THIS TIME IS DIFFERENT

A Bitcoin bubble deja vu

MY MONTHLY column started in January 2018 with the inaugural topic on how Bitcoin was one of history's biggest bubbles. A year later, Bitcoin lost 85 per cent of its value and stayed low for a couple of years. It looked like the early speculative interest had faded, and Bitcoin would end up as another footnote in history's biggest bubbles.

Alas, it was not to be. Bitcoin recovered all its losses by December 2020, and to make a point, proceeded to then more than double in just three more weeks.

So not only did we have one of the biggest bubbles of all time, we also had the quickest recovery ever. Even the Nasdaq's epic 1999 bubble needed 15 years to recover all its losses. Bitcoin only needed three years. The price action warrants a revisit of our original bubble thesis: is it still a bubble, or has it evolved enough to become a sustainable asset for investment?

Bitcoin's current rally has been much broader, with more institutional participation than in 2017, leading some commentators to conclude that crypto is now really a store of value, deserving of a permanent allocation in portfolios.

One of the cardinal rules of investing is to understand what you're buying, otherwise you're just gambling and will get shaken out at the first correction. Over the last two months I've sought out experts on this topic and read all I can in order to gain a better understanding of Bitcoin. I've endured many 20-something- year-old Bitcoin millionaires who couldn't stop gloating about their genius. They were no different from a roulette player who punted on black 12 times in a row and won each time, putting all his money on black again for the 13th time.

But I also found a number of humble and knowledgeable Bitcoin bulls that gave me some very interesting insight on its future. I was even crass enough to ask them how much of their net worth they had in Bitcoin. Tellingly, unlike the 20-something-year-olds, which clearly had 100 per cent of their net worth in Bitcoin, the ones who replied to me had allocations that ranged from 20 to 55 per cent, a more reasonable, though still very aggressive, allocation.

Complex topic

This topic is far more complicated than I can cover in this article, so I've only focused on some of the most important issues. I have left out, for example, the theory that Bitcoin is artificially inflated by Tether, another coin that is supposed to be backed by US dollars at 1:1. If you're interested in a deep dive into the Bitcoin rabbit hole, I recommend researching this.

A former critic who proceeds to do in-depth research and becomes converted would be one of the best persons to talk to, as they can intelligently and lucidly give you both sides of the story and tell you why they changed their minds. Unfortunately I was not able to find such a Bitcoin bull, so I set out to see whether I could become such a person myself. I've been a Bitcoin sceptic since the start, but I'm open to the idea that I'm an old dinosaur and that I may be missing something. Let's see if I can convert from a sceptic to, if not a believer, at least someone who is willing to entertain the potential of Bitcoin becoming 'money'.

First, a word on the Bitcoin philosophy, which claims this new digital gold is a way out of the oppressiveness of global central banks that keep printing money to reduce its value, increasing inequality between the rich and poor. This sounds fabulous, a way for the common youngster to stick it to the fat cats. It's also hogwash. Imagine a money system where the value of money goes up faster than everything else. Everyone would hold off buying anything but the bare essentials, because it would cost half next month. The velocity of money would plummet, and we would be in a permanent recession.

The current interest in Bitcoin is solely because of the recent price gains; there were hardly any stories on the subject in the 2018-2019 crypto bear market. The philosophy is a nice adjunct story, like Gamestop's Reddit versus Wall Street narrative, but Bitcoin's trajectory of future price gains cannot continue if it is to become real money. The long-term returns of a scarce asset will resemble what gold has experienced over a century - annual gains that average out to the rate of inflation.

While writing my original article in 2018, Bitcoin had all the makings of a cult phenomenon. It had a higher power (Satoshi Nakamoto, Bitcoin's mysterious creator, who created the 'genesis' block), and many evangelists who, when pressed by logical questions, fell back to insults ('you're old dinosaurs') or replying that we simply didn't understand the new technology. And there were 'miners' creating new coins. The allusions to religion and gold are marketing genius. Most of the crypto-believers I spoke to still fit the evangelist mould, pointing to the recent price rise as justification for their faith.

More confused

What have I learned from this two-month research quest? I am more confused than when I started.

Bitcoin was originally created as an online cash system. In early stages it failed at this. A crypto conference was unable to accept Bitcoins as entry-fee payments as the volume of payments overwhelmed the system. The experts I've talked to informed me that these problems will be solved via solutions like the Bitcoin lightning network protocol. There are many programmers working on similar additions to the Bitcoin network to improve the payment side, and this has the real potential to replace the clunkiness of the existing international bank money transfer system. But then again, you can do the same with less hassle by linking your bank account to PayPal, even if you're gutted on exchange rate fees.

Another argument against Bitcoin is the immense amount of electricity needed to maintain the network. It is currently equivalent to the annual usage of Switzerland. The next time a Bitcoin fanatic tells you they like ESG (environmental, social, governance), point this fact out to them and see their response. One of my original concerns was what happens when Bitcoin prices drop significantly, like they did in 2018, and the cost of 'mining', the system of verifying transactions, ends up costing more than the reward for a successful miner? Economics 101 will tell you that mining then stops, which theoretically should mean that there are no more Bitcoin transactions. It turns out this is not the case, as Bitcoin has built in 'shock-absorbers' for such events.

So the final and most important question is whether Bitcoin can be a store of value going forward. And if yes, should the price go up in the future? Is Bitcoin a store of value, or is it 'magic Internet money'? This is the critical question in determining whether an investor should own Bitcoin as a long-term asset in a portfolio, but a very difficult one to answer with conviction at this point. Given its volatility, it is definitely not a 'good' store of value, though one could say that it is 'a' store of value.

Apparently according to a recent poll, 67 per cent of the millennials think Bitcoin is a better safe-haven asset than gold. The recent prices paid for digital art at auction (search 'NFT Art Christie's') makes old hands like me think that this is all a gigantic bubble. Can we have a scarce medium of exchange that is completely intangible? The divisibility, transferability, and durability of Bitcoin are all better than gold or fiat money.

Bitcoin proponents will tell you that all money is a function of the population's willingness to accept it as money. This is true of gold, as well as the bits of paper we carry in our wallet. But one key difference is that the bits of paper are legal tender, in other words backed by government.

And herein lies what I think is the biggest risk in Bitcoin: being a victim of its own success. Bitcoin proponents like the fact that it's a system outside of the control of government. But governments have always wanted control over their money supply, and will not give this up. Historically governments have banned the use of gold, and made it an act of treason to use anything other than legal tender (government-issued) currency to settle transactions. What's stopping all developed countries from banning the conversion of Bitcoin into their own currency? China has already done this. What happens if the US and Europe follow, and all other smaller developed countries after that?

Then Bitcoin holders may only be left with the option to convert to North Korean won, Iranian rials, or Venezuelan bolivars. If Bitcoin continues to grow in use to eventually threaten the dollar's status, this is not just a possible event, but a probable one.

I am less bearish than I was in 2018 on Bitcoin's prospects. Ray Dalio summed it up well: "To me Bitcoin looks like a long-duration option on a highly unknown future that I could put an amount of money in that I wouldn't mind losing about 80 per cent of." I would increase the 80 per cent to 99 per cent, and make my portfolio allocation decision accordingly.

  • The writer is co-founder of AL Wealth Partners, an independent Singapore-based company providing investment and fund-management services to endowments and family offices, and wealth-advisory services.

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