Excerpted from Howard Marks latest memo...
Digital Currencies
The discussion of innovative investments brings me to Bitcoin, Ether and other digital currencies. I’d guess these things have arisen from the intersection of (a) doubts about financial security – including the value of national currencies – that grew out of the financial crisis and (b) the comfort felt by millennials regarding all things virtual. But they’re not real.
Some businesses accept Bitcoin as payment. Some buyers want to own Ether because it can be used to pay for computing power on the Ethereum network. Some people are eager to speculate on digital currency for profit. Others want to put a little money into these to-date-profitable phenomena rather than run the risk of missing out. But they’re not real!
People tell me these currencies are solid, because (a) they’re secure against hacking and counterfeiting and (b) the software used to generate them strictly limits the amount that can be created. But they’re not real!!!!! Nobody has been able to make sense to me of these currencies. Here are a few paragraphs on Ether from The New York Times of June 19:
The sudden rise of Ethereum highlights how volatile the bewildering world of virtual currency remains, where lines of code can be spun into billions of dollars in a matter of months. . . .
Ethereum was launched in the middle of 2015 by a 21-year-old college dropout, Vitalik Buterin . . . Mr. Buterin was inspired by Bitcoin, and the software he built shares some of the same basic qualities. Both are hosted and maintained by the computers of volunteers around the world, who are rewarded for their participation with new digital tokens that are released into the network every day.
Because the virtual currencies are tracked and maintained by a network of computers, no government or company is in charge. The prices of both Bitcoin and Ether are established on private exchanges, where people can sell the tokens they own at the going market price. . . .
Many [new currency] applications being built on Ethereum are also raising money using the Ether currency, in what are known as initial coin offerings, a play on initial public offerings.
Start-ups that have followed this path have generally collected Ether from investors and exchanged them for units of their own specialized virtual currency, leaving the entrepreneurs with the Ether to convert into dollars and spend on operational expenses.
These coin offerings, which have proliferated in recent months, have created a surge of demand for the Ether currency. Just last week, investors sent $150 million worth of Ether to a start-up, Bancor, that wants to make it easier to launch virtual currencies.
Bottom line: you can use the imaginary currency Ether to buy other new imaginary currencies, or to invest in new companies that will create other new currencies. In “bubble.com,” I highlighted some illogical aspects of e-commerce by including some of my father’s old jokes regarding how to make money. Here’s another that seems 100% appropriate for the digital currency movement:
Two guys meet in the street. Joe tells Bob about the hamster he has for sale: pedigreed and highly intelligent. Bob says he’d like to buy a hamster for his kid: “How much is it?” Joe answers, “half a million,” and Bob tells him he’s crazy.
They meet again the next day. “How’d you do with that hamster?” Bob asks. “Sold it,” says Joe. “Did you get $500,000?” Bob asks. “Sure,” says Joe. “Cash?” “No,” Joe answers, “I took two $250,000 canaries.”
One of my very favorite quotes concerning the market’s foibles, from John Kenneth Galbraith, says that in euphoric times, “past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.”
Maybe I’m just a dinosaur, too technologically backward to appreciate the greatness of digital currency. But it is my firm view that the ability of these things to gain acceptance is just one more proof of the prevalence today of financial naiveté, willing risk-taking and wishful thinking.
In my view, digital currencies are nothing but an unfounded fad (or perhaps even a pyramid scheme), based on a willingness to ascribe value to something that has little or none beyond what people will pay for it. But this isn’t the first time. The same description can be applied to the Tulip mania that peaked in 1637, the South Sea Bubble (1720) and the Internet Bubble (1999-2000).
Serious investing consists of buying things because the price is attractive relative to intrinsic value. Speculation, on the other hand, occurs when people buy something without any consideration of its underlying value or the appropriateness of its price, solely because they think others will pay more for it in the future.
It isn’t unreasonable for someone to use Bitcoin to pay for something – or for a seller to accept Bitcoin in payment – based on an agreement between the parties: barter takes place all the time. But does that make it “currency”?
The price of Bitcoin has more than doubled since the start of the year. Can something that does that seriously be considered a “medium of exchange” or “store of value,” rather than the subject of a speculative mania? Maybe not, but Bitcoin looks staid in comparison to Ether, which has appreciated 4,500% so far this year. The outstanding Ether is now worth 82% as much as all the Bitcoin in the world, up from 5% at the beginning of the year.
The New York Times notes that together, the outstanding Bitcoin and Ether are worth more than Paypal and almost as much as Goldman Sachs. Would you rather own all of the two digital currencies or one of those companies? In other words, are these currencies’ values real? They’re likely to keep working as long as optimism is present, but their performance in bad times is far from dependable. What will happen to Bitcoin’s price and liquidity in a crisis if people decide they’d rather hold dollars (or gold)?
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