There are many different types of investment risks. I thought a good exercise would be to apply the different investment risks to Bitcoin. This is not a recommendation to buy or sell Bitcoin. It is not considered a security and the SEC does not regulate it (yet).
Bullish case for holding Bitcoin
- Inflation risk – This is the risk of losing your purchasing power because the value of your investment doesn’t keep up with inflation. Bitcoin has a limited supply of 21 million coins, which is one of the main reasons why the price continues to rise. 80% of all bitcoins have been mined. If there was an announcement that another 100 million Bitcoins were being offered, the price would crater (this won’t happen). There is no better inflation hedge than an “asset” with limited supply and increasing demand. To date, Bitcoin has been the perfect hedge against central bankers printing money and keeping interest rates too low.
- FOMO risk –The Fear of Missing Out risk reaches its climax when investment returns are the largest. An unheard of 2,100%+ return in one year can do psychological damage to people in search of easy money created out of thin air. Warren Buffett calls Bitcoin a mirage. Many people have gotten rich with a small amount of money. There is a story of a pizza delivery driver accepting payment in Bitcoins back in 2010. If he held on to the Bitcoins, he would be worth over $100 million. People can do some crazy things when FOMO risks peak. State regulators have commented on people maxing out credit cards and taking second mortgages to buy Bitcoins. Some people have also sold their houses to buy bitcoins. FOMO risk takers have been well compensated. As Bitcoin keeps rising, there will be more home equity lines taken out, until the FOMO risk suddenly transforms into the fear of losing everything (FOLE) – I just made that one up. 🙂
- Disruption risk – If global currencies are getting disrupted by virtual money, then you better hedge against your U.S. dollar weakening. For instance, if a Venezuelan citizen converts his or her Bolivar into Bitcoins, and their money goes up 3,000%, then there has been a global wealth redistribution. This is a good reason why third world countries and people with low standards of living are flocking into Bitcoin. The astronomical rise in Bitcoin is due to international buyers, especially the Japanese.
Bearish case for holding Bitcoin
- Liquidity risk – This is the risk of selling and getting a fair price when you want to sell. Bitcoin has 100% potential loss of liquidity. If everyone heads for the exits at the same time, it’s safe to say you won’t be able to log into your Coinbase account to sell. It has been very common for wallets and exchanges to freeze withdrawals with only limited volatility. A run on the banks was common when there was a fear that banks were running out of cash. I’m 99.9% confident that there will be a run on the exchanges at some point. Even if Bitcoin appears to stabilize in price and consolidate over time, the risk will not disappear. The poor Thanksgiving turkey always has a great year of feeding up until the holiday.
- Concentration risk – Most of the crypto-currencies are held by a very few fortunate people. If they decide to sell to “diversify” into real money, those buyers who are late to the party will be the ones that suffer the greatest losses. The lucky few that were early are the ones that will sell first to the late comers who do not believe that they are putting their hard earned money into the biggest bubble of all time. The later comers will have no idea why their money will evaporate overnight when the Bitcoin millionaires covert to real currency all at the same time.
- Political risk – Central bankers around the world are warning about holding Bitcoin. At Janet Yellen’s press conference, she called bitcoin a highly speculative asset, not a stable store of value, and it is not legal tender. I believe the SEC at some point will step up and begin to regulate trading on the exchanges or ban credit card payments for Bitcoin. They are well aware of the abuse and wild west trading environment where any thing goes. The amount of criminals that have been attracted to this wild west type of trading environment increases the probability that this will not end well.
- Credit risk – Bitcoin has no intrinsic value and doesn’t pay interest. The credit risk is a 100% loss because Bitcoin is worthless. The only thing backing Bitcoin are the largest holders of Bitcoin. They support the price and manipulate the market price. They have programmed computers, which are called bots to continuously buy and sell. If you had billions to lose in Bitcoin and there were no rules in place, you would make sure the price appeared safe. As long as there is public demand, the larger holders can make more money. As soon as the general public gets smart and comes to their senses that this is the greatest scam of all-time, then the bubble will stop inflating. The miners of Bitcoin who run the network need a high price to afford their electric bill and to buy new equipment. One bitcoin transaction now uses as much energy as your house in a week.
Nuveen Asset Management’s Bob Doll said on CNBC this week that a cryptocurrency crash could have a spillover effect into markets. I’m in complete agreement with him that, “the longer bitcoin mania goes, and the bigger it gets — the worse it is for the stock market.” I never thought that I’d sell stocks because of Bitcoin, but it is a new possibility in 2018. The government has been non-existent in stepping up regulation of Bitcoin and if Bitcoin crosses the $1 trillion threshold in market cap, it might be too late to police it. Over time, I believe the conversation will change to Bitcoin being a systematic risk to the entire global economy. If there are more and more people who prefer to hold non legal tender currencies over legal currencies, then capitalism and the stock market will have real problems.
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