Are these ‘Spending’ Bitcoins or ‘Trading’ Bitcoins?

In his book Margin of Safety, investor Seth Klarman shared a story. Many years ago, there was a market craze for trading sardines after they disappeared from their native waters in Monterey, California. The price of a can soared as commodity traders bid higher and higher.

One day, a sardine buyer decided to treat himself to a can of the precious product. He knew something was wrong after the first bite. He quickly became ill and reported it to the seller.

The seller replied, ‘You don’t understand. Those aren’t eating sardines — they’re trading sardines’.

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Sir John Templeton famously said that the four most expensive words in the English language are ‘this time it’s different’. Unfortunately, we human beings are bad at learning from history. Time and time again, we fool ourselves into believing that we know something unique. We want to believe that we have a special insight into the future, which is why people place bets on sports matches or invest big in new and shiny things. More often than not, they turn out to be disastrously wrong.

When I started writing this article, I wanted to explain what bitcoin is and what people mean when they talk about cryptocurrencies. But the truth is that there are plenty of resources out there to explain how bitcoin works and what blockchain technology is. I’ve been asked many times whether I recommend buying bitcoin, and so I decided to focus on that instead.

Crypto is Cool

Cryptocurrencies are the result of a fascinating monetary experiment that’s been misrepresented as a simple tool for speculation. People use cryptocurrencies to make purchases, of course, but it’s apparent that a significant amount of the bitcoins in circulation are being used more as trading instrument than as actual currency. Bitcoin has increased from $400 to +$3000 since 2016 and Ethereum has risen by 3000% in the past twelve months alone.

‘Calling someone who trades actively in the market an investor is like calling someone who repeatedly engages in one-night stands a romantic’.

— Warren Buffett

The mystery is compounded by the sheer number of of crypto-currencies out there. The link below references over 1,000 of them. Their return profile far more closely resembles that of a list of exploration stocks, much less the inception of our new mode of exchange. https://coinmarketcap.com/all/views/all/.

If you’ve bought bitcoin or are considering it, then go ahead, but don’t dress it up as something it’s not. You are speculating, not investing. It’s impossible to stake a claim on the future of anything, let alone an immature invention.

What is Currency really?

Simply put, a currency is a generally accepted form of exchange which allows you to store value and transfer it from one person to another. Bitcoin, Litecoin and Ethereum, like dollars, pounds and euros, stake a legitimate claim as a form of currency because many people accept them. What they’re missing is recognition from international law and global policymakers.

Let Me Check My Crystal Ball

Much like predicting the future of a commodity, a currency or a stock price, predicting a crypto-currency’s future is problematic. In fact, cryptocurrencies are even more difficult to predict as they have no tangible presence or cash flow.

Currency is simply a collective recognition or belief in one form of exchange. If you think about it, the current currency system is the most widely agreed upon belief in the world. This makes the replacement of it such a big task.

So, will bitcoin and other cryptocurrencies replace the dollar? It’s an interesting dinner conversation, but literally impossible to predict with any degree of certainty.

The current system has its flaws

In my view, cryptocurrencies are on the rise because of the rightful disdain for the current monetary system for two main reasons:

- The potential for ongoing devaluation of our dollar as a result of significant increases in its supply

- The inefficiency and costliness of the process of transactions

The points above form some of the strong arguments for a wider use of crypto, and they’re unlikely to change any time soon. That means that they form a strong argument for the continuing rise of cryptocurrencies.

‘It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent’.

— Charlie Munger

What will change, however, is the behavior of investors. This is the stage of the investment cycle where hubris and greed are rife. After nine years of share market growth, 30 years of housing market growth (in Australia), record low interest rates and even a bitcoin price which has risen over 1000% — investors can be tricked into feeling invincible.

The most certain thing I can say is that the investment cycle will one day change and the willingness of investors to buy something they don’t really understand will change with it.

Blockchain

It’s not all smoke. The most interesting discussion of all is about blockchain, the technology which underpins cryptocurrencies and allows for contracts and transactions to be secured and recorded without the need of a middleman.

Blockchain allows transactions to be processed more conveniently (entirely online), securely (encrypted platform) and anonymously (peer review system) while reducing costs by cutting out the middleman. Better still, all transactions are stored on the ‘general ledger’ and cannot be deleted.

I’m in no position to comment on how this technology will be used in the future, but I’m happy to say that it’s an exciting innovation with the potential to shake up a range of industries — and the financial industry in particular.

It’s exciting to watch and is a key motivator for anyone operating in a transactional business to ensure that their services are based on merit. Middlemen who aren’t adding value should beware — disruption is coming and if they don’t change with the times, then they’ll quickly be replaced.

Speculators, meanwhile, need to make sure that they’re not buying inedible sardines. For cryptocurrencies to succeed, they can’t just be trading sardines — they need to be eating sardines as well.

Direct Credits: Sir John Templeton, Howard Marks, Seth Klarman, Warren Buffett, Charlie Munger.