Cryptocurrency : Dinner table talk!

Its 2021 finally and we are almost out of the COVID craze. In 2020, we saw how the stock market tumbled in March, followed by unemployment, business closures, stimulus checks, and the great stock market recoup by December 2020. We also witnessed how a gang of individuals from wall street bets reddit forum took charge of the GameStop and AMC stocks and hammered the hedge fund managers. This democratization of financial markets via easy-to-use Apps along with the influence of social media gave rise to a breed of kamikazes who are now redefining Investing 101. 2021 will be remembered as the year of crypto craze that witnessed a power shift from the capitalist annals into the finger tips of these kamikazes who change directions via tweets and take decisions based on Whatsapp, Telegram, Discord and Reddit groups.

What is crypto currency?

I wont go into complex details. Simply put, its digital coins received after solving a complex algorithm (within the blockchain network). Think of it like a bunch of Math nerds solving complex algebra equations, and the one who solves it first gets a reward in the form of a coin. Solving these equations is called mining which uses energy to support the computational processing.

Why are there so many types of crypto currencies?

Well, remember differential calculus back from your college/High school days? Calculus equation worked differently with a unique purpose. Blockchain technology tends to follow a similar pattern where specific white papers are written for each type of crypto currency and based on that, those complex equations are solved. The technology (or the white paper) therefore plays a crucial role in defining the efficiency of producing/mining that coin, which in turn define the supply of units that influences the pricing of that particular coin.

What do you think about investing in crypto?

Shush! Have you ever heard of someone saying that I am visiting Vegas for investing? You don’t invest on your trip to Vegas, You gamble!

Investing 101 define two broad types of investment:

1. Investment in productive assets
2. Investment in non-productive assets (I call them as “Dumb Assets”)

For 1, an example could be buying a house and renting it out. It brings you cashflows and also value appreciation over the course of time. This investment produced cashflows for you and therefore is called a productive asset. These cashflows represent the intrinsic value that exist in this very asset (i.e. House). Similarly, you invest in stocks. Stocks bring you dividend cashflows and appreciation. Through stock investment, companies undertake new projects and earn profits. The stock therefore has an intrinsic value represented by these future cashflows. Productive assets have intrinsic values and bring prosperity in an economic environment.

For 2, an example is Gold. Gold sits like a dumb piece of metal. It doesn't give you dividend. It doesn't nourish the society. It just appreciates in values (because guess what, she loves Gold), and you sell this piece of metal to realize a profit. The piece of metal has no intrinsic value as such. Its the popularity of Gold (demand) that causes fluctuations in its price and appreciation/depreciation in value.

Cryptocurrency, on the other hand, is yet another Dumb asset that does nothing but appreciates/depreciates in value. Why? Because there is a cypto craze out there and every one wants to be called a Crypto investor. Given the popularity of this intangible, people are ready to pay a higher price to get their hands on it. But guess what, they cant really get their hands on it. They cant even use it to make jewelry (as they would do with gold).

Lets take bitcoin (BTC) as an example. When a person buys BTC, she buys it with the intention of selling it at a higher price and recognize a profit. She buys it under the presumption that there is a buyer out there in the market who will pay a higher price for this intangible currency, and that buyer is ready to pay the higher price because he knows that there is a doofus out there who will be willing to pay an even higher price. Its the popularity that is causing this phenomenal rise.

I once read it somewhere that gambling is addictive just like alcohol. Because Man by nature is a greedy being, and when he sees more money coming in (especially when its effortless), his need for more and more grows exponentially, and he becomes an addict. Now if the govt announces tomorrow that all crypto currency trading will be banned, the person who bought BTC for USD 58,000 will not be able to find a buyer willing to pay even a 1,000 bucks. Why? Because this intangible asset has no use for him and the Government has banned it now. The regulatory risk is the unquantifiable risk that even valuation experts fail to determine with accuracy. Same applies if the networks these currencies are on crash or get hacked. With these vulnerabilities and question marks out there, if a person suggest investing in crypto is a good idea, then he needs to use the word “gambling” rather “investing”.

If crypto is so bad, then why Elon musk is pushing it? Why are the hedge fund managers including these coins in their portfolios?

Well, not just Musk. Even Mr. Wonderful (Kevin O’leary), Mark Cuban and a bunch of other investors are flocking in. But the question is, how much of their net worth are in crypto? While it changes every time, it is currently less than 10 percent. But people are going all-in on crypto. Even the guru Musk recently advised everyone to be cautious while investing in crypto but the craze is following a different direction.

Hedge fund managers are there to diversify their portfolio and want to utilize crypto to hedge their overall portfolio risk. This is different from a typical individual investor whose portfolio is crypto skewed. These managers will be the first ones to know when a big crypto crash is coming (they have experts who can better forecast then the ones in a Telegram group) and so they will always be on the safe side(they had their share of learning from the GameStop saga).

Crypto should be a part of your portfolio but it should be based on the money that you are completely ready to lose. Just like when you play a round on the Roulette wheel, you are mentally ready to lose your cash fully.

Crypto technology fascinates me. What's the future?

Indeed, the technology is fascinating. The democratization of the financial system is such an alluring idea . But there are certain things to keep in mind. History teaches us that human beings have always lived in tribes led by a leader who enforces the rule of law. We have nations (including democracies) that have leaders who take the oath to enforce the rule of law. If I hit you with a glass bottle right now, you are going to call 911 and lodge a complaint. Why? Because you have a trust on the rule of law that will resolve your problem. With the democratization of the financial system, that central authority’s presence goes into jeopardy. It will be a bunch of thugs doing things in the name of democracy the way they want to. Now will that be good? Well I’ll leave it here for you to think. Central banks in various countries are exploring creating their own hybrid crypto currency with central management but with a twist of decentralization flavor to it. When is that going to happen? We don't know.

These huge gains in crypto currencies, is that unusual? Do we have a history lesson here?

Well as I explained, its a case of demand and supply caused by the hype and is impacting these huge gains. History does have an example. Between 1971 to 1980, Gold and silver had price returns of 1600% and 2000% respectively while the total return of the stock market was only 73% during the same timeframe.

Over the last 100 years, the total return on stock market(with dividends reinvested) is around 13 million%. This is due to compounding impact of reinvested dividends which does not apply on non-productive assets such as gold/silver, because they don’t have dividend payments. Over the same time frame, Gold was only 8600% and silver was 3790%. This clearly shows which asset class is the winner in the long run. The unusual behavior in crypto today can be regarded as partly synonymous to the 1971 to 1980 phenomenon and eventually this craze will come down, with some people gaining a lot while quiet a few losing a lot.

Closing remarks..

Don't be a sheep that is programmed to follow the herd, rather be the shrewd fox who paves its own path. Hold productive assets in your portfolio and stimulate economic prosperity through your wealth. Just like the world is incomplete without dumb individuals, your portfolio shouldn’t be left incomplete with some dumb assets. However, too much of dumbness can cause havoc, so be picky in your quantity. The future is here to be embraced. But a level of caution is certainly not a bad idea.