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If investment risk is defined as the probability of permanent loss of your money, how likely is it for you to lose your money if you invest in Bitcoin, specifically in the newly approved Bitcoin ETFs?
We all heard Warren Buffett rejecting Bitcoin as a good fundamental investment because it has no intrinsic value. Still, some of the largest asset managers in the world launched a Bitcoin ETF only a few days ago.
Are they stupid? Don't they know the same things Warren Buffett knows?
The good news is that they must disclose all the risks they see in Bitcoin in the prospectus document accompanying each ETF. And let me tell you, the risks list is long and unbelievable.
In today's post, I review the ETF (Ticker: IBIT) launch document of the world's largest asset manager, BlackRock, and discuss the unbelievable risks this world-class asset management firm sees in Bitcoin. By the end, you can decide how risky investing in Bitcoin ETF really is, and I'll tell you what my plans are.
Let's talk about that!
I'm Hoda Mehr, founder, and CEO of Stock Card, and on this blog and its accompanying YouTube channel and Podcast show, I share detailed fundamental analyses and interesting investment stories.
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Bitcoin's Intrinsic Value
Before we jump into Bitcoin ETF risks, let's address the elephant in the room. Bitcoin has no intrinsic value. This is the biggest risk most Bitcoin critics, including Warren Buffett, have had since the beginning of Bitcoin's rise. Let's decipher it.
By definition, intrinsic value measures an asset's worth differently from its market price. Traditionally, investors use cash flow to measure intrinsic value. In the case of Bitcoin, because there is no cash flow, investors conclude that the asset has no intrinsic value. We will discuss in a few minutes on this show that Bitcoin is not even a company or entity whose value you can assess.
Investing in Bitcoin is not a part-ownership in a company, real estate, or any other asset. Trying to assess the value of Bitcoin using cash flow is similar to asking to measure the weather and how hot or cold is today with a measuring tape. You can't use measuring tape to measure the weather. You can't use intrinsic value to measure Bitcoin's value.
If you accept that fundamental definition, you and I can talk. However, if you cannot accept that Bitcoin can't be valued by cash flow, Bitcoin and Bitcoin ETF are a complete risk for YOU. You must skip them altogether.
Why Do You Need A Bitcoin ETF?
Now! Let's say you agree that Bitcoin's intrinsic value isn't based on cash flow, and you have reasons to believe you want to invest in Bitcoin or Bitcoin ETF. I will talk about possible reasons to invest in Bitcoin beyond intrinsic value later in the show, but for now, let's discuss the value of a Bitcoin ETF compared to investing directly in Bitcoin.
As an individual, you can create a cryptocurrency wallet, go to a Cryptocurrency exchange such as Coinbase (COIN) or Robinhood (HOOD), and buy Bitcoin directly from them. You can also hold your Bitcoin in that wallet or store it securely in what's known as a cold wallet, which is like a vault that keeps your coins secure.
The process may feel complex. Wallet addresses are long and creating a wallet or sending coins between them is different from sending money through a bank. You need to remember how to access your wallet and things of that sort. It's not hard, but it's different. Suppose you are uncomfortable spending about an hour learning the process or worried you may lose access to your wallet. In that case, the risk of losing your money invested in Bitcoin is lower when you invest in an ETF instead of directly buying it.
As Jay Jacobs, BlackRock's U.S. Head of Thematic and Alternative ETFs explains "for many investors, holding bitcoin directly is still challenging. That’s why we launched IBIT" which is BlackRock's Bitcoin ETF.
This works for institutional investors quite well. 401Ks and pension funds don't have legal permissions or technical infrastructure to buy Bitcoin directly. For them, Bitcoin ETF is the only way to add it to their portfolio, so it is less risky. For you as an individual, the legal barrier doesn't exist. Still, you may have a technical barrier like what we discussed earlier and don't feel comfortable with the direct purchase of Bitcoin. In that case, Bitcoin ETF has a lower risk for you, similar to institutional investors.
Three Unbelievable Bitcoin ETF's Risks
Now, let's go into more detail and discuss the risks our good friends at BlackRock have identified for their own Bitcoin ETF, ticker IBIT. There are several pages of risks that I went through, and I will summarize them in three groups:
Volatility: the first risk is volatility. Last week, I shared a post on how volatility is not equal to risk. Risk is your response to volatility. If you sell when the prices are down because you can't tolerate seeing red on your portfolio, you turn volatility into risk.
It's no surprise to anyone that Bitcoin is volatile. Bitcoin's price goes up and down quite rapidly. In the middle of last October, Bitcoin was about $28,000 per coin. Three months later, in the middle of January, the price nearly doubled to above $40,000. In November 2021, you could have bought Bitcoin for almost 70,000, and only three years ago in 2020, the coin was yours for about $4,000. Bitcoin is certainly a volatile asset, and if you know yourself and can't tolerate the extreme movements, then Bitcoin ETF is very risky for you. Indeed, since the launch of the ETF, it is already down 13% from the starting price of $27.51.
