Crypto Currencies: Future of Money or Speculative Hype
As I noted in my previous posts on crypto currencies and bitcoin in particular, I disagree with its most vocal critics and strongest supporters. I do not believe that Bitcoin is a fraud or that those who "stupidly" buy it will be punished. I do not believe crypto currencies are an asset class and that they can alter fundamental truths about risk, investment, and management, unlike its most vocal supporters. The main reason there is a divide is that both sides disagree on bitcoin's definition. At the risk of raising hackles, I will argue that Bitcoin is not an asset and that you can neither value it nor invest in it. It can only be priced and traded.
Assets, Commodities and Collectibles Although not all things can be valued, almost all can be priced. Let me begin by saying that all investments that I look at must fall within one of these four groups:
1-Cash Generating asset: An asset that generates cash flows or is expected to produce them in the future. As such, a business you own is an asset. You also have a claim on its cash flows. These claims can be contractually fixed (bonds, debt), residual (equity and stock), or contingent (options). Assets share one thing in common: they can be valued. Assets with higher cash flows and lower risk should be valued less than assets with lower cash flow and greater risk. Assets can be priced relative to one another by scaling the price you pay to a common measure. This is done with stocks by comparing pricing multiples across companies (PE ratios, EV/EBITDAs, Price to Book, Value/Sales) to make pricing judgments about which stocks are most expensive and which are the best.
2-Commodity - A commodity's value is derived from its use in the production of raw materials to satisfy a fundamental human need. This could be food, energy, shelter, or shelter. Although it is possible to estimate the value of a commodity by looking at its demand and supply, the process of valuing an asset is more complicated than that for a commodity. Commodities are priced based on their history. Normalized oil, coal, wheat, and iron ore prices are calculated by averaging prices over long periods.
3-Currency Currency is a currency. It is a medium of exchange you use to denominate cash flow and a reserve of purchasing power if you do not want to invest. Currency cannot be valued or compared to other currencies. They are not cash flows. Long-term, currencies that are more widely accepted as a medium for exchange and have a higher purchasing power over time will see their prices rise relative to currencies without those characteristics. However, governments manipulating exchange rates may be dominant in the short-term. This is illustrated in the graph below of the US dollar against seven fiat currencies. Over the long-term (1995-2017), the Swiss Franc, Chinese Yuan and Mexican Peso have increased in value relative to the $. The British Pound has fallen in price relative to both the $ and the Indian Real, Indian Peso and Brazilian Real.
4-Collectible- A collectible does not have cash flows and cannot be traded. However, it may sometimes have an aesthetic value (as with a master piece of art or a sculpture), or an emotional attachment (a team jersey or baseball card). Although a collectible has no cash flow, it can be valued based on how others perceive it and its rarity.
This lens shows that gold is not a cash flow-generating asset. But, it is a commodity. Gold's utility functions are not what make it valuable, but its long-standing role as a currency and a store of value. Even if you use it as a personal residence, real estate is considered an asset. Without it, you would have to rent the property (a cash flow). Private equity and hedge funds can be used to invest in assets, commodities, or collectibles. They are not distinct asset classes.
Investing versus Trading-Cash generating assets can both be valued and priced. Commodities can be priced more easily than they can be valued. Currency and collectibles cannot be priced. What's the point? It is important to remember the difference between trading and investing. You must first assess the value of the item, then compare it to its price. Crypto currencies
Then you can act on the comparison by buying if the value is lower than the price and selling if the value is higher. Trading is much easier. You price the item, then you make a prediction about whether it will rise or fall in the future. Then, you place a price bet. Both can be very successful, but the skills and tools you use for trading and investing are different. What makes a good trader is different than what makes a good investor.
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