Cryptocurrency is one of the most prominent investment themes of the past few years. As the industry has grown in size, investors and traders across the spectrum have gravitated towards the new asset class. Today, tens of thousands of different cryptocurrencies and tens of billions of dollars worth of transactions are completed every day.
I am not going to debate the benefits and drawbacks of cryptocurrency. It is clear to me that cryptocurrencies such as bitcoin have a use - several uses, in fact. They can be used as a speculative token or to transfer sums of money around the world, but whether or not they will become widely adopted is yet to be seen.
How to approach the market
The challenge for many investors is knowing how to approach this still relatively underdeveloped market. How will these assets behave in the near future, and how will they change if they become more widely accepted?
If bitcoin and other cryptocurrencies do become widely accepted methods of transferring value, I think they should be treated as currencies for the purpose of investment or speculation. Trading currencies, aka Forex (foreign exchange), is relatively straightforward. Traders and speculators bet on the market on a daily basis and try and guess which direction currencies will move.
However, trying to guess the price movements of currencies over a more extended time period is incredibly challenging. There are so many different factors that influence currency prices that it is almost impossible to incorporate all of these factors into a valuation framework.
Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) have both commented on the cryptocurrency space, but rather than looking at their more recent comments on this asset class, I want to look back at some comments they made back in 2001 at the Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual shareholders meeting, as I believe these comments are of more value to investors in regards to cryptocurrency trading.
Buffett on speculation
At this meeting, one shareholder asked the duo if Berkshire was positioning itself to take advantage of the macroeconomic environment. Buffett responded by saying, "if we thought we knew what the dollar was going to do, or interest rates were going to do, we would."
He went on to say that it is very difficult to predict what the dollar or interest rates will do in the future, and that makes it very challenging to buy or sell securities linked to this asset class.
Instead, Buffett said he liked to focus on what he could understand, which was, in this example, how many people were drinking Coca-Cola (KO, Financial):
"In the end, we're really more interested in whether more people in Japan are going to drink Coca-Cola. And, over time, we're better at predicting that than we are at predicting what the yen will do...
And what's knowable and important about Coca-Cola is the fact that more and more people are going to consume soft drinks around the world, and have been doing so year after year after year, and that Coca-Cola's going to gain share, and that the product is extraordinarily inexpensive relative to the pleasure it brings to people...
So that's the kind of thing we focus on. And interest rates and foreign exchange rates, important as they may be in the short term, really are not going to determine whether we get rich over time."
This was almost a decade before bitcoin was created, but the same principle still applies. Investors need to distinguish what is knowable and what is not knowable. We don't know where the price of any cryptocurrency will be in five or 10 years from now. However, we can say with some level of certainty that humans will still be drinking soft drinks or alcoholic beverages at the end of the next decade.
One of the best ways to build wealth is to buy something today that is likely to be worth more in the future. Specific cryptocurrencies may be worth more in 10 years than they are today, but unfortunately, it's impossible to tell which ones will be higher and which will be lower. In comparison, it is far easier to tell which companies will still be around in a decade.
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