The next category of risk is operational risks. BlackRock brings up the fact that Bitcoin has been around only for 15 years and is run by volunteers. By all definitions, it is still a startup run by people who chose to work on it. If something goes wrong with the Bitcoin code, are we sure and have we seen enough operational history to conclude that the network stays secure? No one knows, really.
Bitcoin isn't a company. It doesn't have a CEO whose leadership quality you can assess in times of crisis. According to the Gemini website, "Bitcoin is not controlled by any single group or person. Instead, it is governed by multiple stakeholders — including developers, miners, and users. Developers write the code that makes Bitcoin run; miners validate transactions, and users put the software to work by trading, transacting, holding, and more. It is a self-governing, software-enabled 15-year-old experiment. If these networks of individuals and companies decide not to participate, or developers who run the network lose the financial resources to maintain their operations, the system will fall apart. No central entity runs the operation that we can assess its quality. That's a risk.
The so-called Bitcoin miners are individuals or companies with lots of computer processing power that record Bitcoin transactions. They do the recording work in exchange for Bitcoin as the reward. Let's say the price of Bitcoin goes so much down that it is not economically viable to record that transaction. If that happens, Bitcoin is not an entity that can go to the bank and get a loan. The integrity of the network falls apart if it is not economically viable to mine bitcoins and record transactions. In all likelihood, there will always be a miner willing to temporarily accept loss so it can stay in business. After all, miners' financial livelihood depends on Bitcoin, but a major disruption to the entire Bitcoin network is not difficult to assume. It hasn't happened yet because Bitcoin hasn't been around long enough. That's a risk.
This leads to the last group of risks: ownership. How does Bitcoin software enhance and improve and who owns the future product roadmap? Bitcoin has a loose network of what's known as core developers. You can find them on Github, a platform for storing and managing software code. These core developers may get corrupted, may not agree on the direction, or undermine each others' work in extreme cases, or a whole myriad of human fallacies and pitiful behavior may take over the core developers' community. I don't know any of them. But history has shown humans are prone to mistakes, and core developers of Bitcoin are no exceptions. So far it has worked because everyone's monetary incentive is aligned to make the network work. At some point, it may not. Of course, consensus and voting mechanisms are coded into Bitcoin's software, but most of us are not technical enough to evaluate them. All we know is that it has worked for 15 years. But there is uncertainty risk for non-technical folks like you and me.
It's also widely believed that a small number of individuals own the majority of Bitcoin. These are wallets or a set of wallets that have owned and hold a big portion of the coin. We don't know who they are and what they are up to. If things go wrong, these owners are incentivized to pay off enough core developers to act on their behalf. After all, as late Charlie Munger used to say, if you want to understand what people do, look into their incentives. Most Bitcoin owners will act in their own interest, especially if something goes wrong.
There are more risks in the BlackRock IBIT ETF document, but those three categories cover them well enough.
Honest Case For Owning Bitcoin
So, I'm even scared of Bitcoin by now. However, in full disclosure, I own some Bitcoin. Why?
Well, evaluating risk without assessing the reward is meaningless. Bitcoin is a promise and a potential chance for the world to store its wealth and transact outside the banking system of one country or another. It is nation-independent. If it gains adoption by large enough people and entities, it is new, unique, exciting, and influential. It reduces the world's dependence on a central monetary system.
ARK Invest and Cathie Wood's team who are one of the institutions that launched Bitcoin ETF along with BlackRock have a paper on estimating the value of Bitcoin in case those monetary system dreams come to reality. It calculates up to a $1 million valuation per Bitcoin. To reach that valuation, all stars have to be aligned, and Bitcoin, its network, and developers have to survive through all operational, ownership, and volatility risks we discussed. But for me, the future reward is so big that if I miss it and 20 years from now, I realize I had the chance to participate in this investment, and I didn't, I cannot forgive myself. That's why I own a small amount of Bitcoin, and I add to it slowly, only to minimize the future regret of not participating in this.
If you are like me and can accept the risk of 100% capital lost with more than 90% probability and perhaps a 10% chance of being a part of a new software-enabled monetary system, then you should invest in Bitcoin or Bitcoin ETF. If you don't like chasing improbable dreams and will not regret missing out in 20 years, you must let it go and stay away from Bitcoin as far as possible. (Note: This is NOT investment advice. You may lose all of your money by investing in Bitcoin or Bitcoin ETFs. Do you research, please. )
I'll see you next time!
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