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Conceptual Foundations of Investing

Looking Back at Bitcoin

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Benjamin Graham once said, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”  That statement is a little hard to interpret.  The market is only open now, in the short run.  The way we interpret Graham is to say although investors may be swayed by emotion and folly in the short run, particularly if information is nebulous, as things become clear the market eventually gets it right.  The trick to being an intelligent investor, according to Graham, is to realize now what the market will only come to appreciate later.  That is to invest based on wise assessments of fundamental value.

That brings us to Bitcoin.  In our book, The Conceptual Foundations of Investing, we discussed bubbles.  We argued that bubble can arise when enough investors buy an asset because the price has risen in the past and, as a result, they believe the will be able to sell it for even more to someone else in the future.  If enough participants employ this strategy, it can become a self-fulfilling prophecy and prices can rise without a fundamental reason for the increase.

In our book, we offered Bitcoin as a modern-day example.  We warned that we could see little fundamental value for Bitcoin as either an investment or a medium of exchange.   We said, “The problem is that if the main source of demand is the general expectation of higher future prices, as soon as prices stop rising, demand evaporates.  With few, if any buyers willing to purchase on the basis of the security’s fundamental value, prices collapse. We suspect this will happen to Bitcoin” (page 123).

At the time of our writing, Bitcoin’s price had been skyrocketing and it was trading at over $15,000.  Not surprisingly, it was the focus of a vast amount of attention in the financial media.  Now Bitcoin is in the headlines again, but for the opposite reason.  As shown in the chart below, its price has fallen from nearly $20,000 to less than $4,000.  We suspect it will fall further still.  As Benjamin Graham stressed, in the long run the market will get it right and prices will converge to fundamental value.