Bitcoin and bandwagons
In the past few months, it might appear – at least to some – that making money in markets is easy. Just buy Tesla or Bitcoin and you’re sure to double your money!
That would be confusing gambling with investing.
A bit more about Bitcoin…
In October 2008, the world was introduced to its first cryptocurrency when a mysterious white paper was published by an unknown author titled “Bitcoin: A Peer-to-Peer Electronic Cash System”. Driven by blockchain technology, the main attraction compared to traditional currency was clear – Bitcoin provides a decentralised way for two parties to exchange value.
In other words, Bitcoin has no need for a governing body, no central bank and is a digital ledger that facilitates and records transactions. Without getting too granular about how exactly this works, the complicated mathematical procedures in place make falsifying Bitcoin transactions unlikely with today’s technology (although never say never!).
The cryptocurrency market value is small relative to the global equity market
Twelve years later and the cryptocurrency space has seen thousands of alternatives, or ‘altcoins’, come to market, all of which attempt to improve upon the blueprint pioneered by Bitcoin. One challenge is scalability – Bitcoin can handle 350k daily transactions compared with VISA who executed 500m per day in 2019.
Despite the implementation issues, the value of Bitcoin – and many of the ‘altcoins’ mentioned previously – have recently skyrocketed leading to a lot of excitement for investors. The only thing we know for certain about investing in cryptocurrency is that it’s highly speculative. The extraordinary volatility of most ‘coins’ makes them an unreliable store of value. Going to sleep and waking up 10% richer (or poorer) is commonplace.
On top of this, Bitcoin is not a capital asset – it doesn’t pay dividends or have a positive expected return. Positive outcomes are simply the result of demand outstripping supply, although investors are quick to forget that the future expectation of demand is already factored into the current price. There are 18.6 million Bitcoins in existence, yet recently the sale of 150 Bitcoins resulted in a price drop of 10%, demonstrating no depth or liquidity to the Bitcoin market.
It’s possible that we may one day transition to a world where cryptocurrency is adopted by the masses. Who knows if that’s even remotely likely, and better yet who knows which cryptocurrency will be the one that ticks all the boxes? As an investment today, cryptocurrency plays no role in portfolios and any investor should be willing to accept a maximum loss of 100%.
Now to another, recent example of gambling masquerading as investing:
GameStop – reddit vs Wall Street
In what has been a fast-moving situation, a group of investors using discussion website reddit as a platform, have banded together to take on the hedge funds in the US.
The group has focused their conversation on a few stocks, the most recent of which has been an American consumer electronics firm, GameStop. On one side of this story we have the hedge fund managers, who are engaged in a process known as ‘shorting’, essentially betting that the share price of GameStop will go down over time.
A successful short involves borrowing stock from a third party, selling it on in the marketplace and then buying it back later when the price has fallen. This allows the short seller to return the stock to the third party plus a fee for the borrowing, and they pocket the profit from the difference in price. The danger is that if prices rise, purchasing the stock back becomes more and more expensive for the short seller and the losses rack up. Professional investors are aware of these risks more than anyone.
A number of companies featured recently on reddit have been heavily shorted and include GameStop, AMC Entertainment, Koss Corp and Blackberry. But by purchasing shares in these firms, speculators have been purposely bidding up prices to create huge losses for some of the hedge fund managers. These are not small market movements either.
As of 27 January, the share price of GameStop closed nearly 2000% up since the start of the year. Yet in the time it’s taken to write this article, the price fell by almost a half! A quick glance at the reddit forum shows that the motivation for some is to ‘stick it to the man’, whereas others are perhaps looking to make a quick buck.
As the situation progressed its caught the eye of the regulator on suspicion of market manipulation, as well as the newly appointed US Treasury Secretary, Janet Yellen, whose team are “monitoring the situation”.
Either way, it’s difficult to see how this will have any sort of happy ending. Other than the handful of investors who might sell at the right time, the only guaranteed beneficiaries to all this are the market makers and middlemen. If you want excitement, just follow the stories and avoid gambling with your future!
If you have questions about the topics mentioned in this blog get in touch with your usual CPW team member or book a no obligation call by clicking here.
Bitcoin.org (2008) Bitcoin: A Peer-to-Peer Electronic Cash System
Forbes (2020) Can All of Bitcoin Be Hacked?
Jemma Kelly (07 Jan 2021), No, bitcoin is not “the ninth-most-valuable asset in the world” Time for some realism. FT.com
Google Finance (2021) GameStop Corp. Share price
BBC News (2021) GameStop: Amateur investors continue to outwit Wall Street
Research Affiliates (2021) Bitcoin: Magic Internet Money
Statista (2019) Number of purchase transactions on payment cards worldwide in 2019
Past performance can’t guarantee what investments will do in the future. The value of a portfolio can go down as well as up, so there’s a chance you’d get back less than you put in.