead us to create another unit of GOLDCOIN. He says if additional units are backed by gold, and paid for, then no one will be motivated to solve the riddle.

He says the solving of a complex problem and setting a maximum limit on the total number of units that can be issued is essential to the psychology behind the illusion. He says to solve the problem of dilution resulting from issuing new units we need to remove the physical gold underpinning the value of GOLDCOIN. By removing any tangible asset backing from our product there can be no dilution when issuing new units – you cannot dilute something that has no value. He argues that people can be convinced that GOLDCOIN, with a capped number of units to be issued, is a new form of digital gold.

Sceptical me asked: “How can something that is imaginary, with no tangible value, be more valuable than our original product backed by one metric tonne of gold?”

Hideyoshi Son, a master of human psychology, says we have the perfect circumstances to create an illusion, one that defies the laws of economics and logic:

  • Post the financial crisis of 2008-09 and the recent pandemic, millions of people are worried that the world’s major currencies are being debased by excessive ‘money printing’ by central banks. He says placing a cap on the maximum number of units of GOLDCOIN that can be issued plays into these fears. He has inverted the law of dilution to a law of scarcity;
  • Removing any tangible value from our product removes any anchoring bias around its actual value;
  • The fact that ownership is untraceable, and the fact that it can be traded, makes units the ultimate medium of exchange for illicit activity;
  • The riddle-solving (or mining as it was to become known) to win a newly created unit and the dazzle of the blockchain give our product mystical properties;
  • Social media, with the right clickbait, will fuel unconstrained and widespread promotion of our product – no need to worry about legal constraints such as laws that demand a prospectus. He is most excited by a platform called TikTok due to its ability to attract a generation of first-time speculators. He guesses that as the price is driven up, more and more speculators will get on board. The mainstream media will become infatuated, thus giving GOLDCOIN legitimacy; and
  • As momentum grows, more people will be attracted to this unregulated system of easy money. Entrepreneurial people will offer services such as exchanges and crypto wallets.

Hand it to Hideyoshi Son, a true genius. He has created the illusion of scarcity and hence value from something that has no intrinsic worth. Our product, he argues, will become the world’s greatest Ponzi scheme. Some call his scheme a new digital currency or even crypto gold – highly amusing given that there is no gold backing.


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The above illustration clearly is absurd and defies logic

This imaginary product has attributes that are similar to those of Bitcoin. In our opinion, it is virtually certain that, in time, cryptocurrencies that are not backed by assets or by a central bank will become worthless. It is concerning, but not surprising, that regulators have not put in place appropriate regulations and consumer protections. They should.

Cryptocurrencies are operating outside the system, which enables their use for money laundering, terrorism, ransom, cybercrime and other illegal activity. It is inevitable that the regulators will catch up, and the day of reckoning may be approaching sooner than people expect. It is likely that this will end in tears for many people.

That said, while we are sceptical about the value of today’s cryptocurrencies, we believe in blockchain technology and think it will have profound implications and disrupt many industries. We expect that most central banks in time will issue digital currencies and private asset-backed cryptocurrencies (or stable coins) will enter more common use.

With the explosion of government debt following the pandemic amid the money printing of central banks, the case for a gold-backed cryptocurrency grows by the day. Maybe there is some truth in GOLDCOIN after all.

 

Hamish Douglass is Co-Founder, Chairman and Chief Investment Officer of Magellan Asset Management, a sponsor of Firstlinks. This article is for general information only and does not consider the circumstances of any investor.

 

42 Comments
Lee Strachov (Westpac)
October 13, 2021

Someone explain to me what problem bitcoin is solving?
I'm quite happy with my EFT to my account each month and online purchases/tap n go etc... all seems pretty solid to me. So bitcoin is what again? I can transfer $ between parties/pay bills for little or no cost.

Seems like we're all drinking the coolade and somehow think btc is the answer to all the worlds problems, when in actual fact, we're probably accelerating global warming now and bringing our species closer to the end.

