Using Debt to Buy Bitcoin is a Bad Idea
Joseph Borg, the president of the North American Securities Administrators Association and director of the Alabama Securities Commission, reported on CNBC this week that he had seen “mortgages being taken out to buy Bitcoin. People do credit cards [and] equity lines.”
Investing with Borrowed Funds Is Risky
Bitcoin, which briefly topped $19,000 on exchanges last week, has been aptly named “crypto tulips” by skeptics and “undervalued” by bullish investors. No matter your position on the subject, competent investment professionals caution their clients about the risks associated with investing with borrowed money. First, the interest an investor pays on borrowed money is an important consideration. If you are paying interest on a loan, then you will need to make at least that interest amount in your investment just to break even. Second, if your investment crashes, whatever you indirectly put up as collateral (by borrowing against it) could be at risk of being foreclosed or liquidated.
Bitcoin Is A Bubble, Sound Familiar?
Bitcoin is a bubble, even if we haven’t yet witnessed its peak. Economists explain that bubbles are sometimes hard to see, but there are some signs to watch for: 1) unusual changes in value relative to historic levels; 2) using debt to purchase assets; 3) explaining away unusual asset prices with weaker arguments; and 4) large media coverage related to the asset.
Does this sound familiar? The price of Bitcoin has risen by over $16,000 this year – compared to its historic price that hovered in the $500 to $1000 range. Now, we have signs that people are using debt to purchase Bitcoin. Bitcoin advocates are seemingly on a mission to explain how Bitcoin will change the future of the world. While we believe that the blockchain technology underpinning Bitcoin may have that potential, we are skeptical that Bitcoin itself will continue to flourish without any intervention by government. Finally, there seems to be non-stop media coverage about the Bitcoin frenzy.
Consider the Following Before Investing
Before investing in Bitcoin, consider this – according to AQR Capital Management, about 1,000 people own 40% of the world’s Bitcoins. A different investment website, ZeroHedge, reports that as of September 2017, just 4.11% of Bitcoin addresses (the wallets used to store Bitcoin) own 96.53% of the world’s Bitcoin.
Nobody can know what ultimate price those persons are holding out for, or whether they even intend to sell their Bitcoin at all. Currently, the demand for Bitcoin far exceeds its supply. But, if and when that roughly 4% of wallets unload their 96% of all Bitcoin into the marketplace, supply will exceed demand and Bitcoin will likely drop hard and fast in value. In other words, if you use real money, or worse yet, use borrowed money, to buy fake money (Bitcoin), don’t be surprised if one day, your fake money isn’t worth nearly as much as the real money you used to buy it.
Vernon is founding partner of Vernon Litigation Group, a law firm that handles the litigation and arbitration of complex business and financial disputes and represents clients in cybersecurity-related matters, including situations involving cyberattacks and data breaches that result in financial losses, theft and regulatory concerns throughout the United States.