Columnist Paul Sutherland shares his perspective on cryptocurrencies.
Question: My son just made money investing in bitcoin. I’m glad he’s investing, but what do you think about cryptocurrencies? Are these a good thing or a bad thing?
Paul Sutherland: You might ask your son if he banked his bitcoin profits or if he’s holding out for more. This and the other cryptocurrencies are incredibly volatile, and any “paper profits” could vanish in an instant.
I remember, back in the Internet bubble era, chatting with “paper millionaires.” They would ask me, as an investment advisor, what they should do with their red-hot portfolios. I would say, “Sell!” They would reply, “You told me to sell three weeks ago and I’m up another 10 percent.” I would respond, “You’re still best off to sell now while the market is giving you a gift—there is no way those companies are fundamentally worth anything near current prices!” Their eyes would roll up into their eyelids.
For the few who did listen, I would suggest they look at the other things they could do with these unrealized gains if they sold: paying off their debts, purchasing a home, or helping their favorite cause with a significant grant. I would also try to remind them that true investing was about assessing things on fundamental merit and price—not chasing what the herd thinks is hot. Investment geeks like me generally start any investment assessment with a framework based on cash flow. Whether it’s stocks, bonds, or real estate, we try to evaluate the present and future cash flow of a given investment and then compare that “fundamental” value to its current market value to determine what kind of upside or downside the investment has. Yet when I’d ask my Internet stock paper millionaires why they were holding their .com stocks, the response was usually: “Paul, I’m holding these things because they are going up and the Internet will change the world!” Well, the Internet has changed the world, but many of those stocks became complete busts.
When I ask people today why they are holding bitcoin or investing in bitcoin-related stocks, the response is much the same: “Because they are going up and blockchain will change the world!” If I probe more about the future cash flow these “investments” will produce, I get stares, or maybe the standard cryptocurrency talking points: Bitcoin will transform global payments systems, eliminate the needless profits made by current financial intermediaries, render central banks powerless to screw up our lives with their market interference, and so on. And from some I get a much deeper dive into the admittedly interesting technological mumbo jumbo about how the whole blockchain works. But I never get much discussion around cash flow, because in the end bitcoin is really just an alternative currency trying to establish what any currency needs: belief among its users that it will retain legitimacy and usefulness long into the future.
Clearly there are many Bitcoin Believers. Despite constant threats of government bans and hacking incidents, bitcoin has surged from less than $50 a coin five years ago to over $18,000 late last year. The early believers have now been joined by the FOMOs, those who’ve hopped on for Fear of Missing Out. Remember: Our basic wiring is for us to follow crowds, even if it is to our doom.
So back to your questions: Are cryptocurrencies good or bad? Putting aside my investment hat, I’m quite confident that the broader application of the blockchain technologies will bring significant benefits to society. One application will be in public finance, where there is real promise to cut fraud, deter bribes, and boost transparency with how, say, a major construction project is completed. Foundations like UNICEF and the World Bank are also using blockchain systems to improve efficiency and transparency around aid programs, to protect property rights, and to fine-tune voting processes.
Should you be happy your son is just investing in something he believes in? Again, I would ask him how strong his conviction is in his investment, and if there’s a chance that the FOMO urge is overwhelming more rational thinking. And because I believe a true investment should be viewed in a cash flow framework, I would call bitcoin a gamble, a speculation, or at best a currency diversification move. And I would suggest that no one buy more bitcoin than they can afford to lose.
Also: No matter how much your son decides to keep in bitcoin, he will feel bad. If he puts a little in and it goes up a lot, he will feel bad that he did not put more in. If he puts some in and it goes down to zero, he might say, “OMG, I could have put the money where it really could have done some good!”
Every action we take is comparative—we take one action instead of taking another action. So maybe you should ask your son if spending time or money on bitcoin is a productive use of his time and resources. Is it feeding his soul? Does it help anyone? Or is speculating on bitcoin feeding greed, envy, and insecurities and pulling him off his path? All that said, and assuming the dollars involved are indeed “losable,” I wouldn’t probe too hard. I see other benefits from having a small vested interest in bitcoin. For example, putting some “skin in the game” may invite inquiry into questions like why throughout history societies have set up governments, laws, and regulatory bodies. And why we’ve created education systems that (we hope) teach our youth to investigate, find the facts, and consider the various consequences before taking a significant action. The axiom of investing is Investigate before you invest. And, of course, never, ever be pulled into an investment (or any stupid behavior) because of FOMO.