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A cryptocurrency is a digital or virtual currency that can be used as an alternative form of payment. Bitcoin and Ether are two examples. Cryptocurrencies use blockchains (a shared online database or ledger) with complex cryptography to process and secure transactions. Traditional currencies rely on intermediaries and central regulatory bodies to work. By contrast, cryptocurrencies are decentralized and are theoretically resilient to centralized management or interference.

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Episode 17: Why cryptocurrencies like Bitcoin don’t fit in our investment philosophy Focusing on long-term investment themes like the metaverse NFTs

[Michael 00:00] Bitcoin, Ether and other cryptocurrencies have gained in popularity. Here's a crash course in the basics. To start, what is a cryptocurrency?

[Alex 00:12] Yeah, the million-dollar question. At its surface, cryptocurrency is essentially a digital or virtual currency, an alternative form of payment. You more or less can convert Canadian dollars and most other fiat currencies to crypto and back. Rather than relying on the existing financial infrastructure to process and secure transactions, cryptocurrencies use blockchains — a fancy word for a shared online database or ledger with complex cryptography, giving them the name cryptocurrencies. Traditional currencies, we either rely on the physical exchange of money, or to do it digitally, we rely on the financial institutions and their computers and their databases. This requires users to put their trust in the government issuing the fiat currency and the financial institutions. In contrast, it is the defining feature of cryptocurrencies that they are generally considered decentralized, or that they're not reliant on a central authority to work.

[Michael 01:02] Which makes them theoretically resilient to centralized management or interference. Cryptocurrency supporters argue that this is desirable because it removes the middlemen between you and your money. They're independent of central banks. You're not reliant on financial institutions, no one else has total control over your money and total transaction transparency. As of recording this, Bitcoin and Ether are the two largest cryptocurrencies. So, what about crypto has captured the mind of so many people?

[Alex 01:35] Yeah, that's a good question Mike. I think it's just because the word is out there. And the news is almost always a spectacle, good or bad, right? What I'd say is, you know, the meteoric rise of crypto is really what's captured the imagination and the attention of so many people and investors, you know, with the extreme volatility comes extreme stories of big losses and big gains. So Bitcoin, for example, went from US$10,000 in the summer of 2020, up to $60,000 in the spring of 2021, back down to US$30,000 by the summer of 2021, rebounding back up to $65,000 in the fall of 2021, and dropped below US$20,000 in the summer of 2022.

[Michael 02:09] Wow. There's also crypto’s fair share of quirky stories. We've all heard the story of the fellow that purchased two pizzas for 10,000 Bitcoin in 2010. Those were some pretty expensive pizzas. Or the other fellow who accidentally threw out a hard drive with 7,500 Bitcoin in 2013, who is currently trying to dig up the landfill to find it. All this attention has led to more adoption and increased access. More brokerages, exchanges, etc., which has led to further news and headlines, massive IPOs, regulation, bankruptcies, and more. Why haven't cryptocurrencies entered traditional investment management strategies yet?

[Alex 02:53] Well, Mike, I think there's really two main reasons. The first being that, you know, investors buy cryptocurrencies in hopes of price appreciation, much like when we buy stocks. But traditional ways of evaluating companies to determine if the stock is a good buy or not don't exactly translate to cryptocurrencies. So, for example, when we look at a company before deciding if we want to invest in it, we look at a variety of things like the product or service they provide, how they produce it, how they sell it, the competitive landscape, how the consumer is responding, macroeconomic conditions, you know, without all this information, it really is just speculative buying, right? So how do you evaluate cryptocurrency to make an investment decision? You know, Warren Buffett has famously said that crypto doesn't produce anything and that it, as an asset, really doesn't provide any unique value.

[Michael 03:40] It's a good point. The second reason is that cryptocurrency has been too volatile over its short existence. The volatility demonstrated is a pretty likely indicator that there is a lot of speculation happening. And traditional investment strategies are about repeatable processes to create successful outcomes. And it's just too difficult to do that with so many unknowns. With that, some of the technologies behind crypto are likely showing up in traditional investment portfolios. Blockchain tech, for example, is being looked at by many companies as a valuable way to store information and a new way to secure and create trust in different transaction scenarios, not just cryptocurrencies.