Bitcoin – Has our opinion changed?

BITCOIN – HAS OUR OPINION CHANGED?

In December 2017 Bitcoin had reached a record price of more than $19 000 and because everybody was talking about Bitcoin, we selected it as a topic to include in our monthly newsletter.  In that newsletter we concluded that anyone investing in this asset should do so with caution.  In what almost seemed prophetic the Bitcoin price collapsed shortly after our newsletter to less than $7 000, and the price continued to fall for the rest of 2018.  Things have however, changed very dramatically with Bitcoin flying over the last 6 months with a 5x price increase over the period.  With Bitcoin currently priced around $60 000 have our opinions changed?

As mentioned in the introduction the price of Bitcoin has indeed rocketed over the past 6 months.  For the better part of last year its price hovered around the $10 000 level until the last quarter where it started to tick up, a trend that has been carried through in the current year.

,In researching this article, we tried to find what factors were driving the Bitcoin price move and in short could not find one definitive answer. Optically the most logical reasoning we could find is that a concern over rising inflation in the US has driven investors into safe-haven assets and away from the Dollar. But that then assumes that Bitcoin is a safe-haven asset. Gold is generally accepted as a safe-haven asset and it hasn’t shot up 5 times in the last 6 months. In fact, gold has lost around 10% over the same 6-month period – so fleeing into assets in anticipation of inflation has not been what has driven this spike in the price of Bitcoin.In researching this article, we tried to find what factors were driving the Bitcoin price move and in short could not find one definitive answer. Optically the most logical reasoning we could find is that a concern over rising inflation in the US has driven investors into safe-haven assets and away from the Dollar. But that then assumes that Bitcoin is a safe-haven asset. Gold is generally accepted as a safe-haven asset and it hasn’t shot up 5 times in the last 6 months. In fact, gold has lost around 10% over the same 6-month period – so fleeing into assets in anticipation of inflation has not been what has driven this spike in the price of Bitcoin.In researching this article, we tried to find what factors were driving the Bitcoin price move and in short could not find one definitive answer. Optically the most logical reasoning we could find is that a concern over rising inflation in the US has driven investors into safe-haven assets and away from the Dollar. But that then assumes that Bitcoin is a safe-haven asset. Gold is generally accepted as a safe-haven asset and it hasn’t shot up 5 times in the last 6 months. In fact, gold has lost around 10% over the same 6-month period – so fleeing into assets in anticipation of inflation has not been what has driven this spike in the price of Bitcoin.In researching this article, we tried to find what factors were driving the Bitcoin price move and in short could not find one definitive answer. Optically the most logical reasoning we could find is that a concern over rising inflation in the US has driven investors into safe-haven assets and away from the Dollar. But that then assumes that Bitcoin is a safe-haven asset. Gold is generally accepted as a safe-haven asset and it hasn’t shot up 5 times in the last 6 months. In fact, gold has lost around 10% over the same 6-month period – so fleeing into assets in anticipation of inflation has not been what has driven this spike in the price of Bitcoin.In researching this article, we tried to find what factors were driving the Bitcoin price move and in short could not find one definitive answer. Optically the most logical reasoning we could find is that a concern over rising inflation in the US has driven investors into safe-haven assets and away from the Dollar. But that then assumes that Bitcoin is a safe-haven asset. Gold is generally accepted as a safe-haven asset and it hasn’t shot up 5 times in the last 6 months. In fact, gold has lost around 10% over the same 6-month period – so fleeing into assets in anticipation of inflation has not been what has driven this spike in the price of Bitcoin.In researching this article, we tried to find what factors were driving the Bitcoin price move and in short could not find one definitive answer. Optically the most logical reasoning we could find is that a concern over rising inflation in the US has driven investors into safe-haven assets and away from the Dollar. But that then assumes that Bitcoin is a safe-haven asset. Gold is generally accepted as a safe-haven asset and it hasn’t shot up 5 times in the last 6 months. In fact, gold has lost around 10% over the same 6-month period – so fleeing into assets in anticipation of inflation has not been what has driven this spike in the price of Bitcoin.

