Aswath Damodaran, professor of finance at Stern Business School, New York University, and legendary investment guru, recently penned down an analysis of bitcoin. Damodaran writes that bitcoin should not be viewed as a cash-generating asset but as a currency. Once you accept this view, he argues, you cannot ‘invest’ in bitcoin but you can ‘trade’ it.

Damodaran writes: “Unlike its biggest cheerleaders, I don’t believe that crypto currencies are now or ever will be an asset class or that these currencies can change fundamental truths about risk, investing and management. The reason for the divide, though, is that the two sides seem to disagree fundamentally on what bitcoin is, and at  the risk of raising hackles all the way around, I will argue that bitcoin is not an asset, but a currency, and as such, you cannot value it or invest in it. You can only price it and trade it.”

What is an asset?

An asset is something that generates a series of cash flows. A bond generates interest payment and a stock generates dividends. A currency, on the other hand, generates nothing. That doesn’t mean that you can’t make money from buying currencies. But you should not invest in it using the same parameters that you would use for an asset.

Prof Aswath Damodaran

Why bitcoin is not an asset

Bitcoin is a cryptocurrency. It does not generate any cash flows. It is also unlike commodities such as oil or metal because it cannot be used for anything or consumed in any manner.

Although currencies generate no cash flows they can rise against other currencies if

  1. They become widely accepted and
  2. Are seen to retain their purchasing power better than other currencies.

Is bitcoin a currency?

Bitcoin can be used for the two primary purposes that currencies are used for. First, as a medium of exchange and second as a store of value. You can settle transactions (although very few at present) in bitcoin and you can hold it to maintain or increase your purchasing power.

But, Damodaran writes, “In the long term, the price that you attach to bitcoin will depend on how well it will perform as a currency. If it is accepted widely as a medium of exchange and is stable enough to be a store of value, it should command a high price. If it becomes gold-like, a fringe currency that investors flee to during crises, its price will be lower. Worse, if it is a transient currency that loses all purchasing power, as it is replaced by something new and different, it will crash and burn.”

Gold, according to Prof Damodaran, is also a currency. Similarly, the Dollar or Swiss Franc can be used to generate wealth if they rise against the currency you are shifting from (eg: the rupee), over time. In the short term, however, currencies are more influenced by the actions of governments and central banks.

Since currencies have no intrinsic value, you cannot ‘invest’ in them. But you can trade them. Thus a ‘buy’ argument will rest on it gaining much wider acceptance in the future or acting as a good store of value (like gold) or both.

He writes: “To be a successful trader in bitcoin, you need to recognise that moves in its price will have little do with fundamentals, everything to do with mood and momentum and big price shifts can happen on incremental information.”

So should you trade in bitcoin? He concludes: “If you have good trading instincts, you should play the pricing game, as long as you recognize that it is a game, where you can win millions or lose millions, based upon your calls on momentum. If you win millions, I wish you the best! If you lose millions, please don’t let paranoia lead you to blame the establishment, banks and governments for why you lost. Come easy, go easy!”

To read Damodaran’s full article, click here.

Author
Staff Writer

This article is written by RupeeIQ editorial staff.