Is Warren Buffett right about cryptocurrencies?
Warren Buffett has openly discredited the integrity and value of cryptocurrencies, but is he correct?
- Popular delusions
- Blockchain technology
- Crypto as a currency
- Criminal Activity
- Crypto as an asset: Warren Buffett on Bitcoin
- Gold versus crypto
- Wider perspective
- Final thoughts
Warren Buffett, CEO of Berkshire Hathaway, ninth richest man in the world and one of the planet's leading investors, has spoken scathingly about cryptocurrencies, calling them “a mirage” which “draws in a lot of charlatans” and “will come to bad endings”. Is he right, or does the emergence of bitcoin and its like signal the dawn of a new era, with economics no longer dictated by central banks and imperfect monetary policy? Is crypto the bubble or is it the safety raft for investors to jump onto as yields from equities and bonds go to negative?
Alternatively, is the emergence of crypto a further indication that cheap money has got out of hand, the blockchain technology it uses a red herring, blinding investors into believing in value where there is none? Or will a future iteration of cryptos on the market become the new currency, standing in opposition to traditional financial structures? Is cryptocurrency an asset or a currency? Does its value lie in both…or neither? Should you invest in Bitcoin? Is Buffett’s view on Bitcoin correct, or is it inaccurate?
“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one” wrote Charles Mackay in his seminal 1841 market psychology book, Extraordinary Popular Delusions and the Madness of Crowds.
From “Tulipmania” in the early 17th century, to the South Sea Bubble in the early 18th century, history is awash with the follies of men. Since the beginning of civilisation, manias have overtaken rationality and logic, be it the belief that alchemists could turn base metals into gold, or the idea that “witches” in early Medieval Europe caused the Little Ice Age. In retrospect, such fads or crazes appear absurd, belonging to an uneducated, unthinking civilisation, so seemingly entirely divorced from our own.
However, as evidenced by the financial explosions which occurred in 1929, 1987 and more recently in 2007, the modern age is just as susceptible to suffering a loss of perspective. Crises, like bubbles, have a predictive value only after the consequences have been experienced. Revelations tend to occur only after the momentous crash has occurred. We are already plunged deep into the depths, before realising we have been taken victim from outside our view of sight.
Unfortunately, memory is short-lived and new mass delusions rear their head, appearing as something else; something which masquerades as something to be believed in.
So where, in all of this, does cryptocurrency locate itself?
Before we begin, it is important to distinguish between crypto as a currency, crypto as an asset, and blockchain technology.
Blockchain, understood as “a decentralised, distributed ledger that records the provenance of a digital asset”, has been widely praised as a massive technological breakthrough. Since its invention in 2008 by the pseudonymous Satoshi Nakamoto, a whole industry has erupted, attempting to apply this technology to a host of sectors.
Nakamoto’s invention was praised by Buffett as “ingenious” and “important”, and the technology has been employed in supply chain management, the financial services, anti-counterfeiting efforts, healthcare and domain names. The International Data Corporation estimates that corporate investment in blockchain will grow to $12.4bn (£8.98bn) in 2022 and according to the research analysis firm Gartner, more than $3trn by 2030.
In the crypto sector, because of the relative ease of making a new type of coin, there are nearly 6,000 different types of cryptocurrencies in existence globally. But they are far from of equal value. According to data by Statista, the top 20 cryptocurrencies make up approximately 90% of the whole market. Thus, while some more insignificant coins may have next-to-zero value, the top three coins, bitcoin (BTC), ethereum (ETH) and cardano (ADA), have a market cap of $894bn, $406bn and $76bn respectively.
While apparently obvious, the value of each coin has nothing to do with the technology used to create it.
Anyone can create something using blockchain technology. In fact, blockchain technology is increasingly being employed by governments across the world as they move to create their own central bank digital currency (CBDC). Like fiat currencies, the term used for “traditional” currencies such as the US dollar, the Japanese yen and the British pound, CBDCs will be backed by monetary reserves such as foreign currency or gold. More than 80 countries, representing over 90% of global GDP, including Russia, Sweden and the UK, have begun developing their own kind of digital currency. China, with its digital yuan, is furthest along, having already initiated a pilot project.
