Today’s question comes from Chris in Long Island. He asks,

You’ve talked about many different asset classes on the show, but I haven’t heard you talk about crypto currency? Why haven’t you talked about it, and what are your thoughts on crypto-currency.

Chris this is a great question.

In order to answer the question, we need to go back to the very definition of what is money. I don’t know if this is strictly a dictionary definition, but in my mind in order for something to be money it has to have three characteristics.

  1. It has to be a means of exchange
  2. It has to be a store of value
  3. It has to be easily divisible into different sizes so that you can use it to exchange for a wide spectrum of goods, services and commerce.

Let’s look at a crypto currency like Bitcoin, or Etherium, or any of a host of others and measure them against those three criteria.

  1. As a means of exchange, it’s not great. There are more methods coming into play. But you can’t just go out and buy groceries with a crypto-currency
  2. As a store of value, it definitely fails. The value of crypto currencies have been extremely volatile, both up and down. The value seems to be linked to the number of coins in existence and demand for coins. The notion of value is based on the promise that supply of coins won’t be inflated and debased the way the dollars are being printed.
  3. Most of the coin exchanges like coinbase allow for fractional purchase of coins. So maybe the third is satisfied.

But against the measures of the definition of what money needs to look like, I can’t see how anyone thinks that crypto-currency is money.

A bank  has a centralized database where they keep track of how much is owed to you. That centralized database is not 100% perfect, but is pretty trustworthy. I assert that it’s trustworthy because I can virtually guarantee that all the listeners of this show have a certain amount of their liquid cash on deposit at the bank where it is being tracked in a central database.

The argument for crypto currency is that there is no bank that is keeping track of your funds. The database technology that sits underneath the crypto-currency is based on a technology called block-chain. The blockchain is a database that is distributed across thousands if not millions of computers and so there are literally thousands or millions of copies of your transaction being recorded across all those computers. The argument is that if someone attempted to tamper with the records in the database, it would be virtually impossible for them to tamper with all of those copies of your records. The inconsistency would show up instantly and the fraud would be exposed.

A single computer updating a single entry in a database can complete that operation in a few microseconds. But if you have to make the same change and recalculate the signature 1,000 times across 1,000 computers, or 10,000 computers, it’s clearly going to take a lot longer.

So blockchain technology is essentially a slow distributed database.

So crypto has some security features that are interesting and compelling. On the flip side, the inherent security doesn’t come for free. There is a technical problem associated with a distributed database and that is scalability. 

Have people experienced huge capital gains in crypto-currency? Clearly the answer is yes. Have people lost money? Absolutely. In my world investing has the notion of value at the foundation. Speculation on the future price is not investing in my world. That’s gambling. I believe there is risk in everything we do. But when it comes to investing I want to take calculated risks, not play in a game of chance.