Cryptocurrency: A Clever Con Or The Future Of Money?

Megan Horneman, CIO, Verdence Capital Advisors

Crypto Is Digital Snake Oil – Ten Key Arguments In Favor Of Cryptocurrency Debunked

Bubbles are a rapid escalation of an asset price with little, if any, fundamental justification. Unfortunately, bubbles have a long history of wealth destruction (e.g., tulip mania, nifty fifty, dotcom bubble) where assets ascend far beyond any possible expectation and ultimately crash further than any possible explanation.

We observed the beginning of one of the most mind-boggling investment bubbles in 2017 with the 1800% increase in the price of bitcoin. Bitcoin reached astronomical heights and investors were searching for an understanding around the hype. The only stated reasons for the rise had no factual basis. 

Bubble Stages

We often heard, “This time it’s different,” or that cryptocurrency was the “future of money.” However, the crypto market exhibited the traditional stages of an investment bubble which include:

  • The quiet grind higher: Bubbles tend to start with an investment that carries significant investor skepticism. The beginning movement in the investment may be impressive but tends to go unnoticed (e.g., the quiet grind of ~200% in the first half of 2017).
  • The crowd joins in: The next stage is acceptance of the investment as more investors are pulled to the asset. In the years after the first grind higher in bitcoin we saw an eye-popping amount of funds flowing into the cryptocurrency market, an exorbitant amount of newly created coins and endorsements from famous athletes and actors.
We warned investors
  • Greed rears its ugly head: The third and final leg is the most important and dangerous in a bubble. Once the asset soars, investors abandon a disciplined approach to pricing assets and are now buying the return, not the asset. The “fear of missing out” takes over and experts come out of the woodwork to explain the phenomenon. The results are the same. When bubbles burst, late speculative adopters get crushed.

Unfortunately, crypto investors have absorbed multiple bursts of this bubble over recent years. We warned investors at the first stage of the bitcoin bubble in 2017. We followed this with a second warning in 2021 when bitcoin skyrocketed nearly 200% in a matter of months. Now investors are back to searching for answers as the entire market and whatever credibility it had evaporated alongside a plethora of wealth. 

In each rise of the crypto bubble there was another justification around why all investors should hold at least a portion of crypto as part of their asset allocation. For us, the rationalization for holding crypto had no fundamental basis. 

Ten Pro-Crypto Arguments Debunked

Here are 10 key arguments that advocates of crypto used to support its position in a portfolio which have proven false and confirmed our reluctance to own the products.

  1. It is an inflation hedge. Inflation as measured by the consumer price index increased 7% in 2022. However, this year the Bloomberg Galaxy Crypto Index is down ~70%.
  1. It is the new store of value. To be a store of value it must be widely transactional and completely liquid with low volatility and a basis for value.
Can crypto store value?
  1. It is a new currency that will supplant the U.S. dollar. Some believed rising fiscal deficits would leave the U.S. dollar with no value and cryptocurrencies could replace it, but the U.S. dollar was up almost 10% in 2022 while crypto deteriorated and the volatility in bitcoin proved it cannot be a viable currency.
  1. It is a new asset class. To be classified as a stand-alone asset class, the asset must exhibit certain characteristics involving correlation, risk, liquidity and a meaningful way to value the product. Regulators are not in agreement on which cryptocurrencies, if any, satisfy all the proper criteria. 
  1. It offers a stable diversification benefit. It is difficult to say that bitcoin can offer diversification benefits when a small number of individuals, known as “bitcoin whales,” hold a disproportionate amount of the total supply of bitcoin. This concentration of ownership makes the market susceptible to manipulation and difficult for smaller investors to compete.
  1. It is safe and not regulated. Because crypto used decentralized blockchain technology some believed it was secure. Some mistakenly believed there was a regulatory body that would keep cryptocurrency safe. However, since 2011 there has been ~$9 billion worth of cryptocurrency stolen with the largest amount in 2022. We also cannot ignore that these crypto wallets are secured with a passcode and if you forget your passcode, there is no reset. Your coins are lost.
  1. It is anonymous. The point of blockchain technology that crypto was founded on is that it is a completely transparent ledger that anyone can access. That does not sound anonymous.
Bitcoin whales concentrate ownership
  1. Millennials and Gen Z are buying it so it must be the future. The lack of understanding and education taken from websites with internet personalities lacking a financial background (e.g., TikTok) left these generations with significant losses.
  1. Due to a cap on coins that can be mined the price must go up. Speculators just came in and created newly minted coins and these prices were driven higher only because they were considered a cryptocurrency.
  1. It reduces the need for paper money, which is better for the environment. The process of mining cryptocurrency, which is necessary to verify and record transactions on the blockchain, requires a significant amount of energy. The energy consumption of the bitcoin network alone is estimated to be equivalent to that of a small country. 

We believe that cryptocurrency in its current form is not a viable investment opportunity for clients. Its high volatility, lack of regulation, absence of intrinsic value and security risks are just a few of the reasons we would avoid investing in this space. We will continue to monitor the evolution of a digital payment system that may have regulatory backing and fundamental value but for now we are sitting on the sidelines with the crypto skeptics.

Megan Horneman is the CIO of private wealth advisory and multi-family office firm Verdence Capital Advisors

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