Bitcoin has experienced a surge over the past few years. Indeed, five years ago it traded at around $450. Today, it is priced at more than one hundred times that figure.
However, not all investors are enamored with the virtual currency in terms of its viability as a stable asset class. Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) chairman Warren Buffett (Trades, Portfolio) has consistently opined that cryptocurrencies are suitable only for speculators, not investors.
In the long run, Buffett believes Bitcoin holders will suffer because of its lack of any physical reserves backing it up.
A lack of value
Bitcoin's price level is determined entirely by demand. Holders can only profit from it if another individual is happy to pay a higher price at some point further down the line. This situation has been tenable over the past few years because individuals have become increasingly positive about its future prospects as an alternative currency free from traditional constraints.
However, the virtual currency's performance could sour dramatically if investor sentiment changes. Although the same could be argued for equities, shares represent small slices of companies that have the value of the company backing them up. For example, companies own assets and produce profits on a regular basis in most cases, which provides investors with the opportunity to benefit from their long-term performance. Therefore, unlike Bitcoin, (most of) their prices are not solely determined by market sentiment, since they have value.
As Buffett once said:
"Cryptocurrencies basically have no value and they don't produce anything. They don't reproduce, they can't mail you a check, they can't do anything, and what you hope is that somebody else comes along and pays you more money for them later on, but then that person's got the problem. In terms of value: zero."
Another asset bubble
Of course, the Bitcoin bubble is not the first time investors have bid up the price of a seemingly worthless asset. Speculators were paying exorbitant prices for tulips in Europe as long ago as the 17th century. More recently, the technology bubble saw the prices of internet stocks reach exceptional highs despite them having no revenue in many cases.
Those bubbles came to swift and dramatic ends. Holders of tulips and tech stocks during their declines lost most, if not all, of their investments. Buffett seems to believe the same ending could be ahead for Bitcoin holders. Although it is not possible to predict when this will occur, a price rise for an asset that has no value is likely to be unsustainable. According to Buffett:
"In terms of cryptocurrencies generally, I can say almost with certainty that they will come to a bad ending. If I could buy a five-year put on every one of the cryptocurrencies, I'd be glad to do it."
Alternative uses of capital
Buying undervalued stocks could be a far better idea than holding Bitcoin. The stock market has a long track record of delivering high single-digit annualized returns. Furthermore, buying slices of high-quality companies provides investors with the opportunity to benefit from their growth in what is forecast to be an improving macroeconomic outlook.
Clearly, the stock market has delivered high growth in recent months. Therefore, investors may struggle to find undervalued stocks to purchase today. Holding cash until the next bear market occurs may be a prudent move. History shows that bull markets never last in perpetuity, which could mean there are better buying opportunities available in future.
Warren Buffett (Trades, Portfolio) has built his career on implementing such a strategy. Following his lead, rather than speculating on Bitcoin, could prove to be a far more efficient use of capital in my opinion.
Disclosure: The author has no position in any stocks mentioned.
Read more here:
- Mohnish Pabrai on Learning From Mistakes
- Benjamin Graham on Allocating Capital in an Ideal World
- Walter Schloss: Don't Rush to Sell Winning Stocks
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