When Tesla said it would purchase $1.5 billion worth of bitcoin and accept it as payment for its vehicles in February, the news helped send the value of the digital currency above $50,000, after it had stood under $500 only five years earlier.
That meteoric rise has expanded to other cryptocurrencies like ether and dogecoin. Now, investors in Northern Michigan are starting to ask their financial advisers about digital currencies amid growing acceptance among mainstream investment firms and companies.
Unlike cash, bitcoin and the other players in cryptocurrency have no physical existence, according to Naveen Khanna, the A.J. Pasant chair in finance at the Broad College of Business at Michigan State University.
“They only exist in the internet as a digital currency,” he said.
A cryptocurrency is a digital currency that can be used to pay for goods and services. Cryptocurrencies work using a technology known as blockchain which keeps records on digital transactions.
Perhaps the most common question concerning bitcoin and its siblings is, how is the value determined?
“That’s the big mystery,” said Khanna. “The reason is there is not a lot of transparency to these markets and that is the whole idea behind it. They are not controlled by a central authority.”
Robert Dittmar,a professor of finance at the Ross School of Business at the University of Michigan, noted bitcoin’s value is driven by different factors than some more traditional assets.
“When we usually think about the value of a financial asset, it is because it can be tied to something tangible that you get benefit from. For example, a stock’s value is (in theory) based on future cash flows that a stockholder has a claim to. A bond’s value is based on the value of the future coupon and principal payments,” he said.
“Assets like crypto don’t fall neatly into this definition,” Dittmar continued.
Neither do precious metals, and Dittmar believes it may be useful to consider the value of bitcoin in the same vein as the value of gold and silver.
“Cryptos such as bitcoin are really similar to this. Bitcoin was created with a finite amount to be mined, just like gold, so that the value of the currency couldn’t be debased simply by producing more. It was also created with the intention of being decentralized so that there was not an entity like the U.S. Treasury or Federal Reserve that could control its supply. I see crypto, like gold, in the following way. When buying crypto, you are taking a bet on the value of crypto being worth more in the future,” said Dittmar.
There is no official regulation for cryptocurrencies.
“That’s the whole idea behind it,” Khanna said. “It is supposed to be a self-enforcing system.”
Dittmar also noted the distinction.
“Bitcoin in particular was created with very libertarian ideals, and I suspect particularly averse to any regulation or control,” he said. “The biggest question has been as to what these instruments represent, and therefore under whose purview (do) they fall for regulation. Are they a security, and therefore subject to Securities and Exchange Commision regulation? Or a commodity, and therefore possibly to the Commodity Futures Trading Commission?”
There is very little transparency regarding ownership, said Khanna.
“You don’t know who is holding the coin or who is moving the market and how much liquidity there is in a particular market,” he said.
Despite Tesla and other companies saying they accept crypto for payment, Dittmar said it doesn’t function as a currency very well right now.
“As of (May 4), bitcoin is trading at $54,366.20. That fact that we quote bitcoin’s price in dollars is really telling to me. It means that people want bitcoin right now more for what it can buy them in dollars. If I convert my bitcoin to dollars, I can walk into my grocery store and buy a loaf of bread. If I present them with evidence that I own bitcoin, they won’t sell me the loaf of bread. So as of yet, it is not a readily accepted medium of exchange,” he said.
Philip Hofweber of the Edward Jones financial advising office in Gaylord said some of his clients have asked about cryptocurrencies. In a company research note he provided, Edward Jones said it believes cryptocurrencies are highly speculative.
“Edward Jones does not offer a way to purchase or hold cryptocurrencies, or futures contracts on cryptocurrencies. Edward Jones does not offer a way to purchase cryptocurrency-related funds, ETFs (exchange-traded funds) or ETNs (exchange-traded notes) that own cryptocurrencies directly,” the company stated.
Shaun Osborne, a financial advisor with Ameriprise Financial Services in Petoskey, said clients have been asking if they should invest in a digital cryptocurrency.
“Unfortunately at this time, we don’t have any advice one way or the other. Cryptocurrency is still very new and is still unregulated. We are unable to make any recommendations to clients at this time,” he said.
Osborne said Ameriprise does not offer any investment products related to cryptocurrencies.
“Cryptocurrency is not yet regulated and most investment firms do not offer a way to invest in digital cryptocurrency,” he said.
As for MSU’s Khanna, “I am very leery of it because I don’t know who is involved,” he said.