We have all sorts of colourful characters banging on about inflation, fiat money etc and somehow bitcoin hedges against all that? Wow - OK. Maybe? until the bend at the end. My taxi driver the other day said he's only driving 2 days a week now because trades bitcoin. Interesting right? Everyone can make money off bitcoin... kids to taxi drivers... and we're all geniuses too! Add in leverage and things really get interesting. I guess it's OK though - because everyone knows crypto investing means you can lose 100%, bit like a casino right? Except don't the whales/pros do a good job fleecing the masses? pump/dump/rinse/repeat - and there's nothing anyone can do about it.

Honestly, this is scary stuff. But I don't want to be the party pooper, I'll watch the collapse from a safe distance thanks.

Chris
September 08, 2021

I've been investing consistently for the past 13 years and made a very good return in that time, so would consider myself an advanced investor; I'm also a scientist/engineer - as a tertiary qualified professional with qualifications (and a PhD) in the "hard sciences" (chemistry, maths etc.), so I deal in hard facts and logic, and am very analytical in how I look at things. I'm humble enough to not consider myself to be outstandingly smart, but I'm definitely "not silly" by any means and yes, I am technologically "with it" as a mid-40s Gen-Xer.

My point is, I want to - and I've really tried to - understand cryptocurrency, and I just can't. So if people GENUINELY can without fooling themselves that they do and can make money on it consistently, then good luck to them...because it makes no sense to me whatsoever at this moment in time, and the market for "coins" seems saturated. Buffett himself said "it's hard to do well in something when everyone else is interested in it".

And if someone like Hamish with his investment pedigree and his team of analysts cannot truly understand it, or even just "myself", as someone who has neither of those, but does understand finance and has the intelligence to understand both complex theories and abstract scientific concepts - but cannot see how this stands up - then what hope does the average person have ? And by that measure - because I suspect that I would be similar to many others out there of a similar intellect and background - and the fact that there would be many more like myself, why is it that there are so many like me, such a weight of people who also, do not fully understand it if indeed, it IS so easy to and is not just a matter of faith and belief ? (as some would say that fiat money is ?)

So, some questions. If it is so good and such a great investment, why does Buffett not invest in it ? Is it because like me, he doesn't understand it and therefore, doesn't invest in it ?

Secondly - as pointed out by Roger Montgomery on ABC nightlife some months ago - what about deflation and inflation, because if your supply of coins is limited, then how does it obey these normal rules of finance ?

And finally, again, as per Montgomery, bitcoin appears to be backed by fiat money (because when you sell it, that's what you get when you 'cash out'). So if fiat money (and by the same token (sic), gold, real estate etc.) is backed by the Government but cryptocurrency is decentralised, unregulated etc., then what else - if not fiat money - backs a cryptocurrency to give it that credibility as being a store of wealth ?

Stephen
September 21, 2021

With bitcoin, you have that peace of mind knowing that every single coin was hard-won through hard work. If you understand the SHA256 algorithm, you know for sure that no one can cheat and create a coin for free out of thin air like they can with fiat currencies. So from that point of view bitcoin is a superior and fairer monetary system because every player in it is equal. That is why people are adopting bitcoin and switching to it once they realise that it is a superior system. With fiat currencies, some players in that system have to work their guts out for a few coins while other players in the very same system like central bankers can create trillions of new currency at the click of a button without working for it. So that is not a fair system, not a level playing field like bitcoin.

SMSF Trustee
September 21, 2021

Stephen, no one can create fiat money out of thin air. Money is created by lending activity from a regulated bank writing a loan to a real person for a real economic action. To do that the bank needs to have equity at risk and capital policies in place to meet APRA requirements. (QE is NOT money creating by the way.)
I'm not anti-bitcoin but you won't win over sceptics by arguing nonsense like this.

Lee
October 13, 2021

Your comment is exactly the sort of 'hype' & anti-govt/bankers that needs to be left out - so we can have a rational discussion. I wouldn't say bitcoin is a fairer/superior system by any means. Whether it is an asset (or speculative object - like tulips?) or a currency - doesn't seem to matter. People are buying it and hoping to sell it for a higher price - that's the greater fool theory, no? Most people aren't interested in using it as a 'currency' because for us mere mortals, that won't work with its huge price swings - sometimes huge % drops in minutes. so the only groups of people unfortunately that stick it out as a currency are the shady folks in our society that want to evade the arms of the law. The rest are just speculators hoping to make extra fiat dollars - that's it. All the stories in the papers, tend to be self serving. i.e. Billionaire #1 buys Bitcoin and is suddenly promoting it. This highlights the shadows that this all operates in... many will lose fortunes, and yes, one day the rush will be on for exits...

