In recent months, cryptocurrency, particularly Bitcoin has been a hot topic. When Elon Musk announced that they bought US$1.5 billion Bitcoins and that Tesla will accept Bitcoins, its price surged 20% to become US$42,000. Today, Bitcoin has crossed US$60,000. So, should we invest in cryptocurrency? To answer this, we first have to understand what cryptocurrency is in the context of money.
At Providend, we always say that money is an enabler of life goals. But to be an enabler, money needs to fulfill 3 fundamental roles: (1) a store of value (2) a medium of exchange and (3) a unit of account. Today, money as a store of value is stored in a physical form through notes and coins but strictly speaking, these notes and coins do not have intrinsic value. It is what people collectively agree on what constitutes money that gives money value. There are 6 characteristics to consider when we gauge the quality of different forms of money:
- Durability – Not easily destroyed.
- Portability – Easily carried.
- Divisibility – Easily subdivided into smaller units.
- Fungibility – $10 of the same currency can be exchanged with another $10 of the same currency.
- Acceptability – Universally accepted by others.
- Scarcity and stability – Cannot be easily reproduced, otherwise value will be diluted.
An ideal form of money should have all these 6 characteristics.
When bartering for goods and services failed, humans have used different forms of money across history. From cowrie shells to oddly shaped snail shells, to cacao beans, to woven cloth and huge rai stones, the problems with all these forms of money and why they failed, are that they either lacked portability, durability, divisibility, uniformity or sometimes, even acceptability because different countries regions value different forms of money. We then saw the use of metallic money in the form of iron, copper, silver and gold. However, the biggest problem with metallic money is its portability. By 1900, about 50 countries adopted the gold standard, a monetary system whereby a country’s paper currency is directly tied to gold held in banks’ vaults. This was given up during the Great Depression in the 1930s. In 1958, the Bretton Woods agreement was implemented in which 44 countries agreed that their currency would be pegged to the US dollar which itself would be pegged to the gold price. In 1971, US President Richard Nixon suspended it. Today, money is mostly fiat currency, represented in the form of paper money backed only by the government who prints it. Modern money is becoming more digitalized as the exchange of money for goods and services are done through internet. We hardly use physical cash and coins anymore.
On 31 October 2008, Satoshi Nakamoto (the name used by the presumed pseudonymous person or persons) published a paper “Bitcoin: A Peer-to-Peer Electronic Cash System and that became the genesis of a new form of money – cryptocurrency that we are seeing today. The name Bitcoin is actually misleading because we don’t actually own a digital coin per se. What we own is actually a computer file that acts like a private ledger recording every transaction. So, imagine that on the entire Bitcoin network, there are 3 parties: Peter, Susan and Andrew. They all have a Bitcoin wallet that starts with an empty private ledger. Peter then buys a Bitcoin at say $100. There will be an “announcement” on the Bitcoin network about this transaction and Peter, Susan and Andrew’s ledger would record this transaction. Of course, only Peter’s wallet will show he has $100. If Peter sends this $100 to Susan to buy a watch from her, an announcement will be made again, and everyone’s ledger will again update this transaction and now only Susan’s wallet will show the $100. Subsequently, if Susan sends the $100 to Andrew to buy 2 books from him, another “announcement” will be made on the network and all the ledgers update this transaction again. In order to ensure that the transactions are genuine, every transaction must be digitally signed by the sender. But how do we ensure that everyone in the network will pay attention to the announcement and update their private ledgers faithfully and correctly? This is where the “checkers” come in. When an announcement of the transactions is made, the “checkers” will organise these transactions into blocks (or ledgers) that are chained together (thus the term Blockchain). Using something called cryptographic protocols, the “checkers” will find the blockchain that are “correct” and announce it to the users and everyone like Peter, Susan and Andrew will update their own private ledgers based on the correct Blockchain. Thus, the Blockchain is the public ledger that the private ledgers take reference from. In Blockchain language, “Checkers” are called Block Creators, also known as miners in the Bitcoin network and they are paid a fee (in the form of Bitcoins) for verifying a block successfully.
We have seen how in history the different forms of money have failed due to the lack of one or many of the 6 characteristics of a good form of money. The biggest problem with cryptocurrency like Bitcoin is the lack of acceptability, at least for now. While a number of companies (such as Microsoft, Tesla, AT&T in US, Burger King in Venezuela and Germany, KFC in Canada) have accepted Bitcoin for transactions, many still did not. Some countries like India are even proposing a ban on cryptocurrencies and fining anyone trading in the country or even holding such assets. The day may come when cryptocurrencies are accepted as a form of money. But no one knows when and whether it would be Bitcoin, Ethereum, Litecoin, etc. that will be accepted.
So, should we invest in Bitcoin or for that matter, any other forms of cryptocurrency? I think we need to ask ourselves whether in our wealth plan to achieve our life goals, do we need the kind of returns that cryptocurrency may give? If we do not, then perhaps there is no need to take such high risk. We may also want to ask ourselves whether we have the ability to take the risk. Since we don’t know when and what type cryptocurrency will be widely accepted, can we afford to wait and if it does not happen, can we afford to lose money on it. And finally, we want to ask ourselves whether we can sleep in peace, if we invest a large part of our money into it. My humble advice is that we should first build our core portfolios using instruments that are proven by evidence, to give us the returns we need. And after doing that and only if you wish to, put some of your money into cryptocurrency. This approach will not make you crazy rich, but it won’t make you poor either. It will certainly give you enough and with peace of mind to live the life you want. Anyway, that is what money is for – to be an enabler.
The writer, Christopher Tan, is Chief Executive Officer of Providend, a Fee-Only Wealth Advisory Firm. Besides being financially trained, he is also an Associate Certified Coach with the International Coach Federation.
The edited version of this article has been published in the Money Wisdom Column of The Business Times Weekend on 20th March 2021.
For more related resources, check out:
1. 2 Illuminating Questions to Guide Your Investment Decision Making
2. The Relentless Pursuit of Better Investment Options
3. Why You Should Focus on Your Goals When You Invest
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