Our columnist, a former portfolio manager at a major UK pension fund, gives a professional investor’s view on the crypto currency craze.
LONDON: Have you listened to the BBC Radio podcast The Missing Cryptoqueen? It does a good job of exposing OneCoin as a fraud, describing it as a fake crypto currency because it has no blockchain.
However, the podcast doesn’t point out that crypto currencies are themselves fake currencies. This omission might mislead the casual listener to believe that while OneCoin is bad, bitcoin is good.
A senior stockbroker once explained to me, and a roomful of other fund managers, that ‘if it looks like a duck, and quacks like a duck, then it probably is a duck’. He argued that bitcoin looked like a bone fide currency and might be an attractive investment proposition.
However, the key point he had missed was that bitcoin, and all other crypto currencies, have no reserves.
What is money?
Actual currencies started off as gold or silver coins, ‘commodity money’. When paper notes were introduced, they were ‘backed’ by gold and silver reserves, ‘representative money’.
The terms sterling and pound relate to the fact that paper notes could originally be swapped for pounds of silver held in reserve by the Bank of England. The UK entered the gold standard in 1844 and left it in 1931. During most of the period, pound notes could be converted into gold at a fixed rate of £1 for 0.235 troy ounces of gold.
Since 1931 the pound has been fiat money, where the link between it and government reserves has been more complex. The pound is now ‘backed’ by the future tax raised by the UK government.
Local inflation and purchasing power parity are also important since the currency is floating rather than fixed against the gold price. When the UK has good GDP growth numbers the pound strengthens. Higher GDP leads to a higher future potential tax take and the UK’s solvency improves relative to other countries.
Inflation risk
Deteriorating government finances due to the 2008 credit crunch and now Covid-19, plus fears over the inflationary impact of quantitative easing has resulted in a surge in the bitcoin price. Conventional currencies are about to devalue, so buy bitcoin is the cry from the crypto currency faithful.
However, just because Zimbabwe’s currency collapsed along with its economy, doesn’t mean that crypto currencies have any value.
ABC having no value doesn’t mean that XYZ has a value. Bitcoin has no reserves backing it and is thus effectively monopoly money with no value. The presence of a blockchain doesn’t alter this fact. It just means that the ownership of the monopoly money is secure.
So why is the price of one bitcoin currently $35,000?
Bubble?
The complex relationship between a government’s finances and its fiat currency has allowed room for misunderstanding and misrepresentation, with one erroneous argument being that it is OK for Bitcoin to have no value since neither does fiat money.
But you might as well ask why did people invest in the South Sea Company, tulip bulbs, or ostrich farms? Of course, it’s possible to make profits speculating in bitcoin.
As long as there is a greater fool ready to buy higher up the bubble will keep inflating. Thomas Guy made a fortune in the South Sea Company, sold out near the top and used his profits to found Guy’s Hospital in London.
However, the only value I can see in bitcoin is as a means to carry out illegal transactions without being detected. A drug dealer may be prepared to transact in monopoly money if he knows that using dollars will result in him being caught and going to jail. So, to him it has some form of option value, to the rest of us it is worthless and should be avoided like the plague.