There have been some harsh words spoken on ‘investing’ in cryptocurrencies. Bill Gates, Warren Buffett, and Charlie Munger have trouble even calling it investing. You might think that these Bitcoin-critics are just jealous over missing the big returns Bitcoin has offered over the past years. You might also think that these people are just old and out of touch with our new digital economy. Then again, these people have been successful so you might also dig a little deeper and try to understand why they are opposed to cryptocurrencies.


Here are some quotes from Buffett, Munger, and Gates on buying cryptocurrencies:

Warren Buffet:

“You aren’t investing when you do that. You’re speculating. There’s nothing wrong with it. If you wanna gamble somebody else will come along and pay more money tomorrow, that’s one kind of game. That is not investing.”

Bill Gates:

“I think the speculative wave around ICOs and cryptocurrencies is super risky.”

Charlie Munger:

“The fact that it is clever computer science doesn’t mean that respectable people should encourage other people to speculate in it”


Gambling and Investing Dialog

Buffett and co are not disbelievers in the disruptive technology that Bitcoin can provide. Quite the contrary, Bill Gates has called the blockchain technology “quite a good thing” in terms of sharing databases and verifying transactions. All three however point out that buying bitcoin is akin to gambling. Munger has stated this quite nicely: “the fact that it is clever computer science doesn’t mean that respectable people should encourage other people to speculate in it.” (Munger, CNBC – 2018)

Justine:
So, what gives?

David:
Well, it all boils down to a simple distinction between gambling and investing. According to Buffett, investing is a process where you take a productive asset, make some informed decisions about its future, compare its returns to the returns of other productive assets, and make a buy or not-buy decision.

Justine:
A productive asset? So, what is a productive asset?

David:
Well, it’s just something you can put your money in and it will give you a yearly return. Some examples:

  • US Treasuries
  • A House
  • A Business (or shares in one)
  • An Education

These are all examples of objects or services where you put a certain amount of money in upfront, and you get a periodical (yearly) sum of money back in return. Think about it like this. You pay $50,000 for an education and afterwards you get an income of $3000 monthly. Or you buy a house, rent it out, and get $1000 monthly.

Justine:
And these productive assets are good things then?

David:
Compared to non-productive assets, yes. But you still have to check whether the returns you get make sense. For instance, if you get an education and pay $50,000 upfront, get a salary afterwards of $3000, but your salary without the education would be $2800, you might questions whether the 200 bucks extra you’re getting is worth the $50,000 upfront payment.

Justine:
I don’t understand. You get $200 extra and that is a bad thing?

David:
No, but maybe you could’ve put the 50,000 in a business venture that will earn you $400 per month. In that case you would be better off keeping your $2800-job, put the $50,000 in the business venture and you end up with $3200 ($2800 + $400) instead of $3000.

Justine:
Ok, so with productive assets you’re comparing the returns you can get and decide where to put your money in. So what where does bitcoin come in? I assume it’s not a productive asset then?

David:
Indeed it is not. When you decide to buy Bitcoin all you are doing is hoping it’ll go up in price so you can sell it at a profit. It’s not just Bitcoin. Just to give you an idea, other non-productive assets are things like Rembrandt-paintings, gold, oil, stamps, etc. With these kinds of non-productive assets you’re always looking for someone who’ll pay more for the thing than you did so you can pocket the difference. With productive assets on the other hand, you’re making business decisions that provide yearly or monthly cash-flow. You don’t necessarily intend to sell the productive asset just because the price went up. See, you’re more interested in the cash-flow it generates than in the principal going up.


In the end investing has nothing to do with predicting which technology will disrupt everything. The main point in investing is finding an asset that can give you a decent return over a longer period of time (preferably one which is higher than the yield of a government bond).

A final example might illustrate the point:

Imagine you have an opportunity to invest $100,000 in three ways:

  1. US Treasuries,
  2. A Studio Apartment,
  3. Gold.

To make things a little less complicated i will leave aside the issue of taxes here.

1 – US Treasuries:

If you buy $100,000 worth of US Treasuries you will be earning around 3% each year. In other words, you will receive $3,000 every year for the next 10 years. After 10 years you will get back the $100,000.

2 – A Studio Apartment:

If you buy the Studio Apartment and are able to rent it out for $1,000 per month (or $12,000 a year) you will be earning a 12% return a year (12,000/100,000). In other word, you will receive $12,000 every year for, let’s say, the next 10 years. After 10 years you sell your property and will either get back $100,000 or you may get more or you may get less.

3 – Gold:

If you buy 100,000 worth of Gold Coins (or ETF’s) you will be earning 0% earch year. In other words, you will receive 0 every year for the next 10 years. After 10 years you sell your Gold and will either get back 100,000 or you may get more or you may get less.

Analysis

Now out of these three options it should be quite clear that the US Treasuries option is the safest and surest thing. You are guaranteed a 3% return and you are guaranteed the 100,000 principal after 10 years for a total of 130,000 (3000 x 10 + 100,000) .

With a little arithmetic it should also become clear that if you take option 2 (the Studio Apartment) you are guaranteed a 12% return and an unknown sum when selling after 10 years. However, we can easily see that a 12% return per year will yield 120,000 (12,000 x 10). So even if you sell the apartment for 11,000 (or a loss of 89%) you still end up with a total of 131,000. This makes option 2 quite attractive compared to option 1.

What’s left then is option 3. Here we are basically at a loss. for 10 years you earn nothing and after 10 years you have no idea for how much you can sell the Gold! We know, however, that we need at leas 130,000 after 10 years for Gold to be a viable option. And this is precicely the problem. Can you be sure that in 10 years time Gold will be 30% higher than it is now? You might say yes, or you might say no but it is pure speculation.

Think about it this way. When you buy the apartment you are able to sell it at an 89% loss and still have a good investment compared to US Treasuries! When you buy Gold you MUST be able to sell it for a 30% premium compared to the price at which you bought. This is why Gold is a gamble, while the apartment is an investment (and quite a good one in this example).

Schematic Overview:

Option 1 – US Treasuries 2 – Studio Apartment 3 – Gold
Price: 100,000 100,000 100,000
Return: 3% Yearly 12% Yearly 0% Yearly
Money After 10 Years: 130,000 Between 120,000 and 250,000 Between 0 and infinity
Risk None – Maintanace could be higher than expected

– Earthquake / Insurance

– Renting Laws

– No way of assessing

.

Risk comes from not knowing what you’re doing.

-Warren Buffett