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Why bitcoin can't be a currency

That nice Mr Musk is selling the top-of-the-range Tesla S for £131,000, but the question is: should Bearbull pay for his shiny new car in conventional currency or dig into his bitcoin wallet since Tesla (US:TSLA) now accepts the cryptocurrency?

The exchange rate for bitcoin is the vital factor. In this mental exercise, if Bearbull buys at the current exchange rate then the motor costs him only B3.33, but if he is unfortunate enough to buy at bitcoin’s lowest exchange rate since just the start of 2020, then the price becomes B37.4. To make that price differential clearer, let’s turn the currencies around and express them in pounds. At the current $1.40 exchange rate, at best Bearbull pays just £11,650 for his Tesla S, about 30 per cent less than the cost of a Vauxhall Astra; at worst, the price becomes £1.47m – enough for about 80 Astras.

This isn’t just a dilemma for Bearbull. It affects Tesla equally. Since none of its costs are denominated in bitcoin, does it want to take the risk of accepting a crypto payment whose purchasing power may plummet? Or does it in effect say, ‘Damn it all to hell, we’re a currency speculator more than a car maker’, so it takes the bitcoin.

All of which leads to the serious discussion, which starts with the classic definition of a currency – that it is a means of exchange and a store of value. Currently, bitcoin does not just fail that test, it doesn’t even make the assessment. Those two functions interlock. A currency cannot be a means of exchange if it’s not a store of value. Equally clearly, it can’t be a store of value if its exchange rate behaves like a manic depressive on cocaine.

The table demonstrates this quantitatively, by comparing the daily closing values for bitcoin expressed in US dollars and the dollar/sterling exchange rate since mid-February 2018. The important data are about the respective volatility of the currencies, where volatility is the price swings around the 30-day average change expressed as an annual rate. The crucial columns are those showing that the minimum levels of volatility for bitcoin are higher than maximum volatility for dollar/sterling in each of the four years (or parts of years in the case of 2018 and 2021).

 

Too volatile to be a currency
 Bitcoin ($)Dollar/sterling ($)
 PriceVolatility (%)PriceVolatility (%)
 HighLowMaxMinHighLowMaxMin
201811,7353,145135.028.81.431.2514.35.3
201913,8853,340156.143.71.341.2013.95.6
202029,3854,930150.532.81.371.1526.36.8
202155,24029,385136.398.41.401.3512.37.2
Source: FactSet

 

Thus it is all very well for Tesla, MasterCard and whoever else to say they will accept bitcoin for payment. In practical terms that’s not going to happen until the currency becomes as boring and as stable as established old-world currencies. For those, a bit of volatility is acceptable – even necessary if a nation is to have a viable monetary policy – but not so much that it undermines confidence. So it is fine that, in the table, the biggest ratio between each year’s highest and lowest exchange rate for dollar/sterling is 1.2 times in 2020. But it is a problem that the smallest ratio for bitcoin is 1.9 times set so far in 2021.

True, it is possible that today’s speculative frenzy is just a staging post on bitcoin’s journey to mainstream acceptability. What isn’t in doubt is that bitcoin ticks the boxes that have defined financial mania through the ages, from Holland’s 17th century Tulipmania onwards:

●  It is plausible. Bitcoin would not have lasted for 12 years if it was a sham. There is little doubt that its underlying technology – the blockchain – has many useful applications where a tamper-proof register is needed.

●  It has mystery. Famous though it may be, bitcoin remains poorly understood; not surprising since its technology is fiercely complex. Paradoxically, that enhances the story because – much like the trading prospects for the South Sea Company in the early 18th century – it means all possibilities remain open. Call it the power of the unknown.

●  Enhancing the mystery is a quasi-religious order of high priests, acolytes and hangers-on plus a mumbo-jumbo of rituals and jargon associated with it; such as ‘mining for nonce’ (or the process of creating new bitcoin). It hardly gets more quasi-religious when the founder of the movement, Satoshi Nakamoto, may or may not exist; and – by the by – if he does, he would be one of the world’s richest men since, apparently, he retired in 2010 having mined 1m bitcoins (current value about $50bn).