Alex
September 07, 2021

I am surprised on how many people in this discussion would conclude that it was really about 'gold' backed coin. Hamish could have used following instead of gold - manure, tulips, Elon Mask's spaceships or planets in the Solar system. He was trying to relate the bitcoin to something of a known calculable value. And that was his 'mistake'. A dog race does not have a tangible outcome of value, still some money or promissory notes exchanged at the end of the race. It is not about tangible value, it is about being 'independent' from banks, governments, taxes - make your pick. And the most interesting - those people that 'believe' that they understand, would like (quote) to educate (end quote) other that do not 'understand', and along the way use a bit of condescension towards those dumb. I have to admit, nothing has changed since the great tulip 'revolution'.

Marek
August 17, 2021

Hamish, I am shocked that someone as intelligent as you would recycle so many hackneyed criticisms of Bitcoin. Like it or not, the technology is revolutionary, and one cannot separate blockchain from Bitcoin, in the same way that the Internet and Intranets (internal networks used by companies) are incomparable. Proof of work is what creates the value. The work in this case is not done by soot-covered miners, digging underground for a precious metal, but by computers - also referred to as 'miners' - all racing to solve a complex algorithm. Whichever computer(s) solve(s) the algorithm first is given permission to mine the next block on the blockchain, and is also rewarded in Bitcoin. This is the first time in history that digital scarcity has been created, and it is a monumental advance in existing technology. I won't go into any further detail about the workings of Bitcoin as the information is out there readily available, and there are people with far more knowledge than me who could explain it better than I ever could. Of course many cryptocurrencies will go to zero, but to suggest that the whole industry - yes, it is an industry - will disappear, is myopic at best. One cannot close Pandora's box once it is opened. One of the clichéd criticisms I will respond to is about illicit activity. Banks and the existing fiat currency system already do a fine job of laundering money made via nefarious means. Who in their right mind would want to try to launder money on a fully open and transparent blockchain, with transactions embedded on it for life? Seems counterproductive in that respect. Hamish, if you had allocated and managed a 5% position in Bitcoin in the Magellan Global fund over the last few years, it would have been the best performing managed fund for some years now. Of course I understand that you don't want to be the one risking his neck, but a 5% position means that if it 'goes to zero' as you say, it will not make a marked impact on the fund, but if it continues to increase in value - which it is likely to do over the long-term - you could have made the best decision of any fund manager. I implore you to listen to some talks by Andreas Antonopoulos, or Lyn Alden, both of whom offer deep insights into what is happening here (the former about Bitcoin and cryptocurrencies specifically, the latter about cryptocurrencies albeit with a background in financial market analysis). 

Satoshi Nakamoto
August 10, 2021

It's disappointing to see such an argument against bitcoin from someone like Hamish. He does himself an injustice. A very solid rebuttal is laid out here https://listedreserve.substack.com/p/bitcoin-is-going-to-zero

Buckerooster
August 09, 2021

Bitcoin has a value to all those who have had their computers hacked with Ransom ware and have to pay in Bitcoin to open up their computers again.
I am a victim of that Ransom ware and had to pay in Bitcoin. I sacrificed the computer.

ozziefrog
August 09, 2021

I agree that a fiat currency has no intrinsic value, but it is issued by A government (elected or otherwise) and backed by A central or reserve bank. As for a crypto the issuer is unknown and backed by nothing.

L
August 08, 2021

There is quite a few flaws in your Bitcoin argument, best summed up in two ways:

Something new, seemingly magical, i.e.
'What's this black stuff bubbling to the surface in my California farm?', 'There is only worldwide demand for like, 2 personal computers (IBM)', "Why would I need a motorised horse?', 'Telephones are only for wealthy people', et al.

Vested interest bias:
Blockchain is good, very good. Except for money.

Cheers.

