Is Bitcoin a more profitable investment than stocks? (Productive vs. Unproductive Assets)
Bitcoin has appreciated significantly in recent years, and polarized debates on social media about which asset will perform best in the future continue indefinitely. Many people swear by bitcoin and cryptocurrencies, while others swear by more traditional assets such as stocks, real estate, and gold.
We own all asset classes (assuming cryptos are an asset class), but we own far more stocks than the other asset classes combined. The reason is straightforward: we prefer to own pieces of businesses that generate positive cash flows year after year. We want to own real productive assets that will keep us financially secure regardless of the currency in use.
The issue with gold and bitcoin is that they do not generate any tangible values – they do not generate cash. As a result, we believe they are unlikely to outperform stocks in the long run (decades).
Most investors are either completely opposed to bitcoin or completely in favor of it. We aren't either. Bitcoins and other cryptocurrencies, on the other hand, are primarily viewed as a call option for the future of finance. Please keep in mind that we are a little old-school, and our perspective reflects that (that's the disadvantage of being over 50...).
An option is similar to insurance, and the majority of insurance premiums are lost. That's the way insurance works. However, we believe that bitcoin and cryptos are here to stay, though we can't say in what form or at what price. We have only a very small allocation to cryptos due to the uncertainty. The internet had a significant impact on the world, but most internet stocks went bankrupt. It's difficult to predict the outcome of something new, innovative, and disruptive entering the arena. We believe the crypto market will be no different.
Is bitcoin the new gold? Who can say? Will bitcoin be widely used for the purchase and sale of goods and services? This, we believe, is highly unlikely. Is it a one-time occurrence or a recurring occurrence? Yes.
Are bitcoin and cryptocurrency more valuable than stocks?
To answer this, we must first understand the two distinct asset classes. We are by no means crypto experts, but we believe we understand enough to be reasonably qualified to understand the main differences.
What exactly is a bitcoin?
Bitcoin is a decentralized digital currency or token that first appeared in the aftermath of the 2008/09 global financial crisis. It is still unknown who is the "inventor" and author of the current and its whitepaper. Who exactly is Satoshi Nakamoto? Is it a person? What is an institution? Is it a company? Who knows, and we assume that the longer it goes, the less likely it is to know who created it.
It is a collection of electronic digits rather than a physical asset. Transactions and balances are kept on a public ledger that everyone can see, though you only see numbers, not "trader Joe" owning a specific bitcoin. When you sell a bitcoin to someone in Nigeria, the transaction is recorded on the ledger for all to see. The true owner, on the other hand, may be difficult to locate. One of the primary benefits of bitcoin is that it is decentralized and has a limited supply. Unlike central banks, you cannot simply "print" more bitcoins than have already been programmed. As a result, many people believe bitcoin is a safe haven against impending inflation and a store of value.
What exactly are shares (or stocks)?
Shares are physical objects. You can own shares through a broker, in "street name," or through a custodian, or you can have stock certificates in your own name. By purchasing shares, you gain ownership of a portion of a company's assets. However, the business could be to own bitcoins, similar to an ETF. However, the majority of shares are used to raise capital to provide products and services in high demand by the general public. Thus, a business serves society by being guided by "the invisible hand," which allocates capital and resources to the most efficient providers. The company hopes to make a profit at the end of the year by selling goods and services. If there is no demand, the company will fail or be taken over. Unfortunately, we might say that most businesses fail sooner or later. During its initial public offering, the average public company fails to outperform short-term Treasuries!
Nonetheless, thanks to a few outliers who are multibaggers, the stock market has been the best asset class over the last century. As a result, if you own a basket of companies (the "market"), you participate in the broad creation of value in society through the production of goods and services. Over the last century, shareholders have benefited greatly from ownership of "the market."
In reality, if you had invested the dividends, your return would have been much higher. The annual return is around 10% (including dividends reinvested) – not bad! After 30 years, $100,000 invested at 10% yields $1.7 million.
categorize assets into two categories:
Assets that are productive vs. unproductive:
Stocks are productive assets, whereas bitcoin and cryptocurrency are unproductive assets.
Bitcoin is a non-productive asset – it generates no income.
There is only one way to profit from unproductive assets: have someone else pay more than you did. This can, of course, be accomplished by increasing bitcoin's network effect and scalability. The more people who use bitcoin, the more valuable it will become. The greater the number of institutions that accept bitcoin, the greater the networking effect. However, one of its flaws is that it does not generate cash.
Is this to say that Bitcoin and cryptocurrency are a Ponzi scheme? Of course not, despite the fact that Nassim Taleb recently stated that it resembles a Ponzi scheme. Gold, too, does not produce tangible values but has managed to retain its purchasing power over thousands of years.
If you own one bitcoin today, you will still have one bitcoin in 2030. Similarly, as Warren Buffett points out, if you own one ounce of gold today, you will still own one ounce of gold in 2030.
Stocks are productive assets because they generate earnings and cash flows.
Productive assets have a significant advantage over unproductive assets in that they generate cash. As long as society does not implode, productivity gains will make owning productive assets more valuable over time.
Why is this the case?
Because, in the long run, the majority of the profits from stock ownership come from retained and reinvested earnings or reinvested dividends. Howard Marks refers to this as "interest on interest" (to use a phrase from the bond market).
The reinvestment of earnings and dividends, rather than the initial investment, has the potential to make you wealthy. As a result, the marginal rate of return is critical.
It accumulates – it snowballs. This is precisely what has made Warren Buffett so wealthy. He's probably a fantastic investor, but his wealth stems from his ability to postpone gratification by reinvesting all profits and allowing them to compound.
Investing in dividends: the marginal rate of return.