What does this have to do with the value of crypto? Well, once the central banks and governments have plundered the unique technologies of cryptos, do they have any chance of competing? Do they have a hope of realising their dream of becoming a global currency, freed from the shackles of the mainstream banking system?
Crypto as a currency
Despite announcements related to Tesla “most likely” accepting bitcoin again and El Salvador becoming the first country to recognise BTC as legal tender, overwhelming evidence suggests Bitcoin has struggled to realize its dream.
While businesses have emerged, such as Lighting Network, to make transactions more efficient and certain businesses, like Paypal, have begun to accept bitcoin, using crypto as a currency has been widely discredited. With a long-term volatility of 80% and a price tag which is apparently ever increasing, using bitcoin as a means of exchange makes little sense. Even investors who praise cryptos as an asset point to its uselessness as a currency. Not only is it an inadequate store of value, the comparative high transfer costs and slow network renders it even more unsuitable.
Alan Greenspan, the former chair of the US Federal Reserve, pointed out that crypto does not possess the characteristics of a currency. “Currencies to be exchangeable have to be backed by something,” he said. “I do not understand where the backing of bitcoin is coming from. There is no fundamental issue of capabilities of repaying it in anything which is universally acceptable, which is either intrinsic value of the currency or the credit or the trust of the individual who is issuing the money, whether it’s a government or an individual.”
Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, in far from complimentary terms, wrote: “The reason that the dollar has value is because the US government has a legal monopoly on producing the dollar. In the virtual-currency and cryptocurrency world, there are thousands of these garbage coins out there.”
Unsurprisingly, Warren Buffett and cryptocurrency do not happily coexist. The Sage of Omaha has said: “It’s not a currency. It does not meet the test of a currency. I wouldn’t be surprised if it’s not around in 10 or 20 years. It is not a durable means of exchange, it’s not a store of value.”
Ray Dalio, Founder of Bridgewater Associates, however, has publicly defended the integrity of the coin, saying: “To have invented a new type of money via a system that is programmed into a computer and that has worked for around 10 years, and is rapidly gaining popularity as both a type of money and a storehold of wealth, is an amazing accomplishment.”
Tellingly, perhaps, crypto activity has rocketed in emerging economies where financial instability, high barriers to financial products, extortionate remittance fees, unpredictable inflation and regulatory uncertainty are a day-to-day reality. According to Chainalysis, Vietnam ranks highest worldwide for crypto adoption. Asia, according to research, accounts for half of all cryptocurrency users. With such low levels of financial security in these economies, it somewhat makes sense to hedge your bets with crypto. For those of us living in a comparatively robust financial system, however flawed, the logic behind adopting crypto as currency appears less obvious.
In fact, the unique selling point of crypto, some critics have suggested, lies in its anonymity. While it is possible to track activity in crypto wallets, it is much more difficult to trace these wallets back to an individual. The ease with which criminal groups and criminal activity can benefit from crypto has, in part, led to deep suspicion on behalf of the authorities.
Indeed, Silk Road, the “darknet market” notorious for its use in selling illegal drugs, was the first major user of bitcoin back in 2011. In 2013, the FBI shut down the website and confiscated 144,000 BTC. Similarly, in 2017, Bulgarian law enforcement seized more than 200,000 BTC from a criminal network. In China, in 2020, police captured $4.2bn in multiple cryptocurrencies during a crackdown on a Ponzi scheme.
In 2020, according to Chainalysis, more than $350m in cryptocurrencies was paid out to hacker gangs in ransoms. The same Chainalysis research however, found that funds received by illicit entities made up less than 1% of crypto flows, a fall from 3% in 2019. This fall in crime can be at least, in part, explained by major exchanges making their anti-money laundering policies more watertight. These exchanges, fearful of being hit by regulation, have also established processes such as know-your-customer to increase transparency.
Despite increased clampdowns by the exchanges on suspicious activity, the reputation of crypto on the whole among influential figures involved in introducing regulation to the crypto market, has remained far from positive.
