Our Two Cents on Bitcoin

Let’s start out with a disclaimer: we do not consider ourselves experts on cryptocurrency (or blockchain technology). At the same time, it is our responsibility as advisors to understand enough to identify potential pitfalls and/or opportunities, so we offer this opinion. Our primary goal in writing this short piece is to cut through the noise and provide some decision logic. We welcome any feedback, questions, or expertise you might offer this discussion. This paper focuses on bitcoin, presently the dominant and most widely discussed cryptocurrency, but our comments generally apply to all cryptocurrencies.

Why the increased interest in bitcoin? FOMO has reached increasingly high levels as it relates to bitcoin. Earlier this year, we have seen Tesla announce that it purchased $1.5B of bitcoin, and that it expects to soon accept bitcoin as a form of customer payment. BNY Mellon, a custodian like Schwab or Fidelity, will soon hold, transfer, and issue bitcoin for its asset management clients. In short, all of these announcements help increase the belief bitcoin is becoming more mainstream and accepted.

Then there is the simple fact that the price of a bitcoin has increased at breakneck speed from year-end 2018 ($3,742) to year-end 2019 ($7,193) to year-end 2020 ($29,001), and as of November, 2021, is priced over $60,000) (source: Yahoo! Finance).

Even with its increased price and growing acceptance, there are still many questions that need to be answered.

Is bitcoin an investment or a currency? Well, bitcoin is a type of cryptocurrency so let’s start by classifying it as a currency. In theory, an advantage of using bitcoin as a medium of exchange is that, as a digital currency, it is global in nature. You don’t have to carry around a physical wallet with physical currency. At the same time, bitcoin is decentralized from the traditional banking system, meaning there is no central bank or government authority that controls the value of bitcoin (this can be seen as both a negative and positive attribute).

With a traditional currency, like the US Dollar, its value is relative to other currencies like the Euro or Yen. To date, we really have not seen bitcoin referenced or measured in this way. In addition, bitcoin has had much more volatility, especially as of late, than we would expect to see in a traditional currency.

So, is bitcoin an investment? If we think about stocks and bonds as investments, we know, at a minimum, there is a framework for how to value them. With bitcoin, it does not appear to be clear that its price is driven by economic fundamentals, making it exceedingly difficult, if not impossible, to apply a valuation to it.

What are some other challenges with bitcoin? As we stated earlier, bitcoin is not created or controlled by any government or monetary authority. Therefore, in the US, the US government nor our central bank are providing regulation over bitcoin. The SEC, which regulates the security industry, does not view bitcoin as a security (they view it as a payment mechanism and store of value) and therefore does not provide regulation over bitcoin either.

Not surprisingly, there is a dark side that comes with the unregulated nature of bitcoin.  It has been reported that bitcoin is being used for illegal activities including the drug trade and ransomware attacks, with online users looking to hide their identity (in all fairness, there is illegal activity associated with traditional currency too, including the drug trade and money laundering as easy examples).

Another downside of using bitcoin for transactions is taxes. The IRS currently views bitcoin as property (and not a currency), therefore any sale using bitcoin is subject to capital gains taxes.

Overall, while there has been increasing interest in bitcoin, we recommend steering clear of it and other cryptocurrencies at this time.  Because of the challenges in rationalizing a valuation framework, its volatility and lack of regulation, we view bitcoin as more of speculation than pure investment. For investors that understand bitcoin better or simply “want a piece of the action,” it may be acceptable to allocate a nominal amount that would not compromise their ability to attain their financial goals if they lost it, similar to our views on other non-diversified investments.

We recognize our view may turn out to be naïve or cynical, but we are willing to be wrong at the present time. Of course, it will be something we continue to follow and monitor.

East Bay Investment Solutions, a Registered Investment Advisory firm, supplies investment research services under contract.

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