There is a humorous video making its rounds on social media that shows three women discussing bitcoin as a possible investment. In it, one woman recommending bitcoin as a good buy describes it as "the first decentralised cryptocurrency that works without a central bank".
She goes further to say: "Transactions take place through the use of cryptography that is verified by network nodes and are recorded in an immutable public distributed ledger known as a blockchain… Bitcoins are mined on computers using the SHA265 hashing algorithm creating 12.5 bitcoins per block, at least until mid-2020. Afterwards, it's 6.52 bitcoins per block for the next four years… nothing could be simpler!''
Of course, the aim of the video was to illustrate the exact opposite, namely that the logic and technology underpinning cryptocurrencies such as bitcoin are very complicated and unproven, and few people can truly claim full understanding. Yet despite this, interest in such instruments has risen sharply over the past year, largely because bitcoin doubled in value in 2016 and then rose an astonishing 13 times last year to almost US$20,000. In mid-January, it crashed to around US$10,000.
However, caution should be the watchword because it would be highly risky for investors to take the plunge in an investment that is extremely volatile, unregulated, thinly traded, not well understood and not sanctioned by many central banks, including the Monetary Authority of Singapore.
Mr Leonardo Drago of AL Wealth Partners, in his "Cryptocurrency frenzy points to it being one of history's biggest bubbles" that appeared in the Jan 20-21 2018 issue of Business Times, correctly pointed out that when buying bitcoin, you do not own anything more than computer code which for now is enjoying a high "market" price. This is despite there being no fundamental backing at all in order to arrive at that price and despite the fact that owners of bitcoin are not entitled to any future income streams to the technology, if any.
Although there are claims that it will be the currency of the future, bitcoin does not possess the main characteristics of money - it is not a good store of value and it is not a good medium of exchange.
"Bitcoin is not a good medium for transferring money," wrote Mr Drago. "As the blockchain gets longer and more transactions are recorded, it takes more time and becomes more expensive to transfer.''
Making things even more complicated, there could be, in theory, an infinite number of cryptocurrencies (there are already estimated to be at least 800 in existence).
"After all this, we're left with what lies at the heart of all speculative manias - that the next person will pay more than what you paid, pushing the price up, and that fear of missing out will perpetuate this cycle. If this is all that is holding bitcoin up, what about when sentiment changes?" said Mr Drago.
Because trading is thin, this has raised concerns regarding gaming, front-running and manipulation. Hacking is also a concern - a Japan-based cryptocurrency exchange recently announced it was refunding about US$400 million (S$527 million) to customers that had been stolen by hackers.
US investment bank Goldman Sachs last week said there is "no doubt" that bitcoin's astronomical rise over the past year "has pushed it into bubble territory". It added that bitcoin's meteoric rise in a short time "has dwarfed the rise seen during the dot.com bubble" and noted as yet another warning sign the trend of companies that have seen their stock prices shoot up after they announce initiatives relating to blockchain or even simply change their name to include the term.
Mr Warren Buffett, chairman and CEO of Berkshire Hathaway and renowned as being one of the greatest investors of all time, said in a Jan 10 interview with CNBC: "In terms of cryptocurrencies, generally, I can say with almost certainty that they will come to a bad ending."
Perhaps more important is that he added: "I get into enough trouble with things I think I know something about. Why in the world should I take a long or short position in something I don't know anything about?"
This does not mean that one should totally dismiss cryptocurrencies. Blockchain technology is seen as revolutionising the way financial transactions are conducted and there is growing belief that it is here to stay. However, the absence of fundamental backing, lack of regulation and massive speculative element surrounding bitcoin and cryptocurrencies in general lead to the inevitable conclusion that for now, investors should steer clear.
•The writer is editorial consultant at the Securities Investors Association of Singapore.
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