Ruth
August 09, 2021

It's speculated that bitcoin is the new gold, replacing it as the motor car replaced the horse. But we are not still driving that same model car, which was quickly replaced by others. I have the same reservation about bitcoin. I also have doubts about blockchain. Hashgraph looks to be a more promising technology, and though it's not open source, the point is it may be replaced by superior code. I can understand the appeal of a limited currency (which gold could provide) though. Trust in banking is low, especially since the GFC as taxpayers are still footing the bill. I also understand the appeal of a currency which is borderless. All bitcoin seems to have going for it is a large network.

James Anderson
August 08, 2021

If you’re trying to value & understand Cryptocurrencies using traditional financial tools, you’re missing the point.

It’s a rebellion that you can invest in.

James Anderson
August 08, 2021

In the 1980s I remember trying to teach my Grandparents how it use their digital clock radio and their TV remote.
In the 1990s I was trying to teach my Mum how to use email.
In 2010 I tried to explain to my Dad the value of a smart phone.
I hope Hamish some patient relatives who can help him with Cryptocurrencies.

Also, as someone noted above and as Hamish seems to have forgotten, exactly what is backing the value of fiat money??

Chris
September 08, 2021

Fiat money is simply a symbol of confidence, that you believe it is worth something or that the promise on the note (particularly UK bank notes) will be honoured, based on the signature of the Governor of the Bank of England / Federal Reserve. Hence, "credit" from the Latin 'credo' - "I believe".

James
August 08, 2021

“Man yells at new ideas he doesn’t understand.”

Oz Dart
August 31, 2021

"Man yells to sell new ideas he doesn't understand to people who also don't understand."

Martin
August 08, 2021

Bitcoin has value for the same reason that the AUD has value.

With the AUD, a lumberjack is willing to do hard labour and chop wood all day for some AUD because he believes that with the AUD from a day of wood chopping he will be able to buy food and shelter for a few days from other suppliers around him. His employer is willing to give the lumberjack AUD in exchange for labour because the employer is rich and he doesn't want to spend his time chopping wood all day.

Bitcoin is the same. The only way a new bitcoin can be created is if you guess the right nonce value so that the SHA256 hashing function comes up with a number with enough leading zeros in the SHA256 hash. This amount of leading zeros has the difficulty level adjusted so that it would take around 10 minutes for all the miners around the world to find this number. There is no way to find this number mathematically using classical computer algorithms because if there was, it would be found instantly and not after 10 minutes of trying using brute force. So this number must be searched for by brute force and it takes all the computers around the world mining about 10 minutes to find this number by brute force. So just like the lumberjack chopping wood at a rate of X AUD per hour, which is what makes the AUD so valuable, the difficulty of finding the right nonce for this hash number through many many brute force attempts is what makes bitcoin so valuable and gives it its value.

When something is difficult to make and takes a lot of labour and effort to create it is valuable. That is why bitcoin, real estate, gold and AUD is valuable.

Chris
September 08, 2021

"When something is difficult to make and takes a lot of labour and effort to create it is valuable". Perhaps to the maker, but not necessarily to others who have had no part in it, because it depends on their perspective of 'worth'. For example, the rocks in my yard involved the Earth using a lot of labour, effort, heat, pressure and time to make them; things that I couldn't do myself, but by that same token, they are not diamonds, they are just rocks.

Joe
August 08, 2021

And Fiat is backed by? Exactly.

The GC
August 08, 2021

Agree with the logic and rationale approach you have taken to unpick why bitcoin will go to zero, but I think you fail to appropriately understand and you underestimate the current movement that has driven the success of bitcoin. It is very easy to point to mania/tech hype/FOMO, but this bubble has exploded/resurfaced multiple times so it is clear to see it is fulfilling some level of underlying growing demand. There is currently enough support in the movement for it to continue to succeed, whether is be a sovereign individual / any government stance, the shift against the USD/petro dollar and use of it as a global reserve currency, or simply an evolution of what the people will decide what is money in a digital/virtual age. Acnoledge there is absolutely huge risk involved, and it is largely a speculative punt at this stage, but I think as a money manager taking a small stake is worth the risk. (which is why so many who have delved even deeper and with deeper pockets have).

