On Warren Buffett and the bitcoin bubble

There’s some small amount of buzz in cryptoland over Berkshire Hathaway chairman Warren Buffett’s recent negative comments on bitcoin.

Let’s preface this by stating the obvious: Warren Buffett is greatest living value investor and one of the greatest in history. The man applied everything Benjamin Graham taught him at Columbia Business School (which is a way better school than Chicago or Wharton) and amassed one of the largest fortunes ever seen. To paraphrase a Yiddish expression, Buffett has already forgotten more about investing than anyone else will ever know.

Yet there’s one sector that Buffett doesn’t feel comfortable with and that’s technology. It’s just not his thing and that’s okay. He’s not poor because of it. He knows himself well enough to know that he just isn’t equipped to dabble too deeply in tech.

Twenty years ago, as reported by CNet, Buffett said at the Berkshire Hathaway annual meeting:

On whether the firm will invest in computer-related companies, Bloomberg quoted chairman Buffett as saying: “The answer is no, and it’s probably unfortunate. I don’t know what that world will look like in 10 years, and I don’t want to play in a game where the other guy has an advantage over me.”

He got to see what the world looked like 10 years later and another decade after that, with Amazon eating the lunch of whole sectors he knows plenty about. Retail, for instance. Buffett now owns shares of Apple, the largest company in the world; two other Berkshire managers own IBM and VeriSign.

At 87, the odds of him warming up to a new technology for the next few decades is slim.

And Buffett’s comments over the years aren’t incongruous with being optimistic about where cryptocurrencies are taking the world.

Yes, on Wednesday, he told CNBC’s Squawk Box, “In terms of cryptocurrencies, generally, I can say with almost certainty that they will come to a bad ending.”

But that depends on one’s perspective.

The chart below is a popular one circulating at the moment showing phases of a bubble. It’s from Hofstra University’s Jean-Paul Rodrigue but it first bubbled up during the financial crisis.

It’s interesting to note is the type of investors Prof. Rodrigue sees dominating each of the phases. “Smart Money” is first as the technology is in stealth mode. Institutional investors come next during the “awareness” phase. They are followed by the naive public’s “mania” phase, only to see their money wiped out during the “blow off” phase.

To paraphrase a lot of people on Reddit, this time it’s different! Only it may not be in a good way, again, depending on where one is.

The type of investor jumping into, say, bitcoin is sorta in reverse. It wasn’t smart money but technophiles who were in on the stealth mode and were there for a couple years. It’s estimated that about 1,000 people and entities own 40 percent of all bitcoin in existence—the so-called “whales”. Generally, these aren’t hedge funds or investment banks but early miners, true believers, and a smattering of high-risk investors.

They were followed by “smart money” (yes, the Winklevoss Twins are surprisingly counted in this lot) during the awareness phase.

Meanwhile, Institutional money didn’t just stay away from cryptocurrencies; they were openly hostile to it. Jamie Dimon, for example, called bitcoin a fraud, though he only recently backtracked from that statement (kinda).

By December 2017, some institutions began capitulating. For instance, the Chicago Mercantile Exchange (CME) and Chicago Board Options Exchange (CBOE) both offered bitcoin futures contracts. Goldman Sachs is reportedly looking into opening a cryptocurrency trading desk by the summer of 2018. It’s a not quite a universally accepted asset to invest in or trade but it seems those institutions are jumping in only as the market gets frothy. That’s the “new paradigm” part of a bubble, according to Rodrigue’s chart.

And we may very well be on to a new paradigm similar to what the internet was back in the late 1990s. That ended badly in 2000 for the latecomers. Yet those who held on to their Amazon shares, for instance, did okay over the long term (many, many others, not so much) when it did indeed become a new paradigm—just not the paradigm anyone expected because no one could gauge or time how smartphones were going to changes things.

As well, even this author’s labeling different phases may be entirely off or premature. How do we know?

Forbes contributor Jesse Colombo used Rodrigue’s chart to describe bitcoin more than four years ago. He even referenced “the 2000 Dot-com bubble, Tulip Mania, and South Sea Bubble”, which are all favorite memes when talking about cryptocurrencies.

That takes us back to Buffett.

In his Wednesday Squawk Box interview, he followed his “bad ending” statement that “When it happens or how or anything else, I don’t know,” when it comes to when the bubble will burst and with good reason. No one truly knows, not even Warren Buffett. Anyone who says he can predict it is either a liar or an idiot.

“I get into enough trouble with things I think I know something about,” he added. “Why in the world should I take a long or short position in something I don’t know anything about.”

Because of the peculiar nature of how this particular “bubble” (excuse the term but just go with it for now) was formed, we just don’t know how this will play out. The oft-cited South Korean housewives and students who are trading from their smartphones may get hit but so will the investment-banker-Johnny-come-latelys who had serious FOMO in from 2015 to 2017.

And the fact that we don’t know how the whales will play into it. They’re sitting on more than 6 million bitcoins at the moment, or over $90 billion worth based on Thursday’s prices. As long as they see bitcoin as only a store of value and not a medium of transaction, circulation will be tight and adoption as a true currency will be hobbled.

Transactions costs are high and take too long to process and even advocates aren’t accepting it at bitcoin conferences. So long as prices are volatile, it’s near impossible to get more than a few people to make and accept payments in bitcoin or any other cryptocurrency without changing the prices to match the fiat currency of choice. It’s like going to a restaurant in a developing world country where the menu prices are written in pencil and changed three times a day. In those places, the restaurant owners base their local currency off of a more stable one, such as the U.S. dollar or the euro. Yet that could have been one of the best roles for bitcoin—the base currency of choice in destabilized countries. Alas!

Here’s a counterintuitive thought: Perhaps the future of cryptocurrencies is best served by the whales dumping their inventory and taking profits right now. More floating currencies would stabilize prices, albeit at a much lower price against major fiat currencies. It could become the medium of transactions that has eluded it from its earliest days, when folks from the Bitcoin Foundation would run around New York City begging vendors to accept bitcoin. It could be the stable base currency for the likes of Venezuela and Zimbabwe and other places facing extreme currency devaluation.

In such a scenario, Buffett is correct that the bubble will end: Some caught at the very top—older financial institutions and new speculators—will suffer a little bit. However, if whales take profit even with prices a fraction of what they are today, they will be much wealthier than when they started. What’s more, the future of cryptocurrencies would be brighter.

That’s not a bad ending.