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The worst way to make a 100,000% return

With Bitcoin at all-time highs, is this bandwagon about to lose its wheels?

Had you invested just $900 in Bitcoin at the start of 2012, you would have more than $1m today. Blockchain is a groundbreaking innovation and, unlike normal currencies, Bitcoin is limited in quantity – the Government can’t whittle its worth away by printing more, as it does with cash. The Government can’t spy on your purchasing habits either because transactions are anonymous. Bitcoin is the future of international currency.

Sadly, sales pitches doth butter no parsnips. These days, Bitcoin may have more hyper-manic fans than a One Direction concert but any investment case – including the one above – is seriously flawed.

The most popular argument for buying Bitcoin seems to be that it's a currency in limited quantity. ‘Contrary to the fiat currency system, without a central authority to create more Bitcoin, its supply can't be increased. The result is that if demand increases, the price of Bitcoin will rise,’ as one investor put it.

No dispute there – without detailing the intricacies, Bitcoin has a hard cap of 21 million coins, which should be reached in the year 2100 or so. Until then, the laws of supply and demand mean that if Bitcoin gains popularity, the price will go up.

A rare asset in limited quantities, however, isn’t an investment case. Diamonds, art, and first edition One Direction albums are all limited quantity assets. Even gold, the granddaddy of ‘limited quantity currencies’, has been a terrible long-term investment. Adjusting for inflation, gold is roughly 50% below its peak in 1980.   

From an investment standpoint, the fundamental problem with buying Bitcoin, gold or albums is that they aren’t productive assets. If you buy one Bitcoin today, 50 years from now you will still have just that one Bitcoin. It’s much better to own productive assets, such as stocks and property, that will produce a growing stream of cash flows that can then be reinvested in yet more cash flow-producing assets. This will compound your money far better than buying a Bitcoin and hoping it gains popularity.

The price of fish

The current hype around Bitcoin reminds me of a (probably made-up) story about sardines. When they disappeared from their traditional waters off the coast of California early in the 20th century, supplies dwindled and the price of canned sardines began to climb. Buyers became increasingly frantic, hoping to get in ‘while stocks last’. Noticing the trend in prices, new investors started to join them, hoping to flip the cans at a profit down the track. As prices continued to rise, every new buyer was more confident than the last.

One day an investor decided to treat himself to a luxurious meal and opened a can to eat. He immediately spat out the sardines and told the seller they were rotten. ‘You don’t understand,’ the seller said. ‘These aren’t eating sardines. They’re trading sardines’.

Speculation is as old as human nature. You can speculate on everything from Bitcoin, to gold, to sardines. All speculation, however, is based on what you think somebody else will pay for an asset tomorrow, rather than conservatively valuing its productive capacity today.

Bitcoin fans are behaving a lot like sardine traders – most are just hoping to sell to somebody else down the track at a higher price than they themselves thought it was worth. That’s fine if you like to gamble, but don’t confuse it with investing.   

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