To stray so negatively against it undermines your ability to think of the positive possibilities and perhaps it will be one of the learnings you might reflect on in future years. You have clearly missed the boat on the initial phase of development of a new asset class, but if you keep an open mind, you dont have to miss even bigger ships sailing.

When you compare bitcoin to gold and then diverge in why one is sucesfull over the other is where I feel you fail to draw the links you need to. Gold clearly has value in use cases such in electronics, jewellery etc, but a vast amount of it sits in a vault gathering dust, it this is valuable then you could argue bitcoin is too, but its not for you or I to decide, its a consensus shift globally that will drive the outcome. Ultimately if the bitcoin experiment does suceed (it clearly has challenges) it will be as the next step in the evolution of money, a digital one driven not by centralised governments (whose trust in is continually falling) but one driven by maths and code. Don't trust, verify will be the mantra that will win.

Steve
August 08, 2021

At the moment, it is interesting to see which managers are performing the same (or above) the Vanguard International Shares Index Fund, and which ones aren't.

Trevor
August 07, 2021

OzTrev you say :
"Gold no longer backs any nation’s currency and consequently should not be accorded intrinsic value of yesteryear and consequently, should not be promoted as a hedge against inflation."
and then you proceed to answer your own question with :
"Diamonds can be produced artificially for industrial requirements but as yet not Gold".
Therein lies gold's unique characteristic. It is an enduring and time-honoured reservoir of value.
Michael O'Hara you say :
"Regulation is coming. When it does, libertarians would be stupid if they actually supported a digital currency. Government oversight on every transaction? Yikes!"
Yes ! Regulation is coming USING blockchain technology , partly because it will be used to oversee EVERY transaction , and combined with surveillance technology , EVERYBODY who is transacting !
"But without regulatory oversight, governments forgo potential taxes."
Money EXISTS to allow commercial activity and also ......so YOU CAN PAY YOUR GOVERNMENT TAXES.
That is why they ISSUE IT and why they BACK IT , and they will "enforce it's use " come what may .
In the US you pay your TAXES in $US , in Canada , in $CAD , in Australia , in $AUD ...and so on.
and if you don't , then EVENTUALLY the Government will send men with guns to make sure that you do !
This is NOT optional ! Governments exist to exert force ! Even Al Capone found that out the hard way !
They might accept gold , possibly the equivalent in STERLING , probably not yuan or renmimbi
but they sure won't accept cryptocurrency !
Whatever the Government finds acceptable !THAT is the measure of an "acceptable currency" !
.
And I don't think BITCOIN meets that criterion.
.
Glad to see Hamish's cogent reasoning and all the other "comments" which offer insights !
.



Pete
August 07, 2021

Hamish talking about bitcoin, is like asking a GP to treat cancer. Whilst he may be an expert in his general world of investing, he is a long way from being an expert in the New world of bitcoin. Blatant dismissal of the system is not based on facts, but rather shows a level of naivety. It's complicated yes, but it's offering a new system that gives freedom back to those who need it most. Listen to those who understand the ramifications.

Brett
August 07, 2021

I have never been able to comprehend the value (intrinsic or otherwise) of any crypto asset and thought I must have been missing something - glad to see that is not the case and I am not alone.

I get paid by an entry into my bank account, and I spend that money by electronic transfers, card swipes and direct debits against the same account. Aren't we already using digital currency, well backed by the integrity of the Government and its capacity to borrow and tax its constituents?

Alan
August 09, 2021

You nailed it Brett

Tony Dillon
August 06, 2021

"cryptocurrencies that are not backed by assets or by a central bank will become worthless"

Indeed. Not only does nothing of any value back them, nothing of any value has been created, apart from maybe bringing blockchain technology to the fore. These are make-believe commodities with price totally independent of value.

Connecticut Yankee
August 05, 2021

A somewhat different focus of why Bitcoin and other cryptocurrencies will not work in the end is their fatal linking of currency and investment . The two functions are incompatible.

Currency is a store of value for which users demand stability and low/nil cost. Exchange rates among different currencies can vary over time, but that is for bona fide economic reasons in balancing world economies. There is forex investing, but it is incidental to the currency function. The cost of issuing traditional currency (seigniorage) is very low and covered by the issuing government, not a user cost.

