Investors should beware of bitcoin

On Wednesday, bitcoin plummeted below the $10,000 level. “Investors” watched the value of the cryptocurrency plummet in previous days, losing approximately 50 percent of its value. Bitcoin believers point to the fact that it has gained nearly 1,000 percent in value in the last year alone.

Investment icons like Berkshire Hathaway Chairman Warren Buffett, Berkshire Vice Chairman Charlie Munger, and Vanguard founder Jack Bogle have been chided on many fronts for suggesting that bitcoin is a bubble and that it won’t end well for “investors” in the cryptocurrency. Complicating the dialogue for those watching the debate, famed money manager Bill Miller told Consuelo Mack on her WealthTrack podcast that he had almost half of the money in one of his funds allocated to bitcoin late last year.

{mosads}The term “investors” is in quotations in the first two paragraphs because aside from Miller, investors aren’t typically committing funds to bitcoin, speculators are. To properly invest in an enterprise, you have to somehow be able to value it. In Bogle’s words, “You know bonds have an interest coupon, stocks have earnings and dividends, gold has nothing.” At least gold has some industrial uses and some real, rather than virtual, limits on supply.

It is still only worth what someone would be willing to pay for it and cannot be valued by the future cash flow it can produce. There is nothing to support bitcoin except the hope that you will be able to sell it to someone for more than you paid for it. There is no store of value aspect to a cryptocurrency. Speculators, on the other hand, rely on the “greater fool theory,” meaning that some greater fool will come along and pay you more than your purchase price.

Of course, you may say that Bogle, Buffett and Munger are 88, 87 and 94 years old respectively, and they simply don’t understand the transformative impact that cryptocurrencies and blockchain technology are likely to have on the way we live. That comment is fair. But these gentlemen do understand investing and that oftentimes people who invest in innovation, in whatever form it takes, have not been glad afterward.

Buffett famously described this phenomenon in an address to attendees at Allen & Co.’s gathering for business leaders in Sun Valley, Idaho, in 1999. He said, “There were 2,000 auto companies…the most important invention, probably, of the first half of the 20th century. It had an enormous impact on people’s lives. If you had seen at the time of the first cars how this country would develop in conjunction with autos, you would have said, ‘This is the place I must be.’ But of the 2,000 companies, as of a few years ago, only three car companies survived.

He continued, “At one time or another, all three were selling for less than book value, which is the amount of money that had been put into the companies and left there. So autos had an enormous impact on America, but in the opposite direction of investors.” In the context of that presentation, Buffett made the point that picking winners is very difficult, if not impossible, in rapidly emerging technologies. Picking losers is easier. He said the right play during the rise of automobiles in this country would have been to go short horses, had there been a way to do that.

I am skeptical, but cryptocurrencies and blockchain technology may very well transform the way we do business. However, consider that there are more than 1,450 cryptocurrencies tracked by Coin Market Cap, according to a recent Zacks report. It seems like there are some parallels with the U.S. auto industry in the first half of the last century. Buffett has said publicly that were there a way to short the whole basket of cryptocurrencies over a five-year period, the results would probably be quite good.

The track record of those dismissing Buffett as being passé is not a good one. Famously, Andrew Bary wrote a Barron’s cover article titled “What’s Wrong, Warren?” at the height of the internet bubble. The article stated that Berkshire had “stumbled badly” and that Buffett “hasn’t anticipated or capitalized on the boom in technology stocks in the past few years.” That internet bubble burst months later, and Berkshire stock soared. When will the bitcoin bubble burst?

Robert R. Johnson, PhD, CFA, is president and chief executive officer of the American College of Financial Services. He is co-author of Strategic Value Investing, Invest with the Fed and Investment Banking for Dummies.