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Are crypto-currencies really currencies?
5/20/2018 3:34:04 PM
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By Fund Library News Wire  | Tuesday, April 24, 2018


 



By Joe Davis, Global Head, Investment Strategy Group, Vanguard Group, Inc.

“What do you think about Bitcoin?” Over the past few months, I’ve gotten this question more than any other. In 2017 the value of Bitcoin, the world’s first cryptocurrency, rose by almost 1,200%, prompting excitement and bafflement.

My answer: I’m enthusiastic about the blockchain technology that makes Bitcoin possible. In fact, Vanguard is using such technology to instantaneously update data like the share prices of companies in our index funds. As for Bitcoin the currency? I see a decent probability that its price goes to zero.

Are cryptocurrencies currencies?

Bitcoin’s creators introduced the cryptocurrency in the wake of the global financial crisis. The goal was to bypass governments and banks when two individuals want to transact. No country, company, or institution controls the currency. But are Bitcoin and competing cryptocurrencies really currencies? Let’s think about what a currency is:

* A currency is a unit of account. Cryptocurrencies qualify, as they can measure the value of other goods and services.

* A currency is a medium of exchange. I’d give cryptocurrencies a qualified yes on this point. Currently, only a limited number of vendors globally accept cryptocurrencies, and recent volatility will only discourage increased adoption.

* A currency is a store of value . Bitcoin is not. Its price volatility undermines its adoption, as fewer vendors will accept a currency whose value can fluctuate so dramatically. The prices of newer currencies have been similarly volatile.

The existential dilemma

Let’s call the verdict on the currency question mixed. Even if cryptocurrencies qualify for niche purposes, their prospects seem dubious.

The greatest threat is central banks, which have begun to research blockchain-based currencies and impose regulations on exchanges. Given the additional control and policy effectiveness that digital currencies could provide, central banks have good reason to adopt digital currencies in the coming decades. Those currencies would be “legal tender,” legally recognized forms of payment for all debts and charges.

If the choice were between Bitcoin or a blockchain-based loonie, which would you rather have in your digital wallet?

Cryptocurrencies as investments

The investment case for cryptocurrencies is weak. Unlike shares and bonds, currencies generate no cash flows such as interest payments or dividends that can explain their prices. National currencies derive their prices from the underlying economic activity of the countries that issue them. Cryptocurrency prices, on the other hand, are generally not based on economic fundamentals. To date, their prices have depended more on speculation about their eventual adoption and use. The speculation creates volatility that, ironically, undermines their value as a currency.

Nor are cryptocurrencies a chance to capitalize on blockchain technology, which is the method most cryptocurrencies use to record network transactions and ensure their accuracy. Although cryptocurrencies are built using a blockchain, they are not necessarily tied to the value of blockchain applications that may improve the cost, speed, and security of executing transactions or contracts. Bitcoin is an investment in blockchain in the same way that Pets.com was an investment in the Internet.

For investors, adding some exposure to Bitcoin would mean reducing their allocations to tried-and-true asset classes such as stocks, bonds, and cash – the building blocks for well-diversified portfolios that can help them meet their goals. With no cash flows and extreme volatility, the investment case for Bitcoin is hardly compelling.

We are early in the development of blockchain technology. We’ll likely see blockchain adopted by governments and enterprises for specific purposes in the coming decades. As innovation quickens and competition increases, the majority of networks (and their associated cryptocurrencies) may be rendered obsolete, leaving many cryptocurrencies like tulip bulbs in 17th-century Holland – soaring to incredible heights before the speculative bubble pops.

And, unlike tulips, they don’t look very nice in a vase.

Joseph H. Davis, PhD, is a Vanguard principal and the global head of The Vanguard Group, Inc.’s Investment Strategy Group, whose research and client-facing team develops asset allocation strategies and conducts research on the capital markets, the global economy, portfolio construction and related investment topics. As Vanguard’s global chief economist, Mr. Davis is also a key member of the senior portfolio management team for Vanguard Fixed Income Group, which oversees more than US$700 billion in assets under management.

Notes and Disclaimer

© 2018 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared on the “Insights" page of the Vanguard Group, Inc.’s website. Used with permission.

Important information

The views expressed in this material are based on the author's assessment as of the first publication date (March 2018), are subject to change without notice and may not represent the views and/or opinions of Vanguard Investments Canada Inc. The author may not necessarily update or supplement their views and opinions whether as a result of new information, changing circumstances, future events or otherwise.

Certain statements in this presentation may be considered "forward-looking information" which may be material, involve risks, uncertainties or other assumptions and there is no guarantee that actual results will not differ significantly from those expressed in or implied by these statements.

While this information has been compiled from sources believed to be reliable, Vanguard Investments Canada Inc. does not guarantee the accuracy, completeness, timeliness or reliability of this information or any results from its use.

This material is for informational purposes only. This material is not intended to be relied upon as research, investment, or tax advice and is not an implied or express recommendation, offer or solicitation to buy or sell any security or to adopt any particular investment or portfolio strategy. Any views and opinions expressed do not take into account the particular investment objectives, needs, restrictions and circumstances of a specific investor and, thus, should not be used as the basis of any specific investment recommendation.

Please consult your financial and/or tax advisor for financial and/or tax information applicable to your specific situation.

In this material, references to “Vanguard” are provided for convenience only and may refer to, where applicable, only The Vanguard Group, Inc., and/or may include its affiliates, including Vanguard Investments Canada Inc.

 
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