Christine Lagarde, president of the European Central Bank, expressed her views on crypto in 2021 in no uncertain terms, saying: “For those who had assumed that it might turn into a currency: terribly sorry, but this is an asset and it’s a highly speculative asset which has conducted some funny business and some interesting and totally reprehensible money-laundering activity.”
Bill Gates, co-founder of Microsoft, was similarly scathing back in 2018. “The main feature of cryptocurrencies is their anonymity. I don’t think this is a good thing. The government’s ability to find money laundering and tax evasion and terrorist funding is a good thing. Right now, cryptocurrencies are used for buying fentanyl and other drugs, so it is a rare technology that has caused deaths in a fairly direct way,” he said.
While many politicians view crypto with suspicion, a minority have wholeheartedly embraced it, seeing the coins as a force for good. Cynthia Lummis, Wyoming Senator, for example, is an investor and an advocate for the coin. Lummis has adopted a hands-off approach to regulation in her own state and pressed others to do the same. Soft regulation and tax exemption have unsurprisingly attracted crypto companies like the exchange Kraken and blockchain platform Cardano, keen to escape from the shackles of incoming regulation in other states, to set up house in Wyoming.
Chris Rothfuss, a Wyoming state senator and fellow friend of crypto, said: “For a state like Wyoming, cryptocurrency provides an alternative store of value as well as the technology that diversifies our economy...We needed to do something that didn’t depend on coal, oil, and gas – those were industries that were waning.”
Regardless of the actual statistics or the divergent voices, like Lummis, the general reputation that crypto has developed among most institutions and establishments means the likelihood of it becoming a future currency of any significant value appears unlikely. The link, however real, between criminality and cryptos gives authorities adequate ammunition to scrutinise and impose regulations.
Why, given its un-unique technology, its negligible value as a means of exchange, and its far-from-glowing reputation, does crypto have such a high price tag? Let’s take a look at bitcoin as an asset.
Crypto as an asset: Warren Buffett on Bitcoin
Bitcoin has enjoyed a meteoric rise since its launch. In 2011, each bitcoin set you back $0.30. By the beginning of 2017, one bitcoin was worth approximately $998. In the winter of 2020, it reached nearly $20,000. By March 2021, one bitcoin would cost $60,000. In June, the price fell back to $30,000 before recovering to $50,000 earlier this month. In 2021, bitcoin price has increased more than fourfold compared to 2020.
Despite bitcoin’s staggering price increase, Buffett’s view on the crypto has remained less than positive. The American business magnate criticises crypto on the basis that it has no intrinsic value. Unlike companies and assets that generate value, crypto has no fundamental value and has no capacity to generate value.
Buffett insists that the only reason to buy crypto is in the hope that “the next guy pays more. And you only feel you’ll find the next guy to pay more if he thinks he’s going to find someone that’s going to pay more”. Unlike equities, the purchasing of bitcoin is not additive. As Buffett points out: “If you and I buy various cryptocurrencies, they’re not going to multiply… We could sit in the house by ourselves, and we could keep running up the price between us.”
Stefan Ingves, governor of the Swedish National Bank, mirrors Buffett’s sentiments, suggesting that “Sure, you can get rich by trading in bitcoin, but it’s comparable to trading in stamps”.
Buffett’s view on bitcoin is that it is of value because it is in high demand and the supply is finite. There are currently more than 18.8 million BTC in circulation. The number of bitcoins that can be produced is capped at 21 million. By 2040, all BTC will be released. The more individuals, especially influential ones, who are in favour of crypto, the greater the demand for crypto becomes. Because the supply does not increase, each coin thus logically becomes more expensive.
While the view that investment in crypto is a mania, dominated by retail investors who are jumping naively on the bandwagon, goes some way to explain the price tag, does it tell the whole story?
Other investors have come out in defence of the asset, as something unique and multifacted. Daniel Loeb, CEO of Third Point, said: “It’s a real test of being intellectually open to new and controversial ideas...another conflict to overcome is the idea that being late to the crypto party will inevitably lead to one taking the sucker seat at a high stakes poker table versus this still being early days in what is just now being adopted in the mainstream.”
