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‘bitcoin’ Category

Given the seemingly national obsession with Bitcoin I’ve had to become more of an expert on the king of digital coin and other cryptocurrencies like Ethereum, Ripple, Litecoin, Tether, and Dogecoin. Equity investing is the heart of my comfort zone, but my colleague Randy Coleman’s commentary Is It Really Different This Time? last week compelled me into a deeper study of the crypto phenomenon. Little known is the staggering number of cryptocurrencies in existence. CoinMarketCap provides quotes for 4,387 cryptos and indicates the total numbers over 7,800. Truly, there are important digital currency developments that need monitoring. They may have important tangential investment implications even if you don’t directly trade in the various versions of digital currency.

Proponents tout cryptos as the currency for the future, an alternative to a flawed financial system where excessive money printing increases inflation by decreasing the unit value of money. While not an exhaustive list, other positives include 1) anonymity – account identities are encrypted, 2) convenience – simply register and set up a digital wallet and you can send or receive payment globally without bank fees and stifling government regulation, 3) democratization – residents in countries with weaker currencies and less disciplined central banks have the means to secure goods and services through a universally accepted means of payment. (Note: Turkey has the highest cryptocurrency adoption rate), and 4) security – the system runs on blockchain technology where “miners” use computers to execute sophisticated algorithms to create and track digital coins, making theft and counterfeit theoretically impossible. Basically, you can think of cryptos as the currencies of anarchists with advocates claiming we’re better off with no central banking authority for money supply.

Critiques of this virtual money world are many. Environmentalists hate the enormous power required to “mine” new cryptocurrencies since they require intensive computer usage to solve complex mathematical formulas to create or maintain a new coin. Some estimate Bitcoin, by itself, already requires more energy than the country of Ireland. Cambridge’s Centre for Alternative Finances calculates a single Bitcoin transaction equating to the carbon footprint of 680,000 Visa transactions. This may propel us closer to climate disaster. Maybe even a darker side, virtual currency anonymity provides cover from regulatory oversight allowing for illicit activity like money laundering, and untraceable money transfers by organized crime and terrorists. Finally, as the explosion in the sheer number of cryptos suggests, the idea that they provide better money supply control is a fallacy, since their non-regulated nature means new digital currencies can be created all the time. Indeed, the popular move at the moment is to create a new crypto, heavily advertise its merits to run up the price, sell your coins, leaving everyone else with losses as it inevitably gets added to the long list of failed cryptos, currently 600 and counting. Obviously, without government backing, cryptos can and have become worthless.

Like it or not, however, cryptos are becoming more pervasive in the marketplace. Virtual currency trading on the top 100 crypto exchanges in dollar terms now exceeds $295 billion per day, far below the estimated $7 trillion in traditional currencies, but growing exponentially. Retail Bitcoin wallets, or those accounts with a balance of less than $1000, number over 31 million globally as of October 2020, up 15 times from five years ago. Mizuho Securities’ survey found 24% of recent U.S. stimulus check recipients plan to use the money to invest in Bitcoin. Not just a Bitcoin phenomenon, other cryptos are growing faster. For instance, cryptocurrency Ethereum transactions totaled more than one million a day at the end of December 2020, more than six times Bitcoin. Cryptos Stellar and Ripple lead the digital currency daily transaction table with Stellar recently reaching 5.6 million transactions per day, or six times daily activity two months earlier. Further, the phenomenon has moved far beyond just retail speculators. JP Morgan indicates institutional Bitcoin purchases in the fourth quarter 2020 totaled 307,000 bitcoins, outpacing the 205,000 bitcoins bought by retail investors. The institutional holders list keeps growing with the much-ballyhooed Tesla purchase, a recent new addition. Ever looking for ways to make money, Wall Street firms have jumped into the fray providing crypto safekeeping services, exchange-traded funds, and derivative instruments. The popularity extends beyond investment, as multiple major companies now accept digital currency for goods and services payment. Examples include Overstock.com which accepts any of four digital coins and many others accepting Bitcoin including Expedia, Subway, PayPal, East Japan Railway, and Microsoft to name a few. Indeed, the digital currency age appears to be coming fast.

Which brings me to the crux of this commentary. With pandemic-engendered record levels of monetary stimulus unleashed by central banks around the world, the above discussion illustrates that investors and institutions seek alternative stores of value in these digital assets. This surging popularity has not been lost on governments and central banks, however, and they’re not interested in losing control of the crucial financial and societal functions of money. Governments will not allow their central banks to be dis-intermediated. No wonder this was a big agenda item at Davos, the World Economic Forum, and, according to the Bank of International Settlements, 65 central banks or 86% of those surveyed are studying a CBDC, or Central Bank Digital Currency, with 14% already moving into development stage. The study concludes 20% of the world’s population will be under a bank’s digital currency within three years. Both the U.S. and Europe are contributing greatly in terms of guidance and proposals. Their task is not easy, but just from the outline being discussed, it’s clear none of the above-mentioned cryptos nor any other private cryptocurrency satisfy the requirements. For instance, a good currency should be relatively stable, providing a good store of value. Bitcoin has already suffered declines of more than 70% three times. It needs to have scale. Unfortunately, Bitcoin usage for daily transactions is limited with miners able to handle three to seven transactions per second compared to 24,000 for Visa. Other criteria include it being government backed and trusted with a robust legal framework for its issuance and use. It has to have universal acceptance, and the infrastructure to allow for payment even with the Internet down. It needs to have mechanisms to combat money laundering and other nefarious activities. Clearly, private cryptocurrencies do not satisfy many of these criteria. Thus, they are not really currencies at all, but just digital assets with dubious intrinsic value.

