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Bitcoin: loved by Elon Musk, distrusted by regulators

19 February 2021

Jonathan Marriott, Chief Investment Officer

This week the price of Bitcoin soared to an all-time high of $50,000 and is up 77% this year[i]. Regardless, the Financial Conduct Authority (FCA) has banned the sale of derivatives and exchange traded notes based on cryptocurrencies to retail clients. As such we will not be including them in discretionary portfolios and agree with the FCA rationale which states that they cannot be reliably valued by retail consumers for the following reason:

  • The inherent nature of the underlying assets, which means they have no reliable basis for valuation
  • Prevalence of market abuse and financial crime in the secondary market (e.g. cyber theft)
  • Extreme volatility in cryptoasset price movements
  • Inadequate understanding of cryptoassets by retail consumers
  • Lack of legitimate investment need for retail consumers to invest in these products.[ii] 

The Bitcoin price was boosted by Elon Musk's tweets and his car company, Tesla, announcing that they had put $1.5billion into Bitcoin. We do not know the price Tesla paid for their stake, but given the price movement, it appears likely on paper that they have made more money from Bitcoin over two months than they have from ten years of manufacturing cars. If you hold shares in Tesla for its green credentials, you may want to consider the electricity consumed by Bitcoin. Bitcoin mining uses vast amounts of electric power. The Cambridge Centre for Alternative Finance estimates that 0.5% of all the electricity in the world is consumed by Bitcoin. This is more than the whole of Holland.[iii] It can be argued that miners are based in areas where electricity is cheap and comes from renewable sources, but this has not been confirmed and the power could be put to better use. Tesla has said it will accept payment for cars in the digital coin, but they have no liabilities in Bitcoin so the purchase is a pure gamble. Given this move, investors may ask if Tesla is an electric car maker or just another hedge fund with a non-transparent investment process.

The reason for doubts

There are over four thousand cryptocurrencies, but it is Bitcoin that dominates the headlines. Why is it that the FCA is so concerned? Currency valuation is always difficult, but the direction can be seen as driven by trade flows, central bank intervention and interest differentials. For Bitcoin, none of these factors exist; it could be $100,000 or nothing and no one would be any the wiser.

This week there have been reports that North Korean hackers are targeting cryptocurrency accounts. If you lose money through fraud in a bank account, you may have some comeback on the bank; for crypto accounts you may have no protection. Anecdotally there are plenty of stories of people buying into cryptocurrency accounts and not getting their money back. There is a saying in the cryptocurrency world: if you don’t control the wallet, you don’t own the asset. Your wallet is on a hard drive, so if you lose the hard drive or the password, you cannot recover the holding. As was the case for the man in Newport who sent his computer to the tip and only realised later that he had thrown away his hard drive, with Bitcoin now theoretically worth several million.[iv]

The lack of traceability with Bitcoin makes it an attractive method of payment for criminal activity. Ransomware demands are usually in cryptocurrency for this reason. It has also been reported that images of child sexual abuse have been stored within the Bitcoin coding.[v] As a result, if you were to make large profits on cryptocurrency and wanted to return the profits to your bank you may come under suspicion of money laundering, making it hard to bank your profit.

Talking of banking your profit – if the market gets a sniff of Tesla looking to sell Bitcoin, be aware. Elon Musk may have helped the price up, but he could also cause it to collapse. When we look back at what seems like the inexorable rise in Bitcoin price we can observe three occasions when the price has dropped over 70%, notably on one occasion it dropped 85%. Volatility is extremely high with Bitcoin and it is far from a one-way street. 

In the same way you can make money betting on horse racing, you may also make money betting on the Bitcoin price rising further, but as with horses be prepared to lose everything. Bitcoin has no intrinsic value and the price can move on a whim.

When investing client money, we look to buy investments which have cash flows we can predict. We may not get this right all the time, but we have a solid rationale for any investment we make. Bitcoin has no cash flow or rationale for investment that stands up to any form of rigorous examination.  Like most fashions, it is a fear of missing out that is sucking in investors. The FCA is right to ban us from selling Bitcoin to retail clients and we will not be risking our clients' money in this way.

[i] Bloomberg as at 18/02/2021

[ii] https://www.fca.org.uk/news/press-releases/fca-bans-sale-crypto-derivatives-retail-consumers

[iii] https://cbeci.org/cbeci/comparisons

[iv] https://www.bbc.com/news/uk-wales-55658942

[v] https://www.bbc.com/news/technology-47130268

 

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