Why the excitement over cryptocurrencies? Dr Benjamin Holdsworth on why it might be gambling, not investing.
We humans are never lacking in our enthusiasm for crazy ‘investment’ ideas. Around 400 years ago, the Dutch managed to work themselves into a frenzy over tulip bulbs.
At the height of the hysteria, one bulb of Semper Augustus apparently changed hands in exchange for 12 acres of land.
In the 1700s, the South Sea Company Bubble ruined many as the stock price rose almost ten-fold in 1720, largely on the back of false rumours, and then crashed precipitously. Even Sir Isaac Newton himself got burnt, losing almost all his savings:
‘I can predict the movement of heavenly bodies, but not the madness of crowds.’
By all accounts, the madness surrounding equity investments was widespread at the time, with one company supposedly coming to market with the greatest marketing spin ever, describing itself as ‘a company for carrying out an undertaking of great advantage, but nobody to know what it is’.
Today, investors face similar sentiment in certain corners of the investment world, from the rise of Tesla’s stock price – at the time of writing, down -36% from high – to GameStop’s ‘to the moon’ rally, now down -51% from high.
Shell companies – known as SPACs (Special Purpose Acquisition Companies) – raise cash from investors to buy as yet unidentified companies – sound familiar? – and have multiplied in the past 18 months.
Cryptocurrencies, such as Bitcoin and the spoof Dogecoin, now have ‘market capitalisations’ of US$741bn and US$47bn respectively.
Unfortunately, humans seem programmed to suffer from FOMO (fear of missing out), which might have been an advantage in the days of being a hunter gatherer, but can be especially dangerous when it comes to the world of investing and ‘hot’ markets.
Just because something has gone up spectacularly does not mean that it is a good investment or even an investment at all. A material risk always exists that latecomers to any speculative game get left holding the hot potato. Knowing what you are getting yourself into is a good place to start.
‘When you have difficulty in finding out what the real fundamentals of an investment are, then what you are doing is not a “real investment”,’ said European Central Bank vice-president Luis de Guindos this year about cryptocurrencies.
In attempting to understand cryptocurrencies, a good starting point is defining what money is. In simple terms, it represents three things: a store of value, a unit of account, a medium of exchange.
So, do cryptocurrencies – using Bitcoin as an example – have these characteristics?
An asset that can rise or fall on any one day, say by +36% or -27 % – Bitcoin’s largest daily price movements since 2013 – is hardly a store of value. The cost of a round in a pub priced in Bitcoin could change materially by the time you reach the bar.
One could concede that Bitcoin is a unit of account, but it is not a common one. In terms of being a medium of exchange, it fails dismally. Virtually nobody – not even Elon Musk’s firm Tesla – accepts Bitcoins and few people trust it enough to use in daily transactions.
As an aside, there is an amusing yet unverified story of the Bitcoin programmer who traded 10,000 bitcoins for two Papa John’s pizzas on 22 May 2010, costing him £280m in today’s money. Tomorrow it may be significantly more or less!
Poor carbon footprint
There are also some other less savoury aspects of cryptocurrencies. The first is that the ‘mining’ of many cryptocurrencies, including Bitcoin, has an extremely poor carbon footprint.
Bitcoin miners alone have a carbon footprint equivalent to the Czech Republic, as much of it is mined in China where a significant proportion of electricity produced is from coal.
The second is that it has become the favoured unit of exchange for ransomware (blackmail) attacks on governments and companies, such as the recent Colonial Pipeline attack in the US, which was settled, apparently, for 75 Bitcoins or around $4.4m.
‘Its price volatility makes Bitcoin risky and speculative, while its exorbitant carbon footprint and potential use for illicit purposes are grounds for concern’: European Central Bank Financial Stability Report (2021).
Putting money into cryptocurrencies is not investing, but gambling. Combined with the possibility of losing your entire capital invested, either through the failure of the cryptocurrency in question or your crypto wallet, where your ‘coins’ are stored, being hacked, the moral hazards of dabbling in it can seem alarming. Caveat emptor!
Dr Benjamin Holdsworth (right) is a director of Cavendish Medical, specialist financial planners helping consultants in private practice and the NHS
The content of this article is for information only and must not be considered as financial advice. Cavendish Medical always recommends that you seek independent financial advice before making any financial decisions.
Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The value of investments and the income from them can fluctuate and investors may get back less than the amount invested.