Assessing The Crypto Crash
After class last week, one of my students wanted to discuss cryptocurrency. Michael led by stating that Bitcoin is down 50% from its peak. He added that surely this must be a great buying opportunity.
I told him it is an interesting question, but admitted I’ve never invested in Bitcoin or other crypto-currencies. However, our office spends time thinking about it. We allocate tremendous time analyzing many assets, most of which we will never invest in.
In the process, a key to successful investing is knowing what you will do and why, as well as what you won’t do and the logic supporting this. If not, you’re apt to chase every story thrown your way.
Understanding this, I didn’t want to just give Michael a yes or no answer. I offered a framework he could apply not only to crypto, but other assets.
We attempt to frame the conversation from multiple perspectives. For instance, if you bought Bitcoin three years ago, you’ve had a very nice return. However, if you chased the “hot thing” and bought the crypto-coin recently, you may be down 50% from its peak. How do you feel being underwater?
Such wide variability in outcomes can make someone neurotic.
For any asset, we attempt to run through a check list to focus our attention. The goal is to assess an asset or investment as logically as possible.
I asked Michael why he is attracted to Bitcoin. Does he genuinely think it has solid investment merit? Or, is it simply jealousy, watching others seemingly make money out of thin air? Jealousy will make you do many undisciplined or foolish things.
Often, we deceive ourselves or use revisionist history. The similarities between great fishing stories and investing home-runs are so similar they are comical.
If Michael genuinely thinks Bitcoin is a solid investment, he needs to draft his investment thesis and answer these questions:
What provides a sustained competitive advantage over any other asset?
What is your valuation process for this asset? If Michael can’t do this, then he has no idea if he is getting a good deal or not. When Starbucks buys beans, adds hot water and sells it as liquid joy I understand the input components, why people pay for it and what gives it value.
For the most part, cryptocurrency does not produce a good or service. As such, it has value because a bunch of people say it has value—and that is dangerous. It will have value until someone decides it does not.
There is an argument that cryptocurrency is a method for transferring something. If I lived in a third world country, such as Venezuela, this might be my only avenue to get value out of the country. As such, there may be legitimacy.
There are dozens of accepted methods for valuing traditional assets whether rental property, homes or financial assets. However, if cryptocurrency does not produce anything—other than a method of exchanging units from one person to another—I have a hard time assessing valuation.
Who stands behind any cryptocurrencies? I may not like the way the U.S. government devalues the U.S. dollar, but I know the largest economy in the world stands behind our currency.
Lastly, I asked Michael if he would rather own cryptocurrency or a productive, profitable business. He concluded that although cryptocurrency may serve as a quasi-substitute for value, it is inferior to the value creation from owning productive and profitable businesses.
After offering these questions, I asked Michael, “Given everything you know about investing and Bitcoin, what will happen next?”
I added that you can’t just answer, “It will go up.” Write out your thesis supported by math and logic as to the expected rate of return and the time frame for this assumption. Assigning a time frame forces you to distill your instinct and logic and be rational with your investment process.
If you can’t logically and consistently determine, within a reasonable range, what happens next, you are gambling.
Gambling is okay if you are honest about it, and you can control it. Unfortunately, many gamblers are not honest about their odds or outcomes.
Regardless of the asset, all investors benefit from a well-defined process of logic, discipline and documentation. Lastly, don’t be afraid to pass on an investment if you don’t understand it. There is always another opportunity around the corner. Be patient and wait for the right one.
Dave Sather is a Certified Financial Planner and the CEO of the Sather Financial Group, a fee-only investment management and strategic planning firm.
