With the recent run-up in cryptocurrency stocks, we believe it is appropriate to revisit the difference between investing and speculating. Investing is the act of committing money or capital to stocks, property or other ventures with the expectation of obtaining additional income or profit. Speculating is the act of committing money or capital to stocks, property, or other ventures in the hope of gain. It generally involves theory or conjecture without firm evidence, as well as the assumption of excessive risk in the hope of obtaining commensurate gain.
Investors tend to:
1) be more conservative and cautious; 2) have much longer time horizons, usually measured in years or decades; 3) invest the time to truly get to know and understand the fundamentals of the business and the industry they are about to commit capital to; 4) place a significant emphasis on valuation; 5) profit from the change in the underlying value of the business, as management delivers on their forecasts; and 6) avoid excessive leverage.
Speculators tend to be less interested in the underlying fundamentals of an investment and more interested in supply-and-demand characteristics propelling an investment higher. Investing reduces, but does not eliminate, risk. Speculators tend to embrace unnecessary risk that can lead to significant losses.
The cryptoasset sector has many constituents; none as well known as Bitcoin. With Bitcoin up 950% year to date, it is not imprudent to suggest that it is speculators, not investors, driving the price ever higher. While we believe that there is great potential for the blockchain, the technology that underlies all cryptoassets including Bitcoin, we are hard-pressed to find fundamentals that would enable us to ascertain the intrinsic value of the industry, or any of its members. Further, given the early stage of the businesses in this sector, there are no earnings or cashflows on which to base a valuation. Finally, given how early we are in the life cycle of this industry it is difficult, if not impossible, to predict which tokens will survive, let alone thrive.
We are reminded of the fanfare and success that Research-In-Motion, now BlackBerry, experienced in its early days in a sector they created. They were met with stiff and seemingly unexpected competition, which has relegated this once powerful industry leader to almost a footnote in the technology history books. That is the nature of the technology sector.
The excitement over Bitcoin is palpable. It is impossible to open a newspaper, review a major business news network’s website or business publication and not see an article or commentary on cryptoassets. Cryptoasset tutorials, weekend trading seminars, and advertisements compelling investors to “Trade Bitcoin with no fees” are now commonplace.
How did we get here? Price appreciation begets further price appreciation. The higher the price goes the more speculators are drawn into the fray. Why is it that so many people have jumped on this bandwagon?
Economic historian and expert in stock market bubbles Charles Kindleberger quipped “There is nothing so disturbing to one’s wellbeing and judgement as to see a friend get rich.” Fear of missing out is a powerful motivator.
Anyone who purchases Bitcoin, and its contemporaries, at these levels (January 2018) is relying on “the greater fool theory,” the hope that there is a less sophisticated market participant that will be willing to purchase their shares at an ever-higher price.
Hope is not an investment thesis.