In summary, private cryptocurrencies’ contribution to the financial world should not be discounted. They’ve shown there is a tremendous appetite for digital forms of exchange and the use of the digital public ledger provides a technology blueprint for central banks to follow in creating a CBDC. Government-backed true cryptocurrencies are coming, but the existing private cryptos may not be the currencies of the future without significant improvements to overcome their weaknesses.

About the Author

David Ruff

David Ruff

Prior to joining ACM as a Portfolio Manager, David Ruff was a managing director and senior portfolio manager at Salient where he co-managed the Dividend Signal Strategy® portfolios. Previously, David was chief investment officer for Berkeley Capital Management. In 2008,…
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This week marks a year since pandemic lockdown altered our lives forever. To say it has been a strange year would be a gross understatement. It has been extraordinarily strange. Everything changed. Work, travel, living arrangements, simple trips to the store, doctor visits, movies, coffee shops, football games, baseball games, birthday parties, you name it, it changed. But we managed. We adapted. We changed. The lesson here for investors is a fundamental key to investing itself. Organic entities evolve. Organic entities seek to thrive regardless—or because of—their environment. They adapt. Let’s delve a little deeper into what has changed and explore the investment implications. Is it really different this time?

Two glaring examples of “what’s different this time” slap me in the face every week: meme stocks and bitcoin. It’s impossible to pay attention to the news and NOT be bombarded by stories about GameStop’s latest trading excesses or the unceasing rise and fall in the price of everybody’s favorite cryptocurrency, bitcoin.

How did GameStop become a thing? How did any of the meme stocks become a thing? The foundation for meme stocks was already in place before the pandemic lockdown. The website reddit.com has a subsection dedicated to investing with nearly 10 million users posting thousands of ideas, speculations, theories, stories, what-have-yous on a daily basis with the hope of creating a crowd effect around a stock. There are certainly other websites dedicated to investing and information sharing, but reddit is a convenient example that captures the effort and ability to drive herd (trader) behavior.

The trading app/platform RobinHood is the second critical piece to the meme-stock foundation. The app allows no-cost (to the user) trading for very small account sizes and the ability to purchase partial shares of otherwise out of reach stocks. Millions of new “investors” opened accounts and began day trading stocks. This combination of website-driven frenzy with distributed trading ability laid the groundwork for craziness.

The pandemic started the fire. Bored, stuck at home, out of work or underworked, young people turned their attention to get rich quick schemes via the reddit/RobinHood combination. Pandemic stimulus checks poured gasoline onto the fire. Much stimulus money funded trading accounts and will continue to do so. According to one survey, fully half of retail investors between the ages of 25 and 34 plan to place a sizeable portion of future stimulus checks into the market.

The result, as exemplified in GameStop, has been unprecedented share price swings in various meme stocks. Mob mentality rules the price swings with no regard to investment merit. Will this go on indefinitely? We’ve seen speculative bubbles before and they typically don’t end well. How long it goes on and how it ends is anybody’s guess. But for us, it’s not a game we play.

GameStop erupts again

Source: Bloomberg

Meme stocks are divorced from investment reality. Emotion, hysteria, and mob rule dictate their price movements. This is trading for entertainment value, not investing. Unfortunately, it creates a lot of noise and commotion in the market but we do our best to ignore it.

Cryptocurrencies, exemplified by bitcoin, are the other newfangled attention grabber at the moment.

Is bitcoin an investment? Let’s first ask a more fundamental question. Can bitcoin evolve? The answer here is, no, it can’t. Its structure is hard coded. When fully mined, there will be exactly 21,000,000 bitcoins in existence. No more, no less. The price of those 21 million bitcoins is entirely dependent on what other people will pay for them. Buying a “thing” in the hope that it is worth more in the future is the very definition of speculation. So far, bitcoin “investors” have been spectacularly right as the price has vaulted over $60,000. But does bitcoin create any value in and of itself? No. It can’t. All it can do is fluctuate in price based on what other people will pay for it. As a speculative vehicle, we wish bitcoin and its fans much success. For us, however, we’ll maintain our investment philosophy of seeking companies that create value in and of themselves. Organic entities that can evolve are our targets.

We’ve been in lockdown for a year, yet life has gone on and we’ve evolved and adapted, as have companies. Organic entities capable of evolution are the key to investing. Eddy currents churn up a lot of gunk and many short-lived species emerge and die out. We place meme stocks in this category. Further, inorganic entities like bitcoin are incapable of evolving and therefore are inherently unattractive as investments. Our portfolios are seeded with companies that we believe are capable and adept at managing change. Which really isn’t different this time.

About the Author

Randall Coleman

Randall Coleman

Randall Coleman, CFA is a portfolio manager focused in international and small/mid cap securities. Before joining ACM, Randall was the co-manager of the Salient Dividend Signal Strategy® portfolios. Previously, Randall was a portfolio manager and analyst for Berkeley Capital Management….
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