As many of our clients know, I'm a devoted follower of Warren Buffett and his principles on investing and on business. So whenever I get a chance to hear what Warren has to say on any topic, I try to listen in. On Monday last week, Buffett was interviewed on CNBC for 3 hours and weighed in on a number of important topics, including the impact of coronavirus, US politics, Berkshire Hathaway's businesses, and even on cryptocurrency. All of these topics are interesting, but I want to focus on what he had to say about cryptocurrency as this still seems to be a topic that many investors are confused by.
For those of you who don't know the story, Buffett has famously been quite critical of cryptocurrencies in the past and has said many times that he thinks it will come to a bad end for investors. These criticisms led crypto entrepreneur Justin Sun to purchase the annual charity dinner that Buffett auctions off each year in an attempt to try and convince the 89 year old investor of the merits of crypto. Buffett was happy to oblige for charity and that dinner took place a few months ago.
You can see Buffett's response on CNBC here. As you can tell by watching the video, Sun did not convince Buffett that investing in crypto was a good idea. In fact, Sun even gave Buffett a single bitcoin at the dinner so that he could have at least one, but Buffett instead chose to donate that coin to charity. Clearly Buffett is not a believer. The question for us to answer is WHY isn't he a believer in crypto.
If you're a supporter of crypto, you're obviously going to point to the fact that Buffett is 89 years old, has said many times that he doesn't invest in things he doesn't understand, and is hardly known as tech savvy. He recently traded in his flip phone for a new smart phone, but I don't think anyone is going to confuse Buffett with being a technophile any time soon. So of course Buffett wouldn't invest in cryptocoin, he's too old and just doesn't understand it. That's the common excuse given. Unfortunately, if you listen closely to what Buffett has to say about cryptocurrencies, his arguments against them can't be dismissed that easily.
Investments typically fall into three categories. The three categories are: Loans, Non-Productive Assets, and Productive Assets. There are many different iterations of each category, and even some investments which are hybrids of two or more categories, but essentially these are the three big types of investments. Loans are obviously when you lend money and earn an interest rate. A non-productive asset is something which has very minimal utility and does not reproduce. A good example of a non-productive asset would be Gold. A productive asset on the other hand, does provide utility and sometimes can reproduce itself and can grow. Productive assets include stocks of companies, but would also include things like real estate and farmland, both of which provide utility.
Cryptocurrencies, along with all other currencies for that matter, fall squarely into the non-productive asset category. They cannot reproduce or grow, and the only utility they provide is as a means of exchange. They are valuable only if we all agree they are valuable because they don't have any utility by themselves. In other words, you can spend paper $20 bills as long as stores will accept them. Once they stop accepting them however, the value of that $20 bill quickly falls to near 0.
Cryptocurrencies are no different. They are valuable as long as someone is willing to buy it off you. Once there is no one else who will buy it from you, it is worthless. I don't think any of what I've said to this point is controversial. I think even the most devout crypto enthusiast would have to admit that without widespread acceptance of crypto, it's value will be capped, and it won't prove to be a great investment.
Paper fiat currencies have widespread acceptance for two main reasons. They have the explicit backing of the government usually, and as such have all of the power of the government backing them, including military power in extreme cases. Governments can legislate the use of one currency or another, and they frequently do. In fact the second reason for widespread acceptance is grounded in government legislation. That reason is paying taxes. Governments usually require you to pay your taxes in the currency that they issue.
So in Canada we pay taxes using Canadian dollars. You can't pay your taxes with US dollars without first converting them to Canadian dollars. The same goes for Bitcoin. CRA isn't going to take your Bitcoin to satisfy your income tax, and in fact even merchants who would be willing to accept Bitcoin would have to convert those coins to Canadian dollars just to pay the GST on purchases. This ensures that there will always be a need for Canadians to have and to use Canadian dollars. Even if we were able to transact entirely in another currency, come tax time we'd all be lining up to buy dollars so that we can pay our taxes.
So, barring some massive change in government policy, paper fiat currencies are not going away. But is there an argument for them to be supplemented by cryptocurrencies? Well there are two main arguments working in cryptocurrency's favour, both of which are well understood by Buffett.
One of the arguments is that Cryptocurrency will provide more privacy and less intrusion by the government. This is an argument which appeals to libertarians, anarchists, and fans of small government. Unfortunately it also appeals to organized crime, terrorists, and foreign dictators, all of whom appreciate the ability to move money across borders in a secretive way. While there is no doubt there is some benefits to having a decentralized currency, it's very uncertain that governments will continue to allow crypto currency transactions when it is proven that it's being used for criminal activities or terrorism. So this benefit is uncertain.
The second main argument working in favour of cryptocurrency is that most of the currencies either have a static or capped amount, or they are subject to regular increases in supply. Since they are decentralized, it would be very difficult for any one party to change this. This means that the supply of cryptocurrencies should be more limited than the supply of paper money. One of the main problems with fiat paper currency is that it is too easy to create. As such, politicians often print too much money and create high inflation, which devalues the paper currency.
Theoretically cryptocurrencies don't have this problem, or at least it should be less of a problem for them. I think this is probably the best argument in favour of cryptocurrency as an investment. It is essentially the same argument for investing in gold. If you believe that the government is printing too much money and is devaluing your savings, maybe buying some bitcoins would be a good idea to preserve the value of those savings.
The problem that Buffett has, and that I also have with 'investing' in cryptocurrencies, is that I think there is a better strategy which will still protect me against inflation. That strategy is to invest in productive assets. If you buy farmland, the value of that farmland will rise over time and won't be devalued by inflation. If your paper money is worth less, that just means you'll need more of it to buy my farmland. Whether or not cryptocurrencies gain widespread acceptance or not, that farmland is still going to produce crops, year after year, and I can use those crops or sell them.
Cryptocurrencies or gold won't provide me with anything. The same principle works for a business. I can buy a share in Alphabet for example, and I can own a business which generates billions of dollars of revenue and profits, each and every year. That share likely won't be affected greatly by inflation, as Alphabet will be able to charge more as the value of the paper currency goes down. This seems to me to be a much more appealing investment than a cryptocurrency, which again won't pay me anything and doesn't produce anything.
Buffett agrees as that's exactly what he said in his interview last Monday. His argument against cryptocurrency really has nothing to do with the technology at all. It has more to do with the nature of the investment. I can't say for sure whether cryptocurrency will change the world or not. Neither can Warren Buffett or Justin Sun. I think it's likely that the technology will have some impact on financial services and on the financial system at large, but it's anyone's guess as to how big of an impact that will be.
No one can predict the future and no one can predict which cryptocurrencies will be around to see it. Because there are so many unknowns, I think I'll stick with Warren Buffett and keep investing in productive assets.
- Craig White, BA, LL.B., CIM
Craig White is an Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.
This information has been prepared by Craig White an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.
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