But the investment aspect turns on changing value up or down (depending on which side of the transaction the investor takes). So, why would a party selecting a currency for transaction purposes use something that varies in value as an investment? . . . unless that party affirmatively decides to transact and invest at the same time.

That is a throwback to a barter economy in which the value of the respective bartered good/services varies on both sides of the transaction. But at least in the old fashioned barter economy both items bartered (e.g., my 10 bushels of apples for your pig) have real value as opposed to Bitcoin having no real value (as Douglass's article highlights) except for misperceived value which will be found out a some point. Besides, the overlapping of currency and investment purposes is a very small sub-set of transactions as evidenced by the size and cumbersomeness of the barter economy.

I cannot see how Bitcoin can survive in the long run in is present formulation except for illicit and entertainment/gambling-like purposes.

Jason
August 05, 2021

The problem with Hamish's argument about non-gold backed currencies being worthless is that the US Dollar, like GOLDCOIN, also lost gold backing in 1971, so everything that Hamish says about GOLDCOIN also applies to USD. Hamish is essentially saying that USD is also worthless because it doesn't have gold backing and it is going to zero eventually.

Hamish would like to see the introduction of a new gold-based currency to prevent Governments from devaluing their currencies with endless money printing. But which Government would have the guts to do that???

Steve
August 06, 2021

I had the same thoughts about fiat money also, though there is the difference in that Bitcoin does have the a finite amount whereas currencies can continue to be printed. I'm not sure ultimately what that means though.

I do think with the current issue of zero or even negative interest rates around the world, money printing and Governments buying their own debt, the careful balance of the world's money supply, which ultimately is a ficticious concept of value built on trust and societal norms, is more precarious than ever.

Bitcoin has become just another extreme example of what happens when you try to change the rules of the market that have taken centuries to evolve. The risk of catastrophic system failure gets more real every day as everyone continues to try and avoid paying the piper for the bill that was the GFC. A decade and a half later and we are still trying to do anything other than actually dial back the mess that created. In the meantime, crazy bubbles are going to get worse and worse.

Phil
August 08, 2021

I tend to think of the USD as being backed by the US economy, not an insignificant backing. The other thing to keep in mind is that while the supply of Bitcoin is apparently, somehow capped, by someone, at 21 million, which may or may not be changed when they are all released/available, the number of cryptocurrencies is NOT capped. Just look at how many there are already. The promotion of apparent scarcity to support value is an illusion.
Brilliant article by Hamish and some thoughtful responses.

Connecticut Yankee
October 14, 2021

Government-issued currencies are backed by taxing power and that is pretty much the strongest, biggest value there is.

Gold backing is irrelevant and, indeed, is a handicap in a modern, dynamic society where limited gold could artificially restrict currency to smaller amount than needed. Taxation power backing, on the other hand, though constrained by the aggregate income of its country, expands with the economy. Easy peasy.

Who will Bitcoin be able to levy when bottom falls out? Handing out some more Bitcoins of plunging value in return for solving puzzles won't cut it. Maybe contribute some GameStop shares?

Michael O'Hara
August 05, 2021

I am in complete agreement with Hamish on Bitcoin.

However, we are in a minority. Most people are open to Bitcoin being something more than just a bit of code. Most people are influenced by the stories of a person buying pizza with Bitcoin years ago, which today values those pizzas at hundreds of millions of dollars. And people have - and are - making real money speculating on this technology. Every central bank investigating cryptocurrency possibilities enhances the perceived value of Bitcoin. 3rd world countries adopting it officially, gives hope that developed countries will as well. Visa allowing purchases using Bitcoin exposures enhances the logic that this technology will just get bigger.

We can logic away all of the supposed advantages of Bitcoin, as Hamish has done in this note. However, logic is not much use in the current marketplace. Call it crowd delusion or whatever else - it's very real. Anyone in the market knows the trends and names. Meme stocks can bring a dead company back to life - and profit! Expensive market exposures are sold as "free", while the traders profit massively. Explicit costs are exchanged for embedded costs, and suddenly a product is fee and it's sold as socially better. Unprofitable companies trade on their ESG credentials. And it's all ok. If enough people agree that an idea is a good idea - then it's going to work, even if it shouldn't.

