Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 240

Bitcoin: digital gold or fool's gold?

Over the past few months, I've taken one question more than any other: "What do you think about Bitcoin?" Through 2017, Bitcoin, the world's first cryptocurrency, rose by almost 1,200%, prompting excitement and bafflement.

My answer: I'm enthusiastic about the Blockchain technology that makes Bitcoin possible. In fact, Vanguard is using such technology. As for Bitcoin the currency? I see a decent probability that its price will go to zero.

Are cryptocurrencies currencies?

Bitcoin's creators introduced the cryptocurrency in the wake of the GFC. The goal was to bypass governments and banks when two individuals want to transact. No country, company, or institution controls the currency. But are Bitcoin and competing cryptocurrencies really currencies? Let's think about what a currency is:

  • A currency is a unit of account. Cryptocurrencies qualify, as they can measure the value of other goods and services.
  • A currency is a medium of exchange. I'd give cryptocurrencies a qualified yes on this point. Currently, only a limited number of vendors globally accept cryptocurrencies, and recent volatility has already discouraged increased adoption.
  • A currency is a store of value. Bitcoin is not. Its price volatility undermines its adoption, as fewer vendors will accept a currency whose value can fluctuate so dramatically. The prices of newer currencies have been similarly volatile.

The existential dilemma

Let's call the verdict on the currency question mixed. Even if cryptocurrencies qualify as currencies for niche purposes, their prospects seem dubious.

The greatest threat is central banks, which have started to research Blockchain-based currencies and impose regulations on exchanges. Given the additional control and policy effectiveness that digital currencies could provide, central banks have good reason to adopt digital currencies in the coming decades. Those currencies would be ‘legal tender’, legally recognised forms of payment for all debts and charges.

If the choice were between Bitcoin or a Blockchain-based dollar, which would you rather have in your digital wallet?

Cryptocurrencies as investments

The investment case for cryptocurrencies is weak. Unlike stocks and bonds, currencies generate no cash flows such as interest payments or dividends that can explain their prices. National currencies derive their value from the underlying economic activity of the countries that issue them. Cryptocurrency prices, on the other hand, are generally not based on economic fundamentals. To date, their prices have depended more on speculation about their eventual adoption and use. The speculation creates volatility that, ironically, undermines their value as a currency.

Nor are cryptocurrencies a chance to capitalise on Blockchain technology, which is the method most cryptocurrencies use to record network transactions and ensure their accuracy. Although cryptocurrencies are built using a Blockchain, they are not necessarily tied to the value of Blockchain applications that may improve the cost, speed, and security of executing transactions or contracts. Bitcoin is an investment in blockchain in the same way that Pets.com was an investment in the internet.

For investors, adding some exposure to Bitcoin would mean reducing their allocations to tried and true asset classes such as stocks, bonds, and cash—the building blocks for well-diversified portfolios that can help them meet their goals. With no cash flows and extreme volatility, the investment case for Bitcoin is hardly compelling.

We are early in the development of Blockchain technology. We'll likely see Blockchain adopted by governments and enterprises for specific purposes in the coming decades. As innovation quickens and competition increases, the majority of networks (and their associated cryptocurrencies) may be rendered obsolete, leaving many cryptocurrencies like tulip bulbs in 17th-century Holland—soaring to incredible heights before the speculative bubble pops.

And, unlike tulips, they don't look good in a vase.

 

Joe Davis is Global Chief Economist at Vanguard, a sponsor of Cuffelinks. This article is in the nature of general information and does not consider the circumstances of any investor.

 

4 Comments
John
February 19, 2018

Anyone prepared to comment on USI-Tech ?? Just that there seems to be a lot of people around that have been sucked in by their marketing.
Also this link may be of interest
https://www.cgdev.org/sites/default/files/blockchain-and-economic-development-hype-vs-reality_0.pdf

Felix
February 19, 2018

Chris, are you referring to Central Banks or commercial banks? Commercial banks offer the services we all need such as loans to buy houses, and cards that we can pay for things with a tap, credit cards that we can use overseas without the need to carry foreign currency. Central Banks ensure the monetary system is functioning. Central banks were instrumental in softening the blow from the 2008 financial crisis, and have done so whilst providing price stability. On the other hand cryptocurrencies are useless as mediums of exchange, and stores of value, and have higher transaction costs than standard bank issues payments systems.

