Thursday, December 28, 2017

Bitcoin Mania in 2017

Pathways Advisory Group, Inc.
      Evon Mendrin

“People get excited from big price movements, and Wall Street accommodates” – Warren Buffett 

Boy have we seen big price movements! 2017 showcased our President’s dramatic first year in office, Congress passing Tax Reform by Christmas (sure to be 2018’s new hit holiday jingle), and media coverage of one “all-time stock market high” after another. But the trendiest story just might be the sudden rise of bitcoin.

Hovering around $900 in January, the price of one bitcoin suddenly skyrocketed to roughly $2500 mid-year and off to $15,883 in late December! That’s a near one-year climb of over 1400%!1

Likely to be locked in as the hottest water-cooler topic of 2017, some investors are rushing to buy this cryptocurrency. Some have even taken out mortgages, run up credit cards, and turned to equity lines. With all of the press and attention, do bitcoins have a place in a well-diversified portfolio? We don’t believe so.

First – what is it?

Simply put, bitcoin is a created digital currency. Launched in 2009, it works on a peer-to-peer system without using an intermediary. Meaning, you can create transactions without using a financial institution – such as a bank – as the middle-man. The transactions are recorded on a public ledger called blockchainIts supporters claim it is a more secure, private, and cost-effective way to transact business.2

Why not jump in?

Any reasonable investment worth considering for your portfolio should carry a positive expected return. That is, there is an inherent value in the investment that will provide some future cash flow or higher value in the future.

Stocks, for example, are partial ownership in companies. These businesses produce products and services that people are willing to pay for. They have leaders, employees, and the power of their brands. These valuable aspects work to bring in cash flow (revenue). Profits can then be paid out to shareholders as dividends or reinvested into the business. Owning the stock of a company gives you a right to that future cash flow and business growth.

Bonds give you a promised future cash flow. When you buy a bond, you lend a company or government money, and they promise to pay you back with interest.

Both of these investments give you an expected return and the means for investors everywhere to reasonably value them. A globally diversified portfolio of stocks and bonds allow you to benefit from the cash flow and growth of businesses all over the world.

Bitcoin, however, does not provide a positive expected return. It doesn’t produce anything of value. Like a nugget of gold, or the dollar bill in your wallet, if you leave a single bitcoin in your digital wallet, a year later you will still have a single bitcoin. It won’t multiply into more bitcoins, and it won’t pay any additional cash.

The price is driven entirely by supply and demand. Meaning, a positive return only occurs when someone else comes along later and buys it for more than you paid. You have to hope the frenzy continues. But what happens when there’s no one left willing to pay $15,000 for a single bitcoin?

What about its actual use as a currency?

Holding a currency such as cash in a portfolio is not for maximizing return but for handling short-term expenses. Bitcoin is not currently very useful as a currency. It isn’t widely used or accepted, goods and services aren’t widely priced in bitcoin, and it’s extremely volatile.

So, what’s the reason for all this mania? Likely pure speculation. It’s the hottest thing, and no one wants to be left out. We are hooked by the glamour of digital currencies and stories of overnight millionaires.

The blockchain technology behind it may be of great use, and its use as a currency in the future is a different debate entirely. But bitcoin today is far from a usable asset or currency.

Remain disciplined with your investments as the year comes to a close. Always start with your goals and have an understanding of how your investments work. Remember the basic foundation of what drives returns over time – expected future cash flow. When it comes to cryptocurrencies, it’s the wild west out there. We urge you to stay indoors, hide the children, and wait for the mess to be over.

We wish you Happy Holidays and great success in meeting your financial goals in 2018 (and beyond)!

1Daily prices through 12/26/2017 from CoinDesk.
2See for detailed information on how it works. 

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