●  There is a lot of skin in the game. Those who have done the hard graft of mining for bitcoin are in a tiny minority, even if they own most of the currency. It is those hanging onto the coat tails of those hanging on – most likely by holding bitcoin via exchange-traded funds – who currently make the most noise, attempting to make the irrational plausible.

Fascinating though it is, the bigger concern surrounding bitcoin is that the frenzy is the extreme example of a wider delusion taking asset prices to unrealistic levels, or keeping them there. As the markets go higher, so the plausibility of the explanations becomes as stretched as the earnings multiples on which equities trade.

Take just one example. The way out of lockdown is stimulating understandable optimism. However, the assumption seems naive that ‘building back better’ will entail humungous amounts of public spending on infrastructure, thus prompting a super cycle in commodity prices. In the US, whenever a new president moves into the White House there is bright-eyed expectation that the new incumbent will tackle America’s crumbling infrastructure, generating huge demand for iron, steel, cement and so on. It never happens and still less is it likely to happen when the public purse is strained by welfare commitments and burdened with debt and deficit almost as never before.

To get an idea of whether asset values are dangerously stretched, it is sensible to call on the so-called cyclically-adjusted price/earnings (PE) ratio for US equities. This simple but widely-used measure, devised by Nobel Prize-winning economist Robert Shiller, takes the ultra-long view – the data in the chart goes back to 1881 – and tweaks the denominator in the PE ratio by taking the 10-year moving average for earnings, adjusted for inflation.

The chart shows that the rating of US equities, at almost 35 times earnings, is higher than it was going into the Wall Street Crash of 1929, although still some way below the peak of the late 1990s dot-com boom. Sure, near-zero interest rates make a difference and, compared with the interest offered by government bonds, the dividend yield on equities still looks acceptable. However, there seems only one answer to the question, which is more likely to shift substantially the ‘P’ or the ‘E’ in PE ratio so as to bring the rating of equities to more normal levels? I don’t think it will be ‘E’.

Yet there is also the thought that the whole calculus of risk, which has been shifting in the past 20 years anyway, has been given a further shove by the pandemic. This affects all walks of life, of which investing is only one, and it is a wider theme to which I intend to return within a few weeks.

●  Back in August, when I re-jigged the Bearbull Income Fund, replacing five dividend strugglers with five whose payouts looked assured, I reckoned that shares in price-comparison website Moneysupermarket.com (MONY) looked safe, while those in diversified miner Anglo American (AAL) looked the riskiest. Since then, Anglo American’s have been easily the strongest of the five while Moneysupermarket’s – at least until last weeks’ results – were the weakest.

Shows how much I know. Yet, as the previous item alluded to, Anglo American shares have been buoyed by hopes for capital spending that won’t materialise. Meanwhile, Moneysupermarket’s have been dogged by the thought that each time consumer spending looks like reviving it will be knocked on the head by renewed lockdown restrictions. Perhaps that sentiment is finally lifting. Even so, Moneysupermarket isn’t in the sweetest spot. In the queue for reactivated discretionary spending, it stands behind the likes of restaurants and holiday operators.

What should shareholders make of this? One issue is that Moneysupermarket is still rated as a growth stock – 22 times earnings for the dull year just reported – while increasingly becoming an adjunct to providers of necessary consumer services. At least that brings advantages – in particular, reliable cash flow. Even in 2020 the group generated £75m of free cash; while that was down 25 per cent from 2019 it covered an unchanged dividend.

However, clear signs of the growth stock remain. Whichever way you calculate it, Moneysupermarket generates a fat return on its equity (RoE) – a figure of 36 per cent drops out of Bearbull’s spreadsheet. Slot that level of RoE into capital spending in excess of depreciation, of which Moneysupermarket does quite a lot, and you have the essentials for value to be created. So – true – valuing average levels of accounting profit as an annuity falls shy of the 290p share price. Focus on cash flow and factor in the possible value to be produced by growth-orientated capital spending and out comes an estimate of per-share value well in excess of the share price.

Sure, Moneysupermarket will have to engage more with its customers, as chief executive Peter Duffy acknowledges. Providing its bosses achieve that, there is upside in the share price. If they don’t, another management team may come along.

email: Bearbull@ft.com