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Bitcoin or a bit crazy?

15th February, 2021

Published in the Sunday Times on 14th February 2021

Bitcoin Schadenfreude

Taking pleasure in other people’s pain is not a particularly endearing character quality, but I couldn’t help the creeping sense of satisfaction as I read the following tale. 

In 2009, James Howells mined 7,500 Bitcoins, put the private key on a hard drive, and then in 2013 accidentally threw the hard drive away. The Bitcoins were then worth about $4 million. 

That was 2013. Bitcoin has gone up a fair amount since then. At today’s price that’s a $270 million hard drive. Buried somewhere under four feet of rubbish in the Docksway landfill site near Newport, Wales (if you are interested), in a space about the size of a football pitch.

I don’t own any Bitcoin. And so the Dalkey dream pad, remains exactly that, a dream. I may not have any Bitcoins, but it must be unspeakably worse to say you’ve misplaced a fortune in Bitcoins.

According to Chainalysis, approximately 20% of all Bitcoins in existence, 3.8m coins worth c. $140bn, are in lost or stranded wallets: if you lose your private key, your Bitcoins are gone, with no bank to appeal to get them back. 

All may not be lost in Howell’s case however. He maintains he has financial backing from a hedge fund to pay for a search of the dump. This is really pushing the envelope on the term ‘special situations’ fund!  

Bitcoin gaining wider acceptance

Schadenfreude aside, I’ve had cause recently to reassess my sceptical view of Bitcoin. It seems to have crossed a line and is gaining wider acceptance. In fact, Blackrock, the world’s largest asset management firm recently filed with the U.S. Securities and Exchange Commission for two of its funds to invest in Bitcoin futures .

For much of its existence Bitcoin has been a highly speculative idea with a low probability of success.  It remains a highly speculative asset, but the longer it survives, the more likely it is to have some value in the future. It’s like Nassim Taleb’s Lindy Effect - the future life expectancy of a non-perishable thing, is proportional to its current age. 

After just 11 years in existence, it may be bit early to conclude that Bitcoin has "stood the test of time" – to borrow a common idiom. But if we accept that it has a future, we are still left with the much thornier issue of what it’s worth. 

Valuing Bitcoin

Valuing Bitcoin is hard. There are no earnings or cashflow or dividends to look at. In that respect it resembles Gold – which itself attracts a fair amount of controversy in terms of valuation. 

Bitcoin bulls argue it resembles Gold in another important respect – finite supply. Maybe. But there aren’t hundreds of precious metals competing with Gold as a store of value. You can’t say the same about cryptocurrency.

Part of the challenge with Bitcoin is termed reflexivity. Viewing it as a currency - if everyone wants it, then it has value. If no one wants it, then it’s worthless. So-called “fiat currencies”  are not backed by anything other than a promise by a central bank to honour its face value. Most holders of US dollars are happy to accept that promise and so it maintains value. It’s likely you would be less inclined to accept that assurance from the Reserve Bank of Zimbabwe, and so the Zimbabwean Dollar hasn’t. The longer it survives and the wider the acceptance of Bitcoin, the greater our bullishness should be. But at what price?

It almost feels quaint to suggest that fundamentals matter. Afterall look at the frenzy around Gamestop, Blackberry and others in the past month. Fundamentals in these stocks may well assert themselves eventually, but it doesn’t stop people making (and losing) a fortune along the way.

Intrinsic Value

The closest thing I have seen to a reasonable valuation approach is relating it to its intrinsic value. Gold’s intrinsic value, in theory, is some spread over what it costs to mine the metal. Bitcoin is also “mined”—by running complex calculations through computers, which use electricity. Estimates vary (depending on the price of electricity where you are mining for example), but it can cost c. $10,000  to mine a single Bitcoin. Beyond that, its price is whatever other people say it is. And that’s the part I find rather uncomfortable. 

Channelling Warren Buffett – Bitcoin is in my ‘too difficult’ pile. I’ve nothing intelligent to add to the valuation debate beyond this. Ray Dalio  of Bridgewater puts it well: “Bitcoin looks like a long-duration option on a highly unknown future that I could put an amount of money in that I wouldn’t mind losing about 80% of.” That seems fair. 

The proportion of my investment portfolio that I could realistically commit to something with these qualities is exceptionally small. And I expect that’s the same for most. 

If you want to own Bitcoin, but don’t have the stomach for the aforementioned risk, you could of course launch a gofundme campaign for an excavation trip to a landfill in Newport.  I don’t think I would donate, but it’s certainly a campaign sales pitch I would love to see.
 

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