Compounding – the long-term mindset's and delayed gratification's magic
Let us look at why Warren Buffett made 99 percent of his money after the age of 50:
After 20 years, an investment that grows at a rate of 10% per year has multiplied 6.7 times. However, if you wait ten years longer, i.e. 30 years, it is worth 17 times more. The last ten years are only one-third of the total time period, but they allow you to accumulate 60% of the gains. This is called exponential growth!
If you manage slightly higher returns, say 11%, the numbers are 8 and 22.
Again, an unproductive asset like bitcoin or gold cannot be compounded. As a result, stocks should be a better long-term investment.
Why a productive asset is more valuable in the long run than an unproductive one:
The math is simple: if you invest $100 and manage to grow it by 30% per year while reinvesting at the same rate, you will have 130 at the end of the first year. After the second year, you have 169, not 160. After year three you have 220, not 190. Your assets grow at an exponential rate! (To demonstrate the exponential growth, we used a high rate of return.) The longer you wait, the better your rewards will be.
Assume you own ABC Food, a company that wants to acquire and manage food companies "hands off." The company is small, and it has no plans to pay dividends in the near future, preferring to reinvest all earnings back into the existing business.
Assume you own 0.1 percent of this food company and indirectly own a stake in 20 other companies/subsidiaries. If the company manages to repurchase 20% of its shares and reinvest in ten more businesses over the next 15 years, you will own 0.12% of 30 businesses after 15 years. Again, the snowball effect aids in compounding.
Bitcoin and gold cannot be snowballed. That is their fundamental issue. This is why gold has vastly underperformed stocks.
The higher incremental returns, the steeper the curve.
How to Inflation-Protect Your Assets
Should you invest in gold or in gold mining companies?
The views of Warren Buffet and Charlie Munger on bitcoin
Warren Buffett is mocked for not "understanding" cryptos, but he is disciplined and sticks to his area of expertise. Those of us who remember the dot-com bubble will recall that he was also chastised for not investing in internet stocks.
In fact, he has made no significant investments in technology to date (however, perhaps his investments in IBM and Apple could be called tech stocks).
One of the reasons is a lack of predictability and intrinsic value estimations. How can you invest if you don't know what the value will be in x years? Most tech stocks finish near the bottom of the performance rankings, with only a few exceptions.
Why is stock selection so difficult?
Munger and Buffett avoided investing in gold because it generates no income. It's considered a "dead" asset. They do not invest in bitcoins and cryptocurrencies for the same reasons. They are unable to combine.
Is Bitcoin a hedge from the financial system?
During the 2008/09 GFC, most asset classes "broke down." The system was on the verge of collapsing, and we believe it is in even worse shape now than it was then. As a result, because bitcoin is decentralized and unleveraged, it could serve as a hedge against all of this.
Is bitcoin a safe haven from inflation?
Inflation has never been a real issue for those under the age of 50 who grew up in the Western world. However, this may come to an end. The balance sheets of central banks have expanded, and trillions of dollars have been created "out of thin air."
However, we are unable to see bitcoin as a play on inflation. The price action suggests that this is mostly speculation rather than hedging. Many people advocate for bitcoin as an investment, but in reality, it is mostly used for speculation. Surprisingly, people speculate in bitcoin to make money in dollars – which, despite an increasing supply, are a usable currency.
In general, there is no link between inflation and Bitcoin. None. I mean, hyperinflation and Bitcoin going to zero are both possibilities. There is no connection between them.
Let's just say that bitcoin has a lot to prove as an inflation hedge.
Bitcoin is far too volatile and dangerous.
However, volatility is not the main issue. It is a symptom of the underlying problem, which is a lack of access to any useful businesses or services (at least as of now).
Tesla invested in bitcoin and made it legal tender for car purchases, but then decided to return to dollars in a "surprise" move. As a result, the value of bitcoin dropped by 30%.
Bitcoin is extremely volatile.
What causes it to be volatile? Most likely due to the difficulty in valuing it. Furthermore, there is a lot of speculation about it. As a result, we can hardly call it a "store of value."
Benjamin Graham writes in The Intelligent Investor that investing is about analyzing the safety of your investment/principal and the likelihood of receiving a "satisfactory" return. We don't see how Bitcoin can fit into such a description because it is such a new innovation.
Why not invest in gold or real estate if you are concerned about sudden inflation? They have data dating back centuries and have proven to be an effective hedge against "sudden" inflation. These two asset classes do have one advantage that bitcoin and cryptos do not: they are physical. If they all go to zero (in value), you still have something useful if you own real estate or gold. you can build/grow/live on your land, or you can wear gold necklaces around your neck.
Similarly, if you own maturing whisky, another physical asset with a purpose, you can at least take delivery and drown your sorrows if your casks become worthless, Cask is king when it comes to whisky investment.
Buy some land if you want to protect yourself against inflation. On it, I'm not sure what, olives? You'll have olive oil on hand. You'll have something if the price falls.
Is bitcoin a scarce commodity?
The limited supply of bitcoin is one of its main selling points. But does scarcity always imply a good investment? That is an interesting argument, and it may be valid.
To our knowledge, there are over 1000 different cryptos, and there are no limits to how many you can "invent" and offer for supply. The total valuation has already surpassed one trillion USD. Which cryptocurrency will emerge victorious in the future? Who can say?
Technology is always evolving at a rapid pace. When the internet became useful in the 1990s, the market was inundated with internet companies. Unfortunately, the majority of them failed and are no longer in operation.
Similarly, even if the blockchain becomes useful in everyday life, it is difficult to forecast the outcome of cryptos and their value.
Conclusion: Stocks should be a better long-term investment than bitcoin.
Stocks, we believe, are the better long-term investment. The reason is straightforward: you own productive assets with the potential to compound and grow.