If you happened to turn on the financial news this week, you undoubtedly heard about bitcoin, which has been on a wild ride: On Monday, it was trading at $11,000, having gained 1,000% since January. On Wednesday, it rose to $15,000. On Thursday it topped $19,000. Then, this morning it reversed, dropping back below $15,000. Despite giving up some of its earlier gains, bitcoin still has gained more than 3,600% in two years.
If you don’t own any bitcoin yourself, you may feel that you are missing out on a once-in-a-lifetime opportunity. But, while it’s true that you could have made a fortune if you had jumped into the bitcoin fray early, the fact is that, for prospective investors, it is only tomorrow’s price that matters. What has happened in the past is interesting and may be enticing, but it has very little bearing on what will happen next. That’s why the standard disclosure on most investment literature states, “Past performance does not guarantee future results.”
I see at least ten reasons why you should continue to avoid bitcoin, despite all the get-rich-quick headlines:
1. No one knows who created it. Bitcoin’s creator goes by the name Satoshi Nakamoto, but no one knows who this really is. That alone should make you uncomfortable. Would you buy anything, let alone a financial product, from someone who insists on remaining anonymous?
2. Bitcoin has no intrinsic value. Unlike a stock or a bond or real estate, bitcoin doesn’t generate any cash flows, such as dividends or interest or rent. As a result, bitcoin’s price is not anchored to anything measurable or tangible. It’s hard enough trying to forecast the price of things that do have measurable value, such as a stock. When it comes to bitcoin, though, you’re completely in the dark.
3. It’s not unique. If bitcoin were the only digital currency, you might be able to make an argument that it has some value, but it is not the only one. In fact, there are nearly one thousand others. Bitcoin is merely the most well known, but that certainly doesn’t guarantee its long-term success. Think Oldsmobile or AOL or BlackBerry.
4. Unlike a true currency, bitcoin has no government backing. While the U.S. dollar no longer has the backing of gold, thus giving the government the ability to “print money,” the reality is that the government is extremely careful about managing our currency. The Treasury and the Federal Reserve govern the supply, and the Secret Service guards against counterfeiting. Bitcoin benefits from none of these government protections.
5. Your funds are not government-insured. In the United States, bank accounts are insured by the FDIC, and brokerage accounts are insured by the SIPC. There is no equivalent for bitcoin. And, though supporters argue that it is airtight, the reality is that there have been several thefts from bitcoin exchanges. Notably, in 2014, the Mt. Gox exchange filed for bankruptcy after 850,000 bitcoins were stolen, and there have been other cases since.
6. It is completely opaque, with no disclosure. If you wanted to buy stock in a public company, you could go to the SEC’s website and access thousands of pages of public disclosures, detailing everything about the company’s operations. And, importantly, these disclosures would tell you the names of the company’s biggest shareholders. In the case of bitcoin, there is no disclosure of any kind. The only thing people know is the price.
7. Governments could choose to regulate bitcoin out of existence. Recognizing some of the risks outlined above, governments around the world have been considering bans on bitcoin. In fact, China has already imposed such a ban. In addition, some banks, such as Wells Fargo, have also placed limits on transactions with bitcoin exchanges.
8. No one knows how many bitcoins Satoshi Nakamoto, or anyone else, owns. As noted above, when you’re a big shareholder in a public company, you can’t hide that fact. That information is important to other shareholders because it helps them assess risk. With bitcoin, there is no such information. That’s dangerous because it means that there could be one person out there who owns enough to be able to cause the price to crash.
9. Soon, investors will be able to short the price of bitcoin. Within the next week, bitcoin-related futures contracts will begin trading on U.S. exchanges. What this means is that investors will now have the ability to put downward pressure on bitcoin prices, something that had not been possible up until this point.
10. Most importantly, bitcoin is an example of the “umbrella” type of investment that I wrote about in September. While it can be frustrating, and disheartening, to feel that you are missing out while others are making money, I do firmly believe that, over time, you will be far better served by keeping your feet on the ground when others are getting carried away.
A final word on this topic: To the extent that I caught your interest by mentioning that soon you will be able to short bitcoin, please be careful. As the economist John Maynard Keynes pointed out, “the market can stay irrational longer than you can stay solvent.” When it comes to bitcoin, I would simply stand aside. As I wrote back in October, I believe you are quite literally better off with a lottery ticket.