Cemetery in Armenia. Photo: Arantz. Source: Wikipedia
Assets come in three flavors: true investments, speculations, and gambling. The difference can subtle be subtle, but real. Investments have their own internal cash flow, and you look at the nature of the asset itself to determine whether you want to commit your cash. By that measure, stocks, bonds, and real estate are investments. Price is what you pay, value is what you get.
Speculations are instruments that have no internal cash flow. They’re assets that can have a lot of liquidity, with millions of buyers and sellers. They may even be essential to the economy. But your only hope for gain is an increase in the price. Currencies, commodities, and collectables are speculations. At extreme levels, speculations devolve into the “greater fool theory”: you feel foolish buying them, but you hope some greater fool will come along and buy it from you at a higher price. Back in the day, a lot of people speculated on Beanie Babies.
Gambling is a transaction which doesn’t have to be part of the system. Betting on a football team is gambling. So is buying a lottery ticket, or playing poker. The cards don’t know you have money at stake. They just are what they are. Gambling is usually a negative-sum game: the house wins, on average. We know this: Powerball is a money-maker for the states, but people buy tickets on the odd chance that they might win. They get an endorphin rush when the bells on a winning slot machine go off.
This framework is helpful when we evaluate new asset classes, like crypto-currencies. Bitcoin, Litecoin, Ether, and other digital media of exchange are getting a lot of attention. People can use them for buying and selling things. Overstock has been accepting bitcoin as payment at their online site for years. And bitcoin’s price has soared: a bitcoin is now worth over $5500, up 800% from a year ago. That kind of price action gets people excited. Where will it go next? And should we buy some now?
Bitcoin price over the last year. Source: Coindesk
But crypto-currencies have no intrinsic value. They could all go away tomorrow and the universe wouldn’t blink. Their price is the only item of interest for most folks. And when there’s a lot of public attention to a new asset – with online promoters, popular news stories, knock-off varietals, and get-rich-quick dreams – you can bet that crooks and criminals will be paying attention, too.
Crypto-currencies are speculations, just like Beanie Babies. The underlying technology may be useful, in the same way that Beanies are fun for kids to play with. But there’s no way to know what a crypto-currency will be worth. If you buy some, just be sure it’s with money you can afford to lose.
Douglas R. Tengdin, CFA