You might have heard about the rise in value of bitcoin and other cryptocurrencies. And you might be wondering whether you should have some in your investment portfolio.
Until recently, the only people interested in cryptocurrencies were digital enthusiasts and anyone who believes that flat currencies (i.e. cash) are coming to an end. But now, the sharp rise in the market value of cryptocurrencies has led to intense media attention.
If you’re a regular reader, you’ll know what we think about the angle the media usually takes, and what we’re likely to say about it. Read on to find out if your guess is correct.
First, let’s define what we’re talking about.
Cryptocurrencies are bits of digital code, created on computers and stored in a digital wallet. Transactions are recorded in a public ledger called the blockchain.
Cryptocurrencies have only been around for a few years. The currency is not issued by a central bank, no regulator or nation state stands behind it, and there are no paper notes or metal coins.
As the currency is made of code, you might wonder what’s to stop the creators simply issuing more. (A practice known as quantitative easing when dealing with traditional currency.)
As for bitcoin, there is a finite supply of 21 million, of which more than 16 million are already in circulation.
As with many things, the price is tied to supply and demand.
The market value of a bitcoin exceeded $16,000 USD for the first time at the end of the day on 7 December 2017 (Source: Bloomberg). However, the total value of bitcoin in circulation is less than 0.01% of the aggregate value of global stocks and bonds.
You can buy existing bitcoins using traditional currencies, be paid in bitcoin for goods and services you deliver, or ‘mine’ new ones until supply is exhausted. (To mine them, you need specialist hardware and software that will unlock and verify transactions on the blockchain.)
What about the future?
Of course, no-one can predict what will happen. But here are some commonsense thoughts:
- Future supply and demand of cryptocurrencies is highly uncertain
- Most products and services are not priced in cryptocurrencies
- They are not used by most financial institutions
- There are many cryptocurrencies (and new ones launching all the time). These can be used instead of bitcoin and will therefore reduce its value
- It’s likely that cryptocurrencies will become regulated at some point, due to the risk of fraud and false promises
- Over time, blockchain technology might develop into a useful resource for the financial sector, as it’s an open, distributed ledger that can record transactions efficiently and in a verifiable and permanent way
How much of a gambler are you?
Bitcoins don’t offer positive expected returns. They don’t provide clarity about future wealth. And they don’t help you plan for a short-term expenditure.
Compared to global stocks, bonds, and traditional currency, their market value is tiny. So we think their proportion of your overall investment portfolio should also be tiny.
We don’t want to be a fun sponge i.e. someone who sucks the fun out of everything. But you have to agree that Bitcoin is a punt. A gamble. It’s speculating rather than investing.
You could have some fun with it, just as you could by placing a bet on the 3.30 at Kempton. But the rising numbers are all paper profits, and won’t make you a millionaire until you sell.
As we always say, a goals-based approach with design, diversity and discipline is the key to long-term investment success. And if you’re a regular reader, you won’t find any surprises there.