By Luke Bartholomew

Many of us now know someone who has made a substantial amount of money “investing” in cryptocurrencies like bitcoin. Just in the last two years, the stellar rise of the main digital currencies has been able to turn a £500 purchase into £15,000. If you bought in earlier, you’d have made significantly more.

So, having watched the speculators literally get rich quick, the question for serious investors and for those who look after other people’s money is: should we buy bitcoin? Can the cryptocurrency now be considered a store of value, a “crypto asset”, and does it make sense to include it as part of a multi-asset portfolio?

The only sensible way to answer this question is to roll up the sleeves and do the kind of serious due diligence that we’d do before adding any new asset to a portfolio. But, spoiler alert, if you were looking for reassurance that you should be opening a digital wallet, filling it full of bitcoin and watching your wealth grow, this is going to be a disappointing read.

First of all, for those who were afraid to ask, what exactly is bitcoin? It’s a currency, invented in 2008 by unknown individuals using the pseudonym Satoshi Nakamoto. The idea was to create a peer-to-peer payment network that would allow transactions without the need to change currencies or involve banks or other payment processors – a sort of PayPal with its own currency. Every bitcoin transaction is verified by a digital ledger, a “Blockchain”, using cryptographic techniques. Owners of bitcoins are not identified personally, but all transactions are public on the Blockchain and identifiable via bitcoin addresses.

The network is maintained by incentivising “miners” to use computers to solve difficult, but ultimately trivial, problems. Whenever one is solved, a transaction is verified and a new block in the Blockchain is created. The miner gets newly-created bitcoin as a reward. The total number of bitcoins can never exceed 21 million. New bitcoins are created approximately every 10 minutes and the rate at which they are created halves every four years until all 21 million will have been created by around the year 2140.

So, why do we believe bitcoin is unlikely to become a major investable asset class for some time, or ever? First of all, and very importantly, the currency doesn’t help you to diversify as an investor. It is extremely volatile – value soars and plunges unpredictably, sometimes based on a tweet by Elon Musk – and its highs and lows closely correlate to the highs and lows on equity markets, particularly at times of stress. The point of multi-asset investing is to give you assets that will react differently from one another and protect your wealth in a variety of situations.

Another major negative is that bitcoin is extremely environmentally damaging, so much so that it has been described as “the coal-fired currency”. There are rooms full of computers all over the world, operating day and night to maintain the currency, verify transactions, and solve the complex equations needed to create more bitcoins. One blockchain payment is tens of thousands of times more energy-demanding than a Visa payment and bitcoin’s global carbon emission is roughly equivalent to that of a mid-sized country like Sweden.

Another problem is that the currency is currently entirely unregulated, but may not remain so for long. Governments do tolerate the anonymity provided by cash transactions, but it’s hard to believe that they will allow the world’s payment systems to be taken over by an anonymous medium of exchange that makes law enforcement and tax collection very difficult. There have been several high-profile cases of bitcoin being used for illegal transactions, to facilitate ransomware, and to finance terrorism. Plus, the anonymity promised by bitcoin can come at a high cost to users: anonymous wallets mean that hacks and scams to steal bitcoins are very hard to stop; unintended transfers are difficult to unwind; and lost coins are practically unrecoverable.

With national currencies and the modern banking system, we have a monetary system that acknowledges mistakes happen and theft occurs, so institutions and norms have been created to resolve these problems. And governments will step in when required. Bitcoin does not have any of these safety nets. Don’t expect regulators to sit idly by if they believe retail investors are being misled. They will not passively allow the global payment system to fall into the hands of unregulated entities, and they will certainly resist loss of control of the monetary system. So, the risk of regulatory action on bitcoin is high. Also, expect the world’s central banks to begin creating digital currencies of their own to combat the threat from crypto.

For these reasons, your pension provider is unlikely to offer a cryptocurrency investment choice any time soon. But that’s not to say there’s no value in buying or holding the currency right now, just realise that like the tulip traders of the 17th century, you’re speculating, not investing.

Luke Bartholomew, senior monetary economist at Aberdeen Standard Investments