The other side of the coin
The recent skyrocketing of crypto has, in part, been bolstered by institutional investors looking to diversify portfolios and hedges against fiat currency inflation.
Indeed, zero and negative yields on assets such as bonds mean even comparably cautious, institutional investors are becoming more interested, especially as bitcoin’s price keeps rallying. According to JP Morgan, institutional investors are using vehicles such as Grayscale Bitcoin Trust to buy the cryptocurrency. This trust allows investors to speculate on BTC without buying it directly. Over 2020, the firm grew from $2bn in assets to $20.2bn. Institutional investors were responsible for 93% of their inflows.
Jonathan Ruffer, founder of Ruffer Investment Company, in response to why institutional investors are jumping onboard, said: “The coming together of a fragile monetary system, distorted financial markets and investors’ hunger for safety could trigger a surge in demand for bitcoin as a store of value. Mainstream adoption by financial institutions could be around the corner, with bitcoin becoming an alternative to gold and government bonds.”
On the comparison between gold and crypto, Michael Novogratz, chair of Galaxy Digital Holdings, said: “I do believe bitcoin is going to be digital gold. That means it’s the only one of the coins out there that gets to be a legal pyramid scheme. Just like gold is...”
Earlier this year, JP Morgan experts forecast that bitcoin could reach as high as $146,000 as more people pile into crypto as an alternative to gold. Will crypto become an alternative to gold? Is it worth investing in bitcoin? Or is the term “digital gold” a convenient way to give greater legitimacy to what remains a risky speculative asset?
Gold versus crypto
Like gold, bitcoins are rare and finite. You cannot print more gold, and you cannot print more bitcoins. They cannot, unlike fiat currencies, be debased. Unlike gold, however, which does have a fundamental value as a metal but also as the ultimate currency of central banks, crypto has no fundamental value. Furthermore, gold, perceived as of great value and rarity since ancient times, has stood the test of time. Cryptos, on the other hand, are very new and to some extent untested, especially during times of crisis.
The two assets also diverge in terms of volatility. Gold possesses one-fifth the volatility of bitcoin.
JPMorgan strategists pegged a price tag of $146,000 on bitcoin on the condition that volatility dropped, stating: “This long-term upside based on an equalization of the market cap of bitcoin to that of gold for investment purposes is conditional on the volatility of bitcoin converging to that of gold over the long term”.
Furthermore, the fate of crypto remains highly precarious. Countries across the world are developing ways of regulating the “Wild West” of cryptocurrencies. Whether these regulations will become outright bans remains unknown.
Just a fortnight ago, US senator Elizabeth Warren compared the crypto industry to shadow banks, and pushed for an outright ban on US banks holding reserves to back private stable coins, the term for cryptocoins that maintain a 1:1 price relationship with a fiat currency, usually the US dollar. This would no doubt be a death knell for stable coins.
Some experts argue the comparison between the rarity of gold and the finite nature of bitcoin is flawed: while one coin may be finite, unlike gold, the supply of cryptos is unlimited.
Lastly, the idea that bitcoin is a good diversifier because of its low correlation rate with other financial instruments, has come under fire. From the period 2013 to 2019, while bitcoin was still very much on the fringes, the asset was indeed uncorrelated. Since 2020, however, bitcoin has become much more visibly correlated with several asset classes, most notably stocks and gold.
The problem is, because bitcoin has only existed during times of financial prosperity, it has gone up, as equities have also gone up. This indicates more that investors are increasingly desperate to find yield somewhere. Oliver Renick, an analyst at TD Ameritrade, suggests a much higher correlation exists between macroeconomic phenomena and bitcoin than bitcoin and gold.
Ultimately, the optimistic idea that bitcoin will become a “safe haven” like gold remains, by looking at its volatility and correlation with stocks, conjecture.
So, what does this mean for crypto?
