Bitcoin is not a good investment

I recently came across a blog by Lyn Alden. According to her bio, her site “provides equity research and investment strategies to give you the insight and data you need for managing your money through all market conditions.” An article that stood out, among others, is 3 Reasons I’m Investing in Bitcoin.

This is one of those articles in which I know the author is wrong only by reading the title. This may sound arrogant and dismissive on my part, but proving or showing Bitcoin is a ‘good investment’ is a virtual impossibility.

Just the title alone if wrong. Bitcoin, being that is is more of a commodity than the equity, cannot be an investment. Much like a commodity, Bitcoin does not generate revenues or provide any form of ‘shareholder value.’ Rather, one does not ‘investment in Bitcoin,’ but instead speculates in it, much in the way someone would speculate in artwork or collecting old automobiles.

Since early 2018–back when Bitcoin was trading around $18,000-$13,000–I have been telling anyone who would listen to get out of Bitcoin and buy stocks instead, and that Bitcoin going forward would generate poor returns for speculators. That has indeed been the case: since peaking at $20,000 in late 2017 (which I predicted), Bitcoin has fallen almost in half, to 10,800 as of writing this. Meanwhile, the S&P 500 is up 30+% since then. This is a huge divergence of performance.

Of course, it is, in theory, possible Bitcoin will repeat its performance of 2017 and go up 5-10x, but as discussed before, that is exceedingly unlikely given how big Bitcoin (and the overall crypto market) is. Bitcoin alone is worth $200 billion. The entire crypto market is worth $350 billion (this includes altcoins such as Ripple and Ethereum), versus just $17 billion in January 2017. So for Bitcoin to increase 400% would imply probably the entire market being worth $1.7 trillion. There is just not enough money sloshing around or on the sidelines to buy up enough Bitcoin to justify such high valuations, especially given that crypto currencies do not in anyway generate shareholder equity, but rather are purely based on supply and demand.

Buying a share of Amazon entitles one to a share of future profits from Amazon, but Bitcoin does not ‘return’ anything to anyone who buys it. This also means Bitcoin (and other cryptos) exhibit strong mean-reversion tendencies: gains do not hold. This means, because no value is generated that can be passed on to holders of Bitcoin, the optimal way to trade Bitcoin is to sell whenever the returns exceed infliction (sell all price spikes). The same mean-reversion is exhibited in all commodities. Gold has been suck in a $1000-$2000 range for over a decade even as the S&P 500 has more than tripled. Oil has done even worse, stuck in a $20-80 range since the ’80s. Silver has also done very bad, too. Thus, commodities are NOT to be held for the long-term, as the returns are vastly inferior to equities over the long-run, even if in the short-run commodities can sometimes do better (such as in 1997-2008). Precious metals such as gold can be used to hedge a stock position if one enters and exists the position based on certain signals/factors, but few people do this, but rather intend to hold long-term, I guess in the hope hedging future inflation.

From the article:

My base case is for Bitcoin to perform very well over the next 2 years, but we’ll see. I like it as a small position within a diversified portfolio, without much concern for periodic corrections, using capital I’m willing to risk.

People always say this when they want to give themselves an ‘out’ in case they are wrong. If Bitcoin performs poorly, she can just defer to her disclaimer. The amount of capital one is willing to risk, is irrelevant in regard to whether or not Bitcoin is a good investment.

As someone with an engineering and finance blended background, Bitcoin’s design has always interested me from a theoretical point of view, but it wasn’t until this period in early 2020 that I could put enough catalysts together to build a constructive case for its price action in the years ahead. As a new asset class, Bitcoin took time to build a price history and some sense of the cycles it goes through, and plenty of valuable research has been published over the years to synthesize the data.

But we’re not talking about design or properties, but whether or not it is a good investment. These are different. Investments are about generating returns for shareholders. A beautiful painting may have certain properties that make it beautiful, but this does not change the fact that its value is subjective and a function of supply and demand, as opposed to profits or intellectual property. The onus is on her to show that Bitcoin can generate enough value to make it worth more than its present price. In the case of equities, present value is a function of discounted future earnings, but Bitcoin does not generate earnings, so this is harder to do.

Bitcoin’s protocol limits it to 21 million coins in total, which gives it scarcity, and therefore potentially gives it value… if there is demand for it. There is no central authority that can unilaterally change that limit; Satoshi Nakamoto himself couldn’t add more coins to the Bitcoin protocol if he wanted to at this point. These coins are divisible into 100 million units each, like fractions of an ounce of gold.

Note how she likens Bitcoin to gold in this example. Similar to Bitcoin, there is a finite amount of gold that can ever be extracted, but this does not change the reality that gold has been a poor investment relative to stocks.

Although Bitcoin has a finite supply, the size of the crypto market has swelled due to people creating competing coins, so this means capital that may otherwise go to Bitcoin is allocated elsewhere, hurting hypothetical returns. This acts as a form of inflation, that hurts Bitcoin holders. And because Bitcoin is decentralized and opensource, there is no form of ‘intellectual property’ or ‘walled garden’ to protect Bitcoin holders from others appropriating Bitcoin’s technology.

For context, these “coins” aren’t “stored” on any device. Bitcoin is a distributed public ledger, and owners of Bitcoin can access and transmit their Bitcoin from one digital address to another digital address, as long as they have their private key, which unlocks their encrypted address. Owners store their private keys on devices, or even on paper or engraved in metal.

This is perhaps one of the worst explanations I have read of how Bitcoin works. Public keys are not encrypted (or else they would not be public), rather the public key is derived from the private key using the so-called “secp256k1” elliptic curve algorithm.

In fact, a private key can be stored as a seed phrase that can be remembered, and later reconstructed. You could literally commit your seed phrase to memory, destroy all devices that ever had your private key, go across an international border with nothing on your person, and then reconstruct your ability to access your Bitcoin with the memorized seed phrase later that week.

What she meant to say is, the private keys are derived from the seed phrase. There is a difference between storing and deriving. Her fundamental misunderstanding of these concepts suggests she is not even qualified to write about Bitcoin, let alone offer investment advice about it.

That is enough for now. To be continued…