Investing in Bitcoin?

Xavier Freixas , director of the Master's Degree in Finance and Banking

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On October 19, the United States stock market regulatory body, the Security Exchange Commission (SEC), authorized the first Bitcoin ETF in history. Previously, the Chicago Mercantile Exchange had opened a Bitcoin futures market. All this, while, at the beginning of September, the self-proclaimed Emperor of El Salvador decided to give legal tender to Bitcoin and, at the end of the same month, the People's Bank of China announced the prohibition of all operations in virtual currencies. As I write this article, the price of Bitcoin is at € 54,003.36, and when you read it the price will be totally different. Since its launch, the price of a Bitcoin has risen dramatically, but with dizzying volatility, ranging from losses of 74% to gains of 305%. With the legitimacy conferred by being a form of investment recognized by the SEC, Bitcoin with the mathematical elegance underlying blockchain technology now seems to enter a phase of maturity, almost 13 years after its creation.

I'm surprised to see that some mutual funds have now started investing in Bitcoin. A priori, this decision could be justified by the high historical profitability of the cryptocurrency combined with the little correlation that its variations have with the stock market. These characteristics make Bitcoin attractive, following the criteria of Markowitz, whose research earned him the Nobel Prize in economics in 1990, since it would allow increasing the profitability of a portfolio without increasing its risk. However, historical returns do not predict future returns, and in the case of Bitcoin, as we are going to see, future performance is particularly difficult to predict.

Let's analyze the investment in Bitcoin from the perspective of the so-called value investment, by Benjamin Graham and Warren Buffet , and ask ourselves what is the business model? What added economic value is generated? What is the company's strategy on environmental, social, and governance issues? What defenses does the company have against potential competition?

Investing in Bitcoin is more like investing in philately, where we invest in a small piece of paper in the hope that others will be willing to pay more for it in the future

Let's start with the business model. If I buy a BBVA share, I buy a part of its profits, and for every euro invested I will obtain future profits that today I estimate at € 0.17 per year. Investing in Bitcoin, on the other hand, does not produce any profit, and this is the reason why it is difficult to predict the future evolution of its price. Economic value added, profit margin and EBITDA are also zero. Thus, from this point of view, investing in Bitcoin is more like investing in philately, where we invest in a small piece of paper in the hope that others will be willing to pay more for it in the future. The possibility of analyzing the dividend policy is not even considered. Ultimately, if we are based on discounted future dividends, the intrinsic value of Bitcoin is zero. In order for its price to increase, new investors must enter, as in a typical pyramid scheme.

If we examine the ESG criteria to determine the implications for environmental, social and governance issues, the outlook is bleak. First of all, Bitcoin is the currency per excellence of the deep web that is used to pay ransoms from kidnappings, and for more or less organized crime, money laundering, terrorist financing and tax evasion.

Second, it is an ecological catastrophe. To validate transactions, it is necessary for the so-called miners, acting in a decentralized way, to proceed to solve a mathematical problem whose complexity increases over time. The process requires power-consuming supercomputers, both for the computer and for cooling. In the case of Bitcoin, the process involved an annual consumption of 144.28 TWH (Terawatt hours), 0.66% of the energy produced on the planet, equivalent to the electricity consumption of Switzerland. Not surprisingly, then, Tesla CEO Elon Musk eventually distanced himself from Bitcoin trading.

The intrinsic value of Bitcoin is zero. In order for its price to increase, new investors must enter, as in a typical pyramid scheme.

Finally, as for possibles barriers to entry that limit competition, although it is currently estimated that Bitcoin has almost 90% of the market, there is no clear advantage of Bitcoin over its competitors, with the exception, of course, of the liquidity associated with it. volume of Bitcoin in "circulation". Let us remember that there are some 6,000 cryptocurrencies in the world and, although many of them may correspond to scams of the "take the money and run" type, the Ethereum platform, which issues the cryptocurrency Ether, sometimes called "the little sister of Bitcoin", allows, in addition to carrying out transactions, managing smart contracts.

In short, the well-known aphorism of Warren buffet “only when the tide goes out we know who was swimming naked” perfectly sums up the investment decision. If we buy Bitcoin we can make money, but the day the tide goes out we can lose all the accumulated capital. With cryptocurrencies we stopped investing in the stock market to speculate.