In recent months, Bitcoin has captured the public’s imagination like few things have. Barely a day goes by without a newspaper headline mentioning it. Some say it is like digital gold, while others write it off as a bubble. In mid-December, the price hit a record high of $19,783 before falling by more than 40%. However, it has rebounded since then, and some people are asking – is it a bargain now?
In order to know whether or not it is a bargain at around USD17,000 per Bitcoin (as of 8th January 2018), the question we need to ask ourselves is: How much is 1 Bitcoin really worth? After all, it is only a bargain if it is actually worth more than the current price.
How do we value an asset? The intrinsic value of an asset is the estimated sum of its future cash flows, discounted to the present value. Bitcoin, unlike stocks, bonds, properties or even fixed deposits, does not generate any cash whatsoever. So essentially, we are unable to estimate its intrinsic value. Its value is solely dependent on what someone else is willing to pay for it, and that is impossible to predict.
In other words, we have no way of knowing whether the current price is a bargain or way overpriced.
Benjamin Graham and David Dodd, authors of Security Analysis, defined investing this way: “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” If the value of an asset is determined by sentiment, there can be no safety of principal. There is no downside protection in the same way that a stock’s earnings and dividends, a bond’s interest coupons or a property’s rental income provides to the investor. Additionally, the past performance of an asset is not indicative of future returns. If an asset has no hope of generating cash, whether now or in the future, one cannot rightfully expect an adequate return. One can hope to make money by buying it, because perhaps demand may increase and supply is relatively limited, but that is entirely different from expecting to make money from it. It is a little like buying 4-D – you may guess the right numbers and win a prize, but that does not mean that you actually expect to win money when you buy 4-D. Over the long run, due to the odds of buying lottery, the expected return is actually negative.
This is why at Providend we only invest into asset classes that generate cash – such as fixed income and equities – because we believe that over the long term they promise safety of principal and we can expect an adequate return. We do not invest into Bitcoin, and have no intention to – no matter what price its proponents claim it is capable of reaching.
If you would like to buy Bitcoin, by all means do so, but please do so with the recognition that you are speculating – not investing.
This is an original article written by Sean Cheng, Portfolio Manager at Providend, Singapore’s Fee-only Retirement Financial Adviser.