The Bitcoin hype train is back! Bitcoin halving, Bitcoin ETF approval and the prospect of lower interest rates have put Bitcoin back at the center of attention.
But before jumping on the bandwagon, it’s worth asking – is bitcoin is a productive or speculative asset?
Productive assets are able to generate income for the owner such that we don’t mind holding the asset forever. Speculative assets can’t.
To profit from speculative assets, investors need to find a buyer who will purchase the asset at a higher price, which is known as the “greater fool theory”.
The greater fool theory suggests that we can make money as long as someone else comes along and buys the asset for a higher price despite the asset producing no income to the owner.
This may be profitable for a while, but relying on this method of making money is pure speculation and the party will end when the world runs out of “greater fools”.
With this in mind, let’s see what assets are productive and what are just speculative assets.
Bitcoin
Bitcoin does not produce income for the owner and hence the owner of the Bitcoin can only make a profit by selling it to someone else at a higher price.
By definition, this is relying on the greater fool theory and is speculation.
I judge an asset by whether you will be willing to hold on to an asset forever. In the case of Bitcoin, holding on to it does you no good and you can only profit if you sell it.
Bitcoin is a clear case of a speculative asset.
Art
I’ve heard people comment that Bitcoin holds value because of its scarcity and hence is akin to rare art which can also appreciate in price.
But the fact is art is a speculative asset too. Art yields no income for the owner of the asset and the owner relies on selling the art piece at a higher price to make money.
Similar to Bitcoin, art does not generate income so holding the piece of art forever does not generate any returns. Most art are speculative assets.
However, occasionally, rare art may bring some form of cash flow to the owner if the art piece can be rented to a display centre or museum. If that’s the case, then rare art pieces can be considered an investment that generates income.
At least for art, the artwork can be considered a beautiful asset which some people appreciate and may pay to see or buy as a decorative ornament.
Real estate
Real estate generates income for the owner in the form of rental income. Rental provides real estate owners with income that eventually offsets the amount paid for the asset.
Real estate investors don’t need to sell the property to realise an investment gain. Rent out the asset long enough and they’ve made enough rental income to offset the property price.
Real estate is clearly a productive asset.
Stocks
Owning stock of a company is having a part ownership of the business. It entitles you to a share of the profits through dividends.
As such, stock investors do not need to rely on price performance but can earn a good return simply by collecting dividends paid from profits of the company.
However, we cannot paint all stocks with the same brush.
There are occasionally stocks that trade at such high valuations that people who buy in at that price will never make back their money from dividends. The only way to profit is by selling it to a “greater fool” at a higher price.
These stocks that fall into this category hence move into the “speculative asset” category.
Bonds
Bonds are a “loan” that you make to a company or government body. In exchange, the “borrower” will pay you interest plus return the full loan amount at the end of the “loan period”.
Bonds provide the investor with a regular income stream and the investor can also get the principle back at the maturity date assuming no default.
Given the predictable income stream, bonds are a productive asset that produce cash flows to the investor.
Stock derivatives
Stock derivatives are financial assets that derive their value from stock prices. These can be options, futures, warrants etc.
Derivatives such as options can provide the investor with the option to purchase a stock at a particular price before a given date.
However, as stock derivatives have a predetermined expiry date, they are highly dependent on relatively short term stock prices and hence is a speculative asset.
The difference between stocks and stock derivatives is that a stock pays you dividends whereas a derivative does not. On top of that, the derivative has an expiry date which means owners of derivatives rely on short term price movements of the stock to make a profit.
The Bottom line
Don’t get me wrong. I’m not saying investing in Bitcoin, art or derivatives cannot be profitable. In fact, investing in speculative assets has made some people very wealthy. That’s because speculative assets can keep appreciating due to the sheer number of people who believe in them.
For instance, the narrative around bitcoin and the amount of money flowing into cryptocurrencies at the moment have caused bitcoin price to rise substantially in the last decade or so, minting billionaires in the process.
But while it can be profitable, speculation is a difficult game to play and depends on the narrative surrounding the asset. In addition, since the asset is not backed by cash flows, the price can come crashing down and owners are left holding a “non-productive” asset that produces no cash flows.
Personally, this is a game I rather not play. I prefer to invest in productive assets that can produce cash flows to the owner so that I don’t have to rely on narratives or a “greater fool” to profit.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I do not currently have a vested interest in any stocks mentioned. Holdings are subject to change at any time.