Fourth Quarter Letter of 2017

We hope you enjoyed your holiday season and wish you a very happy new year.  Most likely you spent time over the holidays gathering with friends and family to celebrate the season.  And almost certainly there was a topic that came up at these gatherings at least once for everybody.  That topic is Bitcoin.  The first and largest of the so called “Crypto currencies” and the number one buzz word of late.  The reason for its popularity is its 1,403% increase in value during 2017 when it shot from $952 to $14,310.  Those that had purchased some bitcoin were able to boast of their gains.  But, those who left the party excited about this new opportunity and went home to buy some in mid-December may not be so happy with its 23% drop in the last two weeks of the year.  Let’s get a little deeper into what’s going on here.

Bitcoin is built on a new network technology platform known as blockchain.  Blockchain is a distributed database or “distributed ledger” as it is technically referred to.  The technology holds transactional data recorded across many devices in a manner that allows all parties of a transaction to access it and trust that its history has not been altered.  This is all done without an intermediary, on a peer-to-peer basis.  Blockchain technology can reduce transaction time and costs by eliminating intermediaries and increases the integrity of critical data.  This open technology has all the players, large and small, scrambling to develop it further and deploy it where its utilization may increase profitability for enterprises.  Financial institutions have been the most interested for the time being.

Bitcoin, created in 2009, is a digital “crypto” currency that can be bought and sold online for other currencies around the world.  Though it was the first application of this new blockchain technology, it is important to understand that buying bitcoin is not buying blockchain technology; it has no underlying asset, value, nor guarantee.  Bitcoin is a speculative currency that’s value is only driven by what the next buyer is willing to pay for it.  If all parties wanted to cash out back to dollars or other hard currencies at this point, they would receive pennies on the dollar, if anything.  Crypto currencies are the new alchemy.  New crypto currencies are being created frequently now.  The founder of another crypto currency in 2011, litecoin, sold his entire holdings in December fulfilling his alchemist’s dream of creating riches from nothing.

While crypto currencies’ futures are uncertain, the technology underlying them has the potential to be transformational.  Think of the internet as the new technology twenty years ago and Yahoo! as one of the first major applications.  While Yahoo! may come or go (see chart below), the underlying technology that made it possible was here to stay and has transformed our economy over time.  Blockchain has the potential to do the same, but that cannot be bought.  Bitcoin is not blockchain.  The value of blockchain will be derived by firms who can unlock its potential and innovate new applications for it.  That is what intrigues us.  As for bitcoin, it is pure speculation.  History can teach us a lesson if we look back to the fairly recent bubble, when internet stock prices soared to ridiculous levels with no justification for their valuations.  They had little or no revenue, let alone profits, but they were the new buzz of the time, triggering the snowball effect of higher prices begetting higher prices by attracting buyers with the hopes of quick and easy profits.  Just think back to 1999 when dot.coms were the talk of the party and taxi drivers and barbers were giving you their stock tips, or 2007 when real estate was the hot topic at parties and everybody was a landlord or a house flipper.  When a market reaches such exuberance, as it seems to have with the cryptos, it is time for the buyer to beware!


The Team at Reilly Financial Advisors




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