Bitcoin And Tulips: 'This Time Is Different'

Oct. 03, 2017 11:24 AM ET58 Comments

Summary

  • Bitcoin has been getting a lot of attention lately, thanks to a 300%+ run-up year to date.
  • Bitcoin is one of just 900 cryptocurrencies out there. Any one of them could go to a million or to zero.
  • Statistically, you're better off with a lottery ticket.

Sometimes, a joke is clearly just a joke, like this bumper sticker, which I saw recently:

To be sure, every joke has a kernel of truth. But most people who play the lottery do know, rationally, that Powerball isn’t a reliable route to retirement.

Sometimes, though, it’s not as easy to make that distinction. Consider, for example, bitcoin, which has been in the news recently. In my view, bitcoin is a dangerous get-rich-quick scheme. In fact, I see it as being even worse than the lottery and recommend that you stay far away from it.

I’ll explain, but first, some background: Bitcoin is an unusual creation. It has been around for years but started getting much more attention recently, when it gained more than 400% in the space of several months. Some call bitcoin a currency. But, unlike national currencies, it was the creation of one (anonymous) individual, or maybe a group, and isn’t backed by any government. Also, it exists entirely online. As a result, there is significant debate as to what exactly it is. Is it really a new form of currency? Is it an online payment tool? Is it a vehicle for criminals to transfer money? Is it an investment? Is it maybe just an elaborate fraud? No one can say for sure.

To be clear, I’m not opposed to bitcoin because I’m worried that it’s going to go down in value. I have no way of knowing that; no one does. The fact is, you might buy it and make a fortune. But, if you did, it would be pure luck, and that’s my real problem with it. You can’t keep both feet on the ground and make a logical argument for bitcoin in the same way that you can for a real currency, or for a real investment.

To better understand this, consider the following spectrum of possible destinations for your hard-earned dollars, ordered in terms of risk. You’ll see that bitcoin ranks near the bottom of this list.

The safest possible investments are those that are guaranteed by the US government. These include FDIC-insured bank accounts as well as Treasury bonds. These are the only investments that are truly guaranteed.

One step up on the risk spectrum are investments that are not guaranteed but still have measurable value. Here, I’m talking about conventional, publicly-traded stocks and bonds as well as real estate. People can disagree about the right price for a given investment, but at least, there is a tangible basis around which to have that discussion.

One step further up the risk scale are investments with harder-to-measure value. These include private investments such as hedge funds, private equity, and startup companies. In each case, the investment manager will tell you that there’s value, and there very well may be. But, there’s risk because it will be hard for you to verify for yourself.

Moving even further out the risk spectrum are games of chance. This includes the lottery, slot machines, roulette wheels, and the like. These are all gambles, and the odds are usually stacked against you. However, and importantly, at least you know the odds (or could find out), and that’s worth a lot.

Moving beyond games of chance into even riskier territory are what I call pure random gambles. Examples include precious metals and commodities, the prices of which are not anchored by any intrinsic (income-producing) value. As a result, your odds of making a profit here are completely unknown, and unknowable. This is how I see bitcoin, though it’s even worse than that. Unlike gold or silver or oil, bitcoin has no inherent utility. And, that’s why I’m so opposed to it. With unknowable odds and no obvious utility, there is no logical reason why tomorrow it couldn’t go to zero, or to a million. You have no clue. And, that’s a real problem.

In fairness to bitcoin, there is one category of investments which is even riskier: Those in which your losses are potentially unlimited. Just a few things fit in this final category, and they are relatively obscure - for example, short positions in securities and certain options strategies.

Bitcoin supporters have ready responses for their critics. For example, they point out that there is a limit to the total number of bitcoins that can ever enter circulation. And, while that does address one risk, there are still many others. To name just a few: governments might outlaw it, or competitors might overtake it. In fact, there are now 900 other crypto-currencies out there. Who’s to say that one of them might not steal the hearts and minds, and wallets, of today’s bitcoin users?

One final point: Bitcoin supporters are quick to argue that the US dollar itself, absent the gold standard, has no real value either. But that’s not quite true. My friend Dani, an astute investor, points out that the dollar will always hold significant value, if only for the fact that we must all pay our taxes in dollars, to the tune of three trillion dollars per year. It’s a very good point. Until such time as the IRS allows you to pay your tax bill in bitcoin, its risk will always be orders of magnitude greater than that of any stable, national currency.

Since my job is to help folks develop reliable retirement plans, I don’t advocate gambling. But if you are looking to roll the dice on something more exciting than ordinary stocks and bonds, here’s what I’d recommend: stick with the lottery. I never thought I’d say this, but it’s not actually the worst thing out there.

This article was written by

Adam Grossman is the founder of Mayport Wealth Management, a financial planning and investment firm in Boston. Mayport's mission is to deliver white-glove service on fair terms. Specifically, this means reasonable, fixed fees, rather than the traditional 1%-of-assets that is the industry norm. Adam received his MBA from the MIT Sloan School and BA from Williams College. Follow Adam on Twitter at @AdamMGrossman. Sign up for his weekly memos at www.mayport.com/friday.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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