As many of you might know, this week, the SEC approved exchange traded funds (ETFs) which invest in or otherwise track the performance of cryptocurrencies/Bitcoin. This was not a surprise even if the timing of the announcement might have been. A lot of major players in the investment industry, BlackRock, et al., have been lobbying Washington for this for a long time.
For all intents and purposes, this throws the door wide open for this asset class to retail investors, even your grandmother. Those people who didn’t want to open a Coinbase account and/or trade on some dodgy platform now have a much easier way to invest in crypto. As a result, I/we anticipate there could be a proverbial ‘rush to the gates,’ which might initially push prices higher in the short-term, but might actually hurt the asset class over the long haul (Which I will discuss in brief below).
Despite this, my basic position on cryptocurrencies is largely unchanged. If and when a client directs me/us to purchase them in their accounts, we can oblige them, as we have done in the past with the GBTC exchange traded note (ETN). I won’t go into the differences between ETF and ETN here.
However, I/we have no immediate plans to incorporate either a cryptocurrency ETF and/or ETN into our primary strategies at this time.
The primary reason is simple: it is virtually impossible to determine what a reasonable valuation for these assets should be, other than unsubstantiated estimates. After all, there aren’t any cash flows. There is no revenue. No profits. No profit margin. No interest rate. No final maturity. No intrinsic value. Nothing to see, hear, smell or touch. Nothing.
- Is blockchain technology cool? From what I understand, it is.
- Is it the wave of the future? That is what the tech people tell me.
- Will it change our lives, how we disseminate information and conduct business? Again, sure.
- Can I put a firm value on a spot on the chain? On an NFT or a cryptocurrency? Not so fast.
You see, while we refer to these assets as cryptocurrencies, is that the reason why investors, particularly domestic ones, buy them? As a currency? In order to purchase depreciating or immediately consumed goods & services? Perhaps some people do, but the logic escapes me since we already have the dollar to do exactly that.
Essentially, I don’t need bitcoin to buy a Diet Mountain Dew at the Chevron on Euclid Avenue. A couple of Washingtons will do just fine, and I would prefer to use them in any event. After all, I don’t expect my pictures of George to appreciate in value over time, quite the contrary. Further, I probably shouldn’t be drinking the things anyhow, but that is a different story.
Secondly, are cryptocurrencies a good store of value? I think it fair to say the wild swings we have seen over the last several years would suggest it probably isn’t. After all, Bitcoin reached an all-time week-end high of $64,337/xbt during the second week of November of 2021. Since that time, it has traded below $20,000/xbt on numerous occasions. Currently, it is trading around $43-44,000/xbt. That is a lot of swing for something you would ideally like to be somewhat stable.
So, it doesn’t meet my/our definition of a currency, which is unit of exchange which facilitates transactions and has some capacity as a store of value.
As such, currently, we would have to classify cryptocurrencies as a separate asset class, a relatively volatile one at that. This takes us back to our problem: how do we value an asset which has no cash flows, no intrinsic value, never matures, etc.? One where the primary pricing factor/decision seems to a “fear of missing out” (FOMO)? And it doesn’t matter whether it is going up in price or down.
At least with a stock, I can back into a number or have some kind of ballpark idea as to what is reasonable. “A P/E ratio of 30x isn’t that much for a company growing as fast as that one is. After all, its PEG ratio is less than 1.0.” That sort of thing.
With a cryptocurrency, at present, it is basically my guess as to what the fool coming up behind me is willing to pay.
Over time, thanks largely to greater retail availability, the cash flows into and out of cryptocurrencies will moderate or smooth. Essentially, they will become more stable and predictable. Over my 30+ years in the investment industry, I have seen this happen with mortgage-backed securities, international investments and others.
As this is happening, the significant volatility in the price swings the asset class has demonstrated thus far will moderate, perhaps significantly.
Basically, a lot of risk will dissipate as cryptocurrencies ‘grow up.’
Since we should all understand, return and risk have an extremely strong positive correlation, meaning they move in the same direction, the potential for return will diminish, perhaps dramatically.
In the end, our Investment Committee believes there are numerous, more easily quantifiable assets available which would, could or should produce higher risk-adjusted returns (in the short-run) and higher absolute returns (in the long-run) than cryptocurrencies.
To be sure, we understand the so-called sizzle the new ETFs might have and why certain investors might be excited about them.
However, we maintain there are more reliable ways of generating an attractive rate of return than rolling the dice with cryptocurrencies in our primary investment strategies. That isn’t to say we will never incorporate them…just not at this particular point in time.
In the future, and this will likely singe the eyeballs of the Bitcoin aficionados still reading this, I can easily see crypto playing a role like commodities currently do in portfolio construction. It could be a slightly more volatile (read: higher-returning) hedge against the dollar than silver, gold or other primary reserve currencies. Regardless, it likely won’t have the same price fluctuations it has had to date.
As I have stated already, that will likely compress returns, both positive and negative. Voila.
With all of this said or written, if you want to play in the cryptocurrency sector, these new ETFs are probably a less risky, and liquid, way of doing so than by buying the things directly. However, don’t expect to see the same gaudy return Bitcoin was generating a couple of years ago. If they happen, great. Just don’t expect them.
If for no other reason, by the time the big players in the investment industry decide to bring the good stuff down to the retail crowd, to grandma, the easy money is normally long gone.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this any every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
John Norris
Chief Economist
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.