Does Spirit Super invest in cryptocurrencies?

According to the Australian Financial Review¹ (8 June 2021), a survey by researcher YouGov found more than a third of Millennials and Gen Z planned to purchase cryptocurrency in the next 12 months, in many cases as an alternative investment to unaffordable property.

Spirit Super doesn’t invest in bitcoin, but we did undertake significant research into the potential role of cryptocurrencies as an alternative asset class.

The most well-known and actively traded cryptocurrency, bitcoin, was launched in 2009. It’s said to have been created by Satoshi Nakamoto, but it’s not all that clear who (or what) this is.

It’s reported that there’s now a total supply of over 18.7 million bitcoins. At current prices, this suggests a total market value of over US$640 billion. For comparison, as of June 2020, there was a total of 1.8 billion A$ banknotes in circulation worth A$90.1 billion.

Bitcoin first made headlines back in 2014 when its price rose from around US$1 to over US$1,000. In late 2017, it traded as high as US$14,000 – a return of 1,400,000 per cent for anyone who had acquired and held it since its inception.

In 2018, the price of a bitcoin fell sharply to around $2,900 before commencing another stratospheric rise to US$60,000 in March this year. Since then, the value of bitcoin has fallen by almost half again to around US$34,000. Another leading cryptocurrency, ethereum, has also lost around 50 per cent of its value since surging to an all-time high in May. Ethereum is similar to bitcoin, however alongside being a cryptocurrency, it also has other capabilities including smart contract functionality.

Like most investments, timing is everything!

So, what is a cryptocurrency?

A cryptocurrency is a digital currency (sometimes called a ‘virtual’ currency) that can be used, in many instances, to buy things online. Holders of bitcoin are provided with an anonymous and highly encrypted key and password. They can use this key and password to transact online, with all purchases recorded in real time on a publicly available distributed ledger.

This ledger, known as ‘blockchain’, is managed by a private network of servers. The role of blockchain is a critical element for digital currencies because the transaction is recorded concurrently at different points in the network. Any unusual or fraudulent transactions should (in theory) be automatically detected and prevented.

Cryptocurrencies are different from traditional currency because they’re not ‘issued’ by any government, nor are they regulated by any central monetary authority. In this sense, digital currencies like bitcoin can be thought of as a decentralised, peer-to-peer medium of exchange, subject only to the internet protocols of the blockchain network.

Supply and demand

When assessing the future outlook for the price of bitcoin and other cryptocurrencies, one important question is whether the supply of new currency is limited?

For instance, in traditional currencies, the supply of banknotes in circulation is carefully managed and regulated by central banks. On the other hand, new bitcoins are ‘mined’ by computers through a process of solving complex mathematical algorithms to create new blocks in the blockchain. (Once mined, they can be bought using traditional currencies and stored in a bitcoin wallet.)

A feature of most cryptocurrencies is that the rate of increase in supply, or production, is designed to reduce over time, with some having a finite limit on the number released into circulation. For example, the total number of bitcoins produced is thought to be limited to 21 million (just another 2 million or so from the current supply).

Other cryptocurrencies have no hard limit. Instead, they cap annual production. Ethereum, for instance, is said to cap new supply at 18 million ethereum tokens per year, or around 25 per cent of the initial supply.

In terms of demand, there are a lot of reasons bitcoin is popular. One is that it’s discrete. Purchases can be made anonymously. In fact, the bitcoin code changes for every purchase. Not surprisingly, it’s often reported that bitcoin is used to fund illicit activities, including the sale of goods sourced on the dark web.

However, it should be noted that as bitcoin is increasingly accepted by retailers and incorporated in payment systems such as PayPal and Mastercard, the degree of anonymity may be changing, and the security of passwords may not always be guaranteed.

Another advantage to bitcoin is its apparent simplicity and accessibility. It can be used through a smartphone with no bank accounts, no registries, no pesky 100 points of ID. Arguably, there are little or no transaction costs, such as bank fees. However, there may still be ‘maker’ or ‘taker’ fees and other fees and charges imposed by payment systems that accept bitcoin. Transactions also can’t be reversed, and there’s no customer service desk to help you out if you’re not happy.

There may also be taxation considerations for those investing in bitcoin or other cryptocurrencies.

Blockchain

Putting bitcoin itself aside there does appear to be valid uses for the blockchain technology that underpins it. The technology is currently being considered in large-scale record keeping such as hospital records, insurance contracts and registries. Some large companies already using this technology include BHP, Toyota and Maersk in supply chain management and record keeping.

Other considerations

As many people are aware, the mining of bitcoin and many other cryptocurrencies is highly energy intensive. Elon Musk made a shock announcement in May that Tesla would no longer accept bitcoin as payment, because its ‘insane’ energy use threatened the environment. According to the same article, bitcoin mining uses more energy each year than Sweden, according to Cambridge University researchers and, as most of this takes place in China, it’s likely to be predominantly coal-fired energy.

Conclusion

Our research of cryptocurrencies is still very exploratory. In many ways, it’s not surprising that the value of something that presents an element of ‘real’ transactional value might rise against traditional currencies when central banks around the world are feverishly printing more currency to fund record levels of government spending.

Nevertheless, our preliminary conclusions are that cryptocurrencies are still too new and volatile to be considered for inclusion in retirement savings portfolios. More specifically, the current price of bitcoin, ethereum and the like don’t necessarily reflect their intrinsic value but rather a rush of speculative demand.

The age-old maxim in relation to such speculative investments, ‘what goes up, almost surely must come down’ probably still applies here.

¹ https://www.afr.com/companies/financial-services/four-million-aussies-set-to-buy-into-crypto-20210608-p57z2g