Bitcoin is outdoing even Donald Trump in the amount of news space it is capturing. Some people have already made huge returns and some are wondering whether it could turn into a “real” currency that replaces or at least competes with the dollar. No doubt, there are more and more people thinking about how to get a piece of this action. Well, this conservative old man (in a brightly coloured shirt) says, “Beware!”
Before making any investment, you first of all need to know what it is about. Financial players are famous for—and rich because of—selling complex investments that buyers do not fully understand. In India, we had hundreds of corporates getting burned back in 2007 and 2008 buying complex derivatives that offered wonderful returns on the surface with no understanding of the underlying risk—the Swiss franc has never fallen so low before, being a sample justification. Even today, there are companies in court with banks struggling to settle transactions that are over ten years old.
Thus, “buyer beware” should be the baseline for activity in the financial market. If you don’t understand a product, at least at a high level—to the extent, for instance, that you understand that the value of, say, the Euro is based on the strength of the European economy, global interest rates and other macroeconomic factors—DON’T BUY IT.
Now, frankly, I don’t understand bitcoin. I believe it is a software-generated entity that is indestructible once created, has limited supply, but can be “mined” by skilled IT people. It derives its value from I don’t know what—supply and demand, perhaps, which makes it look suspiciously like the greater fool theory.
The second element in any investment decision is risk. How much are you willing to lose? People seldom ask that question before investing. Of course, if you go long on an asset, it is implicit that the maximum you can lose is the amount you have invested, unless, of course, you are a sound investor and build a stop-loss into your investment.
However, if you are considering going short on bitcoin—and, at least from press reports, much of the recent froth in the bitcoin market is linked to the prospects of the major financial exchanges listing a bitcoin product so people could short it—you may find this story interesting.
My father, who was in the financial markets for 75 years before he slipped away recently, was a bullion broker in his early days. As a young market man he, of course, like so many others, developed strong views and, one day, he was trying to convince a client to short gold. His client, a venerable gold trader, kept fobbing him off till, finally, after a week or more of persuasion, he agree to sell 2 tolas short. My father was astonished—this man regularly ran positions of 200 tolas or more, so he asked him to increase the position. The elder gent smiled at my father and said (something like), “Young man, if I buy 100 tolas or 200 tolas, I know how much I can lose—the market can only go as low as zero. If I short even 1 tola, my losses can be any amount since markets can rise to any level.”
In other words, the risk is unmeasurable. Never take a short position unless you have an effective stop-loss in place. Given the Wild West that passes for a market for bitcoin, good luck with finding a halfway credible intermediary who can provide you a credible stop-loss.
Clearly, shorting bitcoin is a BIG no-no. What about going long? Well, in my view, the risk, while again limited to your investment, is huge and, again, unmeasurable. With each passing day, technology is becoming less and less secure, and it seems patently obvious to me that all our hand-wringing efforts to protect data or privacy or whatever is simply (if you will excuse the expression) pissing in the wind. The technology genie is out of the bottle and it ain’t going back in. Everything is hackable.
As likely as not, it is only a matter of time before someone figures out how to generate bitcoins by the truckload, shorts the market and smiles (for a while at least), and there goes more or less all of your initial investment—remember, no credible stop-loss.
Thus, given that I don’t understand very much about bitcoin and that, partly as a result of that, the risk is extremely high, I would not invest in it—and neither should you.