Bitcoin and cryptocurrency are a fools playground. It's so ridiculous that nobody should have to state just how ridiculous it is. Yet that playground is opening up the long-lost "animal spirits" of the financial economy. Wild speculative gains are attracting not only scammers and speculators - but incredibly talented people, and in incredible numbers. That talent is going to find more and more ways of utilising this technology, and Bitcoin is the epicenter of it all.

I see Bitcoin as a complete farce. Yet the underlying technology will be useful. Probably not in the way anyone expects today, and probably not as a currency. Logic suggests Bitcoin's value as a currency is only valid outside of regulatory supervision. Therefore, it can only be useful so long as it can avoid regulatory supervision. But without regulatory oversight, governments forgo potential taxes. Regulation is coming. When it does, libertarians would be stupid if they actually supported a digital currency. Government oversight on every transaction? Yikes!

Investment speculation has created huge pools of HotMoney. That HotMoney will flow from place to place - including Bitcoin - upending logic and creating instant zillionaires. Millions of those speculators will slowly lose their capital. Much like Lotto, those small capital losers will just shrug their shoulders saying it was a risk they knew they were taking. This speculative mania is likely to get a lot bigger before it blows up. I thought WeWork was the pinnacle of irrational exhuberance, but no - if enough people treat speculation like a Lotto investment, this craziness will continue, and it will be the stuff of history books.

Mark
August 05, 2021

Leaving aside the content (which I support) it is a pleasure to read such a well written and constructed response.

H
August 22, 2021

Just theories. I like use cases

Sending money oversees. Sending $100 worth of crypto, fee is 10c. Sending $200, fee is 10c. Sending $1mil, fee is 10c. Make sense, PC uses the same amt of electricity in all cases.

Now sending $100 and most likely exchange it in EUR. Sending $100, fee is 50c. Sending $200, fee is $1. Sending $1mill, cpl of $000. It’s like your charged per digit, not per amt of energy used.

Yes, I like BTC. Solves problems, makes life easy, I feel I am not tricked.

OzTrev
August 05, 2021

When will the populace at large recognise that GOLD is just another mined metal used in electronic (junctions) and in jewellery in most Middle East and Asian countries.

Gold no longer backs any nation’s currency and consequently should not be accorded intrinsic value of yesteryear and consequently, should not be promoted as a hedge against inflation.

YES it is costly to mine as are diamonds, but to what purpose.

Diamonds can be produced artificially for industrial requirements but as yet not Gold.

Ruth
August 09, 2021

Bitcoin speculators are constantly talking it up, but those who own gold don't promote it. It's quietly held as a store of value and is currently being bought by central banks and seasoned investors. You won't be heckled into participating.

Russell (a veteran adviser)
August 05, 2021

Is a collapse of crypto triggering a financial crisis one a significant risk?

Ruth
September 13, 2021

That amusing thought has crossed my mind. Imagine if the Fed found itself having to buy up bitcoin to prevent a financial crisis! Except that it wouldn't be funny. And perhaps Wall Street bankers are already working on packaging them into 4 star securities to be onsold; with no skin in the game themselves they should escape with a good profit.

Ian
August 05, 2021

Interesting and a dilemma for an ESG investor where investing in Coal breaches Environmental requirements but the same ESG investor seemingly able to still support companies or funds where the Chinese government breach governance issues with arbitary intrusion in the market, human right abuses, the militarisation of the south China Sea and arbitary tariffs on Australian exports of Coal, Wine, Barley. Is adjusting risk management the solution?

Steve
August 05, 2021

Hamish
Re locking profits in ahead of IPO.

Why not write OTC calls, buy putts( synthetic sale- delta=100%) with your friendly investment banker. You PM can do this can’t they?

biggusriggus
August 05, 2021

Nice explanation of the issues with Bitcoin.

The idea of a gold-backed coin is problematic because the physical nature of gold undermines any derivative of it, whether it be an ETF or blockchain. The whole point of gold that is is physical. Everything else has counterparty risk; which is fine, as long as it is acknowledged.

 

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