To crypto or not to crypto?

Plato concluded that the right thing was the right thing, even if no one else was doing it.

Equally, he concluded, that the wrong thing was still the wrong thing, even if everyone was doing it.  

My former UBS colleague, Hamish Douglass, is a Warren Buffett devotee. He is the Co-Founder and Chief Investment Officer at Magellan Financial Group, and a very rich man.

Hamish recently reminded us that in 1965 Warren Buffett wrote in his letter to investors:

"We derive no comfort because important people, vocal people, or a great number of people agree with us. Nor do we derive comfort if they don’t. A public opinion poll is no substitute for thought.”  Warren Buffett, 1965.

        

Fast forward to 2021, and Charlie Munger, Vice Chairman of Berkshire Hathaway, said at the company’s 2021 AGM: 

“If you are not a little confused by what's going on, you don't understand it.”  Charlie Munger, 2021.
        

I am a little confused by crypto; but I'm keen to think about it and to learn. 👩🎓

There are more than 6,000 crypto-currencies with the best known being Bitcoin and Ethereum. But what is their value? And is that value as a medium of exchange (a currency) or as a wealth-creation tool (an asset)? Or something else? 🤔

<< What is the value of crypto? >>
        

To help me understand, this week I tuned into UTS Business School's excellent webinar on crypto hosted by Dr Gerhard Hambusch where this key question was posed to an expert panel that included Fred Schebesta from Finder, Benjamin Chong from Right Click Capital, seasoned quant and prop trader Alicia Vidler plus Prof. Talis Putnins.

Now Australian Dollars are both a currency and an asset. I can make a payment in AUD inside Australia without any quibble over their value. I can go to the FX market to find their value in terms of other currencies or to the commodities market to find out how much it would cost me in AUD to buy gold, oil or soybeans. 

I can spend AUD on consumption goods like hamburgers and hoodies. I can use them to pay my rent and my taxes. If I have a surplus of them, I can put $100 dollar notes under the mattress or have an at-call savings account or term deposit with a bank. 

Nothing new there.

What is new here in these strange pandemic-times is that:

1. RBA official cash interest rate is 10bps and it may stay there for years.
2. Inflation spikes and jumps “out-of-bounds” to 3.8%.
3. Unemployment drops to 4.9% which puts us in NAIRU territory (non accelerating inflation rate of unemployment, widely accepted to be 5% for Australia althouth I note that Treasury believes it’s a band of 4.5-5%.)

Hyper-inflation is bad. Deflation is also bad. The "right" amount of inflation is good for the economy. The RBA targets inflation “through the cycle” of 2-3% pa but most recently for the June quarter it printed at 3.8% yoy and the economists on prime time media talked about the “reflation trade” and “inflation headwinds” alongside fiscal & monetary policy and quantitative easing. 

Why are low interest rates and high inflation of concern? 

It's all about risk versus return. This is Finance 101. So let’s start with the concept of the risk-adjusted return on cash, where inflation is the risk, giving us a real or inflation-adjusted rate of return.

Unless you earn an interest rate (your “return” or “yield”) on your cash that is greater than inflation, you are actually going backwards in terms of your spending power, which we call the real or inflation-adjusted return. 

This is part of the risk of holding cash. Whilst it has a low-risk, safe, non-volatile value, and its value versus itself is self-evident, there is also an opportunity cost of holding cash in that you are not invested in growth assets and, in a world of negative real rates, each year your spending power goes backwards in real terms, by which we mean we have adjusted the nominal interest rate return for the effect of inflation. 

Here comes some more Finance 101: Time-Value-of-Money or Financial Maths.

Let’s say you are getting 30bps somewhere on your at-call cash from a government-guaranteed bank. So we can call it “risk free.” If inflation stays at 3.8% for say 5 years (which I don’t think it will … this is just an example), what would $100 be worth in 5 years time? 

Put this into Excel =FV(-3.5%, 5, 0, 100,0) and you get $83.68.

Either you accept to go backwards by $16.32, or you accept some additional risk, because you have to run to stand still. 🏃♀️

"Earn yield in real time"

As a PR pro, I can see that this message works. It's a good marketing message.

You have to “earn yield” and find a better “store of value” which is where the conversation on crypto seems to have landed.

Also, as a PR pro ... with a Masters of Applied Finance ... I'm still a little confused.

For me, an asset as something I hold for the accretion of wealth, rather than a mere store of value. This is because my portfolio is tilted to Growth and if I'm going to take the risk of crypto and its crazy volatility, why would it be just so I can store value?

What is crypto's value anyway?

The panel on the UTS webinar tried to answer this. Fred said it's a "fervent debate," Talis talked about traditional valuation methods like DCF and multiples, and Alicia talked about alternative assets like antiques and art.

Could it have value as a currency? 

Currency evolved to make trade easier. When all we could do was barter to exchange bananas for beef, it was very hard to negotiate a deal.

(If you haven’t seen The Laundromat (on Netflix) then the opening scenes explain this origin of money very well.)

If you agree that I can pay you in used tea leaves or sea shells, then that’s a currency. 

✅ I can get my head around a medium of exchange. 

✅ I can get my head around speculation (as long as it's only a small percentage of your total assets). (Another bit of Finance 101: Diversification.)

❓ What I can’t get my head around is why you would take the risks of crypto just to have a “store of value.”

On the UTS webinar, Fred said: "If you don’t think Bitcoin has any value, very happy for you to send me all your Bitcoin." 🤣

Hamish Douglass says that Bitcoin is worthless. I suspect he doesn't have any Bitcoin to send you, Fred. And nor do I ... at least not yet ...

#JenniferJoinsTheDots #FridayFinance #MakeGoodDecisions