If the price move has not been driven by market factors possibly it is driven by the instrument itself. Was it a misunderstood asset and now it has become more mainstream asset? Certainly, Bitcoin is a lot more in the news headlines over the last few months.

At Magwitch we are predominantly Chartered Accountants. We do believe we have the ability to conduct valuations of financial instruments using various formulas at our disposal. Most of these formulas require an assumption of income generated by the asset. Bitcoin is not an asset in itself that can generate a return, similar to any other currency. Generally speaking, you need to invest your currency into something else or deposit with an institution to get a return in the form of dividends, interest, rental income etc. With Bitcoin the profits that investors have made have been done so through the movement in the price of Bitcoin and not through any return generated. Without being able to ascribe a return to the asset our valuation models fall flat.

We guess that means next step is to look at why the asset “Bitcoin” would increase in value. That factor is easy for us as our Economics studies teach us that price can be affected by supply and demand. If demand exceeds supply than price goes up until the economic forces reach equilibrium. That is a very simple explanation and very applicable to Bitcoin – simply the price has gone up because people want to own it. In addition to this Elon Musk (at one point this year, the richest man in the world) and his company Tesla have publicly announced that they invested about $1.5bn in bitcoin. Furthermore, they stated they would accept Bitcoin for payment of their vehicles. These two factors would definitely have added to the publicity and the demand for Bitcoin.

In our December 2017 article we looked at the value in use. As it currently stands, unless you are planning on buying an electric vehicle from Tesla there still isn’t much value in use of Bitcoin, however the cost involved in generating each additional Bitcoin does increase. On that basis it does make sense that the price of Bitcoin increases over time. Finally, unlike the US Dollar there is a finite number of Bitcoin (21million) that will ever be mined. This scarcity of product will also contribute towards increasing value. It does make sense that the price of Bitcoin would go up over time, but would this factor alone result in an asset that increases fivefold in value in 6 months? The input cost to mine a Bitcoin and the speed to mine a new Bitcoin has not increased by fivefold in 6 months.

Another factor to be consider in determining the price of Bitcoin would be linked to the cost for the hardware to process the algorithms needed to mine new Bitcoin. The miner with the best processing power will solve the algorithm first and thus whoever has invested the most into their IT infrastructure will be the ones rewarded. Gone are the days where hobbyists and normal computers could mine Bitcoin. The current Bitcoin mining centres are housed in giant data warehouses with China being the leaders at this. The problem you have is that as soon as your competitor has a better machine than you then yours is obsolete. There are many ex-Bitcoin miners out there that cannot afford to keep a pace with developments. Our solution, buy the hardware manufacturers – they are selling to everyone. Has anyone noticed that there is a shortage of semiconductors? This may actually give us our best indicator of what the fair value of Bitcoin should be. Intel Corporation, the largest manufacturer of semiconductors, has seen their share price increase by 25% over the last 6 months.

What is clear in our minds is that none of the underlying factors could contribute to the fivefold increase in the Bitcoin price. In our simple minds it would appear that the Bitcoin price has delinked from reality and based on the fundamentals it does appear to be in the “overvalued” territory. Currently, in response to the covid 19 epidemic and lockdown, the world is awash with new money printed by major central banks across the world and this has the ability to push asset prices up very quickly. Without an ability to value Bitcoin if we were holding Bitcoin in our portfolios we would be quite prepared to take profit at these levels and be grateful for gains made to date, nothing grows at 1000% a year indefinitely.

We assume that the main reasoning for investing in Bitcoin is that “it has gone up and people have made money from it, there are new buyers in queues that want Bitcoin and as a result of FOMO – the “fear of missing out” on easy money. That is classic bubble thinking and reminiscent of the Tulip bubble of 1637.

As they say in the contract Law of principle, that controls the sale of real property after the date of closing but may also apply to sales of other goods — Caveat emptor – this is the Latin for “Let the buyer beware“. In other word, know what you are dealing with and don’t put all your eggs in one basket. Finally, if you are speculating don’t speculate with more than you can afford to lose.