MARKET COMMENTARY

Bitcoin: Is There Something to the Hype?

12.22.2017 - Viraj B. Patel, CFA, FRM, CAIA

In the financial press and among investors, few topics are generating as much curiosity as Bitcoin, a digital currency that exists only on the internet. Given this high level of interest, we have been tracking Bitcoin’s evolution carefully.

What is Fiduciary Trust’s Position on Bitcoin?
While the future possibilities for Bitcoin are fascinating, and it has attracted a lot of attention from speculators, our conclusion today is that Bitcoin is not an appropriate holding for investors who are focused on preserving and growing their family’s wealth. In our view, the risks far outweigh any potential benefits it might offer long-term investors.

In summary, we believe Bitcoin is: 

  • Highly speculative: Bitcoin prices have been up as much as 1,900% this year, driven largely by speculators looking for quick gains. In our view, its price momentum appears unsustainable, and its volatility makes Bitcoin a high-risk investment. 
  • Technically risky: Bitcoin is bought and sold on unregulated web exchanges and it is vulnerable to theft. Risks range from the relatively minor inconvenience of losing the password to your online Bitcoin wallet to a global security breach that compromises the entire system.
  • Not a traditional currency: Bitcoin falls short of the characteristics associated with money and it has none of the safeguards that are in place for most fiat currencies. In our view, it is unlikely Bitcoin will become a commonly accepted medium of exchange any time soon.
What is Bitcoin?

Bitcoin is referred to as a “cryptocurrency” because sophisticated encryption techniques are used to regulate the creation of new units and make online transactions safe and secure. Unlike the traditional currencies used by most consumers today, Bitcoin is not issued or regulated by a governmental agency. Instead it is created by a computer program and traded on the web through online exchanges such as Coinbase, which typically hold it for buyers in a “virtual wallet.”

Why Are Investors so Interested in Bitcoin?

The skyrocketing price of Bitcoin is the main reason it has attracted so much hype. Because Bitcoin exists only in cyberspace, there are no physical assets for a seller to deliver or a buyer to receive. This makes it relatively easy to buy and sell Bitcoin quickly, creating a volatile market that appeals to traders and other market speculators. A smaller number of investors see Bitcoin as a defensive holding, believing it will hold its value during tough economic times. The government does not control its supply, so theoretically it cannot debase the value of Bitcoin the way it debases fiat currencies.

Finally, a growing number of Bitcoin advocates are convinced it will eventually become a commonly used medium of exchange, offering more privacy than traditional currencies.

How Does Someone Invest in Bitcoin?

Beyond purchasing it directly from an online exchange, options are limited. Most brokerage firms and wealth managers (including Fiduciary Trust) are not able to buy or sell Bitcoin for their clients. The SEC has denied several applications for Bitcoin ETFs—although it may reconsider those requests now that Bitcoin futures are trading on the Chicago Mercantile Exchange and Chicago Board Options Exchange. But it is generally expensive to trade futures contracts.

So the only other reasonable option for individuals might be the Bitcoin investment trust offered by Grayscale Investments, but it is available only to accredited investors who meet certain requirements for income and net worth. Furthermore, its share price has risen to almost twice the value of the Bitcoin it holds, indicating to us that speculators are active.

How is Bitcoin Priced?

For most traditional currencies, exchange rates are influenced by economic fundamentals and the government’s monetary and fiscal policies. In the US, the dollar is also backed by the full faith and credit of the US government. But these factors are not relevant for Bitcoin. Instead, prices appear to be driven by strong demand from speculators and a limited supply established by its creators.

Is Bitcoin a Currency or a Commodity?
In a traditional sense, it does not fit neatly into either of these asset classes.

A currency must meet three criteria:

  • Is it a “unit of account”? Yes. Consumers must be able to divide a currency into smaller units, count it and exchange it for another type of currency. Bitcoin appears to meets this standard adequately. 

  • Is it a commonly used medium of exchange? No. A currency must be accessible and portable. Only a small number of merchants accept Bitcoin today and many use a third-party agent to convert Bitcoin to US dollars before receiving payment. As a medium of exchange, Bitcoin appears to fall short. 
  • Does it retain its value over the long term? The answer to this question is yet to be determined. But Bitcoin’s price volatility in 2017 tells us that its usefulness as a store of long-term value is questionable.
As a commodity, Bitcoin’s qualifications are somewhat stronger.

  • Can it be divided into smaller units, counted and exchanged? Theoretically, yes. 

  • Are supplies limited? Yes, but the scarcity of Bitcoin is established by a computer code. Traditional commodities like silver and gold, are in limited supply because they are natural resources.

  • Is its price driven by supply and demand? Yes, but it has been inflated by market speculators.
Our View: Bitcoin is for Speculators, Not Investors

In addition to its price volatility, risks associated with Bitcoin range from losing the password to your online Bitcoin wallet to a global security breach that threatens the entire cryptocurrency system. In early December, hackers allegedly stole $70 million worth of Bitcoin from a popular online exchange. By some estimates, Bitcoin owners have lost $30 billion in Bitcoin held on their personal computers.

While we are intrigued by the potential Bitcoin might offer in the future, it is difficult to find compelling evidence that it will protect purchasing power if the economy stumbles or become widely accepted as a common currency any time soon. In fact, judging by the patterns we have witnessed in other asset classes, we believe Bitcoin prices are likely to fall back down to earth in the not-too-distant future (CHART).

Is This Time Different? Bitcoin Compared to Market Bubbles

A Better Opportunity? Blockchain

In order to prevent double payments and bogus transactions, and ensure the validity of all Bitcoin transactions, a sophisticated system called Blockchain was developed. It verifies transfers but does not rely on traditional intermediaries such as banks or brokerage firms. In concept, the goal is to provide a peer-to-peer medium of exchange that allows buyers and sellers to remain anonymous. It is decentralized, “incorruptible” and transparent—every transaction is broadcast to the entire network of Bitcoin users, allowing all users to maintain a running tally of each transaction so that the same unit of currency is never used more than once.

Blockchain may also have applications beyond Bitcoin, including the execution of smart contracts, online voting, notary services, identity protection and more secure cloud-based data storage. These potential advantages have attracted investment dollars from large, well-known companies in the technology and financial sectors as well as smaller, publicly traded start-ups. So we are monitoring the evolution of Blockchain carefully. We are especially interested in companies that are researching ways to leverage its strengths in ways that do not involve Bitcoin or other cryptocurrencies.



This analysis is provided for illustration and discussion purposes only and does not guarantee future results. Please speak to your Fiduciary Trust contact if you have questions or would like more information. This communication is intended solely to provide general information. The information and opinions stated are as of December 22, 2017, and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

CFA® and Chartered Financial Analyst® are trademarks owned by CFA institute.

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