If crypto’s value does not lie in its relationship with the technology used to create it, does not lie in any fundamental value and it remains very far away from being a “safe haven” during times of financial difficulty, why does money keep pouring in?
Why, then, given that over many years, experts and analysts have come out calling cryptocurrency a bubble, a mania, do retail and institutional clients alike come out in droves to cash in?
Looking at the state of the financial markets in general, the idea that crypto is a symptom of a larger problem holds some weight. If the financial markets are the quietly dysfunctional family, crypto has become the naughty child. All the problems of the family are materialised in this one offspring. The family pretends to itself and to the outside world that the child has emerged out of a vacuum, rather than the dark shadow of the family itself.
Extreme overvaluations, staggering price increases, speculative investment behaviour, a long bull market: the current landscape bears many similarities to a bubble.
Jeremy Grantham, co-founder of the Boston-based asset management firm GMO, said: “The long, long bull market since 2009 has finally matured into a fully-fledged epic bubble…this event will be recorded as one of the great bubbles of financial history, right along with the South Sea bubble, 1929 and 2000.”
The London School of Economics professor Robert Wade, in The Coming Financial Crash, discusses the extreme inequality between rich and poor, a phenomenon which has been intensified as a result of the 2007 financial crash and, now, the Covid-19 pandemic. Wade says moneyed retail investors, stable during the pandemic and saving money, could pour money into stocks, causing equities to soar to disproportionate prices.
Wade’s research found that global equity market cap as a percentage of GDP increased almost 40 percentage points between the start of 2019 and the end of 2020. This is a staggering increase when set against the six years between 2013-2019, when there was only an increase of 20 percentage points.
The explosive levels of debt, hitting $281trn in 2020, combined with the fact, according to Wade, we are in a debt trap, provides a gloomy outlook. Raising interest rates may risk economic crisis, because of the high levels of debt and ballooned equity valuations. However, if stimulus continues and interest rates are not increased, higher levels of inflation could equally result in an economic crisis. In short, we are damned if we do and damned if we don’t.
So what does this have to do with crypto?
Crypto is not a bubble occurring in vacuum. It is arguably a symptom of a wider problem. From top executive remuneration craziness to the current mania in non-fungible tokens (NFTs), to the mania in super yachts, crypto is part of something much larger.
Problematically, the extreme complexity of a financial crisis means that crises are almost impossible to predict until they have already occurred. Indeed, the fact people constantly point to crypto as a bubble suggests it is the insignificant distraction we are focusing on as something of much greater impact rears its head outside our line of sight.
Forecasting models have unfortunately been unable to predict these so-called “black swan” events in the past. So why would they now?
As Wade writes: “The standard economic forecasting models are unable to grasp policy paradigm change and are almost designed to be upbeat…But we have ample if not systematic evidence that the level of 'financial fragility’ is dangerously high in much of the West, especially the US and the UK, China too; reflecting very high levels of wealth and income inequality, now combined in the West with pandemic effects.”
Crypto acts as both a solution to and a symptom of the problem.
Blockchain technology has and likely will continue to promote positive changes across the financial industry. It may even become the building blocks to rebuild the industry should a financial crisis occur.
Sadly, crypto as an asset has become appropriated and absorbed into the current system. It has become a symptom of a problem it was attempting to fix. Perhaps sadder are the crypto believers who have invested in bitcoin in support of the idealist, libertarian, anarchic spirit which drove Satoshi Nakamoto to create the coin in the first place.
But what of the future for crypto?
Will investments from insitutional investors keep pouring in, providing crypto with much needed legitimacy?
Or will the coins, as Buffett predicts, come to a “bad ending”, blowing up in the faces of retail customers – be that the student in Nigeria, tucking all of his savings into crypto, or a mother in Venezuela, who, on the advice of her neighbour, has put her inheritance in crypto – who simply do not have the money to spare?
While the rise of “smart money” is certainly reassuring, retail investors still make up a large portion of crypto ownership. While current inequality levels are already painful, there is palpable danger that investors, charmed by glossy Tesla headlines and El Salvador gimmicks, will buy into hot air and lose much- needed money as a result of it.