»Smart Contrarian by Equitymaster

On This Day - 3 JANUARY 2018
Why the "Talking Heads" Are Afraid of Bitcoin

Rahul Shah, Editor, Smart Contrarian

I don't know, dear reader, if you're happy to be receiving all these bitcoin-focussed letters or not. The truth is, this idea is so intriguing to me that I can't help but read all the interesting stuff that is coming out.

And some of Tama's ideas are so eloquent and, well, persuasive, that I can't help but share them with you. I really want to know what you think of all the bitcoin theatre - so do write in and tell us if these weightless 'coins' are making a lot of noise in your heads...

Keep reading,
Rahul Shah (Research Analyst)


Tama Churchouse

It seems like every day another financial luminary declares the death of bitcoin...

For example, in just the past few months:

  • Former U.S. Federal Reserve Chair Alan Greenspan said bitcoin will ultimately "prove worthless."
  • Nobel Prize Winner Joseph Stiglitz said bitcoin "ought to be outlawed."
  • And billionaire investor Howard Marks said cryptocurrencies "aren't real".

These talking heads all have one thing in common...

They're victims of the default bias

Most people stick with what they know. They don't conduct experiments in their life... whether it's something small like trying a new brand of soda... or something bigger, like investing in an entirely new asset class.

Think about it... How often do you change the route you take to work? How often do you try a new dish at a restaurant? Or, when you buy the latest mobile phone, do you just accept the factory default settings and not even bother changing the ringtone?

This is default bias. Most people like to stick with what they know and shy away from making big changes or taking on new risks, even if the change would be a good one.

The default bias is the offspring of two other biases: status quo bias and loss aversion. Keeping things the same is convenient, and the pain of losing is greater than the joy that comes from winning.

Put these together, and our brains often tell us it's just easier to keep things the same and avoid any potential pain that might come from changing things.

For investors, this can stop us from making changes to our portfolio or strategy because it's too inconvenient or it makes us feel uncomfortable. We tend to cling to the way things are, even if it's not the best thing for us.

It happened with the Internet

In the early 1990s, the Internet was just starting to go mainstream. And many otherwise smart folks were convinced it was just a fad.

Here's a quote from U.S. astronomer Clifford Stroll in 1995:

  • "Visionaries see a future of telecommuting workers, interactive libraries and multimedia classrooms. They speak of electronic town meetings and virtual communities. Commerce and business will shift from offices and malls to networks and modems. And the freedom of digital networks will make government more democratic. Baloney."

Even the inventor of Ethernet, Robert Metcalfe, didn't believe in the Internet.

"I predict the Internet will soon go spectacularly supernova and in 1996 catastrophically collapse.

And telecommunications expert Waring Partridge had this to say:

"Most things that succeed don't require retraining 250 million people."

These people fell for the default bias. They believed in what they knew and were anxious about making big changes or taking on new risks. Plenty of other investors fell for this bias too. And they missed out on big gains as the Nasdaq - which is home to many tech stocks - grew 400 percent from 1995 to 2000.

We're seeing the exact same thing happen with bitcoin and cryptocurrencies today...

People still don't get bitcoin

Anyone who claims bitcoin isn't real or just a fad doesn't understand the cryptocurrency at all.

As we've written before, bitcoin can be moved around (far more easily than traditional currencies), used to buy goods and services and it has scarcity. Only 21 million bitcoin will ever be mined. And over 16 million have already been mined.

Bitcoin is just a cryptographically secure medium of exchanging value. It's not "fraud" or not a "real currency".

And as for the concern that bitcoin is purely "digital", it's worth remembering that more than 90 percent of all money that exists today around the world is not physical (i.e., not notes or coins).

In short, every now and then something truly different and new comes along. And if you're willing to go against your default bias, you could make a fortune.

That doesn't mean bitcoin won't be volatile

I'm not saying bitcoin won't be volatile. Like any asset, cryptocurrencies will continue to experience rallies and corrections. Don't fall into the trap of thinking "this time is different" and that bitcoin will go up forever. The cryptocurrency could absolutely be in for a short-term price bubble. But over the long term, the upside is potentially far from over.

Even though there's plenty of hype around it, the level of general public participation is still extremely low. Buying bitcoin is still relatively cumbersome. Exchanges need to do know-your-customer (KYC) checks. Depending on where you live, funding a bitcoin account can require a trip to the bank and an expensive bank transfer. And you still need to familiarise yourself with a new asset class, which takes some effort.

But all that means is the opportunity is still there.

The most appropriate course of action for the majority of investors is simply to buy a little bitcoin - and forget about it. Buy, hold and ignore the volatility. It's not a one-way ride, it's a bumpy one. Be prepared to stomach big declines and sit tight. And don't invest more than you can afford to lose. For most people, crypto should be reserved for the small and speculative part of your portfolio.

Bitcoin is an asymmetric bet... if it falls or even goes to zero, your loss is small (assuming you've put in only what you can afford to lose). But if over the next few years it continues go up, then gains of 10 to 50 times are entirely possible... and even bigger gains lie outside of bitcoin in the cryptocurrency space.

Good investing,

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