In other words, what problem currently exists in our current payments/monetary system that requires a solution that is volatile, unregulated, prone to hacking and requires contributing to climate change by production of useless digital tokens?

Blockchain technology is a different issue, and may be developed into something useful, but that is irrelevant to the fact that all cryptocurrencies will revert to a price/value of NIL in time.

Chris
February 19, 2018

Too brief of an article to portray the broad scope of 1400+ cryptocurrencies and blockchain technology. Also how did the author barely touched on the smart contract potential of Ethereum and the potential use cases in everyday life, and that being a key reason people are speculating/investing and value of bitcoin going up based on first mover basis.

Also people are sick of centralised banks. If I had the choice, decentralised currency, does not have to be bitcoin, will always win over anything a bank can offer me.

Alex
February 15, 2018

Bitcoin is not a ‘medium of exchange’- nobody is accepting Bitcoin since the crash started (even before the crash, maybe 0.0001% of retailers in the world accepted it as payment for goods or services).

 

Leave a Comment:

     

RELATED ARTICLES

Gold remains solid as Bitcoin melts

Bitcoin as the new gold, or where I’ve seen this before

banner

Most viewed in recent weeks

A tonic for turbulent times: my nine tips for investing

Investing is often portrayed as unapproachably complex. Can it be distilled into nine tips? An economist with 35 years of experience through numerous market cycles and events has given it a shot.

Rival standard for savings and incomes in retirement

A new standard argues the majority of Australians will never achieve the ASFA 'comfortable' level of retirement savings and it amounts to 'fearmongering' by vested interests. If comfortable is aspirational, so be it.

Dalio v Marks is common sense v uncommon sense

Billionaire fund manager standoff: Ray Dalio thinks investing is common sense and markets are simple, while Howard Marks says complex and convoluted 'second-level' thinking is needed for superior returns.

Welcome to Firstlinks Edition 467

Fund manager reports for last financial year are drifting into client mailboxes, and many of the results are disappointing. With some funds giving back their 2021 gains, why did they not reduce their exposure to hot stocks when faced with rising inflation and rates?

  • 21 July 2022

Welcome to Firstlinks Edition 466 with weekend update

Heard the word, cakeism? As in, 'having your cake and eating it too'. The Reserve Bank wants to simultaneously fight inflation by taking away spending power, while not driving the economy into a recession. If you want to help, stop buying stuff.

  • 14 July 2022

Welcome to Firstlinks Edition 465 with weekend update

Many thanks for the thousands of revealing comments in our survey on retirement experiences. We discuss the full results. And with the ASX200 down 10%, the US S&P500 off 20% and bond prices tanking, each investor faces the new financial year deciding whether to sit, sell or invest more.

  • 7 July 2022

Latest Updates

Financial planning

Five charts show predicaments facing financial advice

The number of financial advisers in Australia has almost halved at a time of greater need than ever. What has happened to the industry and its clients as yet another Quality of Advice Review takes place?

Property

House price doomsayers: Could housing prices really fall by 20%?

Why do house prices move in an up-and-flat pattern rather than up-and-down like shares? When house prices start to fall, supply reduces to create a new equilibrium, rather than needing even more price reductions.

Latest from Morningstar

Why I’m not ready for an SMSF

SMSFs are increasing in popularity among younger investors, drawn by the investment control and fixed costs. But until a sufficient balance is achieved, it may be better to stay with a large fund.

Investment strategies

Six ways to take a ‘private equity’ approach in listed markets

By taking a private equity approach to investing in the public equity markets in this difficult market, investors can harness the 'best of both worlds' and still make superior returns over the long term.

Investment strategies

How to avoid being a bad investor

It's tough to become the 'best' investor in the world, but we can certainly avoid being the 'worst'. Here are graphical examples of some long-term principles to adopt, including the difficulty of timing the market.

Financial planning

The case for closing the financial gender gap

While the gender pay gap is slowly improving in the workplace, ATO data shows Australian men aged 55-59 average $50,000 more in super than women of the same age. Financial advisers have a role to play.

Property

Three opportunities in property in Australia and APAC

Rising interest rates and occupancy threats have reduced the share prices of many property companies and trusts, but the selling underestimates the strong pockets of demand and robust earnings from good tenants.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.