Bitcoin is basically electronic cash that allows online payments to be sent directly from one party to another on a peer-to-peer network without going through a financial institution. The Bitcoin network shares a public digital ledger called a blockchain, which contains a record of every transaction ever processed and allows users to verify the validity of each transaction.
More than ten years after its creation, there remains a lack of consensus—both within the investment community and among regulators—as to what cryptocurrencies actually are. Some allocators consider cryptocurrencies financial assets, though this classification is at odds with United States Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), under which they are generally accounted for as intangible assets. Though not physical in nature, the IRS classifies cryptocurrencies like Bitcoin as property (i.e., a real asset), not currency.
Some proponents argue that Bitcoin and other cryptocurrencies act as a store of value and medium of exchange, though their extreme price volatility and the resulting uncertainty surrounding their value makes it difficult to support these claims. Bitcoin has already gone through several cycles of boom and bust, despite having just been created in 2009. As one example, in the fall of 2017, the price per Bitcoin was around $5,000. By December, it had skyrocketed to nearly $20,000 before plummeting back to $6,600 a few months later.
At Cobblestone, we believe cryptocurrencies most closely resemble an alternative asset, or in other words, an asset that falls outside of traditional asset classes like stocks, bonds, or cash. When we look at alternative investment opportunities for our clients, we seek risk premiums that meet each one of our four investment criteria:
- Economic underpinnings that differ from common portfolio risk premiums. For example: equity risk, credit risk, and duration risk.
- Intuitive and economically justifiable. For example: compensation for risk transfers.
- Pervasive across comparable markets.
- Persistent over time.
For Bitcoin and other cryptocurrencies, the risk premium has been neither persistent nor pervasive (some cryptocurrencies have generated returns while others have not). Nor is there an intuitive explanation or economic justification for a risk premium.
Additionally, there is significant uncertainty surrounding regulatory risk of this relatively new asset class and the tax ramifications that are likely to unfold in the months and years ahead. Investors should also consider the heavy environmental impact of Bitcoin mining. “Mining” Bitcoin involves solving complex math problems in order to create new Bitcoins, which requires significant amounts of computing power and, consequently, electricity. In fact, a recent Bank of America report failed to find many other human activities with a higher carbon footprint.
In short, there are still too many looming questions for us to recommend investing in Bitcoin or cryptocurrencies more broadly. While cryptocurrencies may ultimately evolve into an asset class that is worthy of prudent investment—as opposed to one driven by speculative motivations—our view is that we are just not there yet.
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