For super funds and their advisers

Bitcoin: a cautionary tale for institutional investors


One would expect the inventors of the RAFI index to apply fundamental research to their work. When they turn to something as ephemeral as cryptocurrencies, the results are also entertaining.

The Research Affiliates Fundamental Index (RAFI) is the strategy which kick-started the smart-beta trend; the best-known strategy developed by California-based manager Research Affiliates in 2005. The firm has subsequently developed many strategies under the RAFI brand and helps clients in bespoke research-based offerings and has offices in London, Sydney and Melbourne.

The latest research note, ‘Bitcoin: Magic Internet Money’, is a little different in its style. It is a personal essay backed up as much by gumshoe research as the usual fundamental assessments the firm makes. Author Alex Pickard, a vice president, research, in Newport Beach, says he was encouraged to write the piece by Rob Arnott, the founder, and colleagues Chris Brightman and Bradford Cornell.

You get the gist from the opening paragraphs. It’s a classic Hollywood tale about an entrepreneurial young man who learns a big lesson about investments the hard way.

“When I bought my first bitcoin (BTC) in 2013 at 25 years of age, it was a small investment appropriate for my risk tolerance and stage of life,” he writes. “Not knowing much about it at first I began learning all I could. My conviction grew and in 2015 I invested between US$400 and US$700 a coin. Little did I know I was about to go down a rabbit hole that would ultimately take me to a small town in central Washington state, building rudimentary data centres in garages to cash in on the bitcoin mining craze.”

To cut a long story short (the research note is actually not long – just a five-minute read), Pickard lost all his money and returned to Newport to get a job, wiser for the experience. But he lost all his gains, not from a sudden fall in price, so much, but from an unexpected player in the space. The local electricity supplier of what was the country’s cheapest electricity because of a nearby hydro-electric plant, shut him down because he had become too much of a drain on the system. The sharp fall in price that accompanied that news was coincidental.

Pickard argues that bitcoin is not a means of exchange, nor a store of value. And the worst-case scenario is that the price is being manipulated by at least one “stablecoin” (a cryptocurrency designed to reduce volatility), known as Tether, which is being sued by several investors. The company is also under investigation by the New York Attorney General for unrelated fraud allegations.

“Regardless of the reason for BTC’s astronomical price movement, investors should resist the temptation to chase the price,” he says. “Extreme fluctuations in price invalidate claims that BTC is a store of value. Neither is it a capital asset; merely an entry in a digital ledger. BTC does not generate cashflows and its only real use is to sell to someone else. High transaction fees make it a poor currency and negate claims of fungibility. The price of BTC is nearly certainly a bubble and likely manipulated. Investors should proceed with extreme caution.”

If his Research Affiliates salary is insufficient to regain his bitcoin losses, perhaps Pickard could sell this research note to Hollywood as the basis for a movie script.

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