Cryptocurrencies, NFTs, Meme Stocks and the Dangers of the “Next Big Thing”
By Andrew Harvey, AIF®, CPFA™
FOMO (Fear of Missing Out) was a driving force in marketing and investing long before it was acronymized. The message is a simple one, especially in the investing world: “Look at how well this worked out for this other person who jumped in early! You don’t want to be the only one to miss out on that, do you?” Just like the wave of fraud and manipulation in the early 20th century that led to the regulation of the financial and banking industries, we now live in the age of digital fraud, investment scams, and weaponized FOMO designed to part hopeful investors from their money. A century after the Roaring Twenties, the old classic scams are still going strong in the digital age. As an investor, you should always be extremely wary of anything that bills itself as “the next big thing.”
Much hullabaloo is made about the decisions of the “rational investor,” and how they can perfectly assess the market and the fair value of any asset free from the influence of any emotion or irrational behavior. When you find them, please let me know. I am eager to become their client. At Opus, we think it is much more achievable (and better for everyone’s sanity) to strive to be reasonable investors – meaning “at the time we make any decision, does that decision seem reasonable based on all the available information and doing our best to account for cognitive and emotional biases?” There is a great deal of fence-sitting surrounding crypto and NFTs (and a great deal less surrounding meme stocks) in the world of financial punditry, I imagine out of a fear of later looking foolish if they fulfill all the wild promises that their respective communities make to their users. At Opus 111 Group, though, we adhere to a simple creed that our clients want us to tell them the truth, even when they don’t want to hear it.
This is the truth: nothing about the current state of most digital assets, including cryptocurrencies, NFTs, or so-called “meme-stocks” pursuing a “short squeeze” makes them worth the risk of their inherent volatility or lack of investor protections. The likelihood of fraud, use for other criminal affairs, and lack of transparency means that our advice on these things can best be summed up by three words: “steer well clear.”
Our concerns around cryptocurrencies chiefly revolve around the lack of regulation, transparency, and investor protections. Jim and I discussed this on the firm’s weekly radio show “Money Management” in December of last year (you can find the archived show on this playlist) following the collapse of crypto exchange FTX and the indictment of its founder, Sam Bankman-Fried on a laundry list of charges including wire fraud, money laundering, securities fraud, and conspiracy. Another popular exchange, Coinbase, recently received a Wells Notice from the Securities and Exchange Commission (SEC) – signaling that the regulator will soon bring an enforcement action against the exchange. An article from the Wall Street Journal in 2013 found that, in a two-year period, 80% of recipients of a Wells Notice were later charged with violation of securities-related laws.
These examples were two of the most visible in the crypto industry. They went to great lengths to market themselves as legitimate business enterprises. Coinbase aired an ad during the Super Bowl in 2022. FTX had sponsorship deals with Major League Baseball, Formula 1, and the naming rights to the Miami Heat’s arena. If these are the “legitimate” actors in crypto, what about the rest of them? In a world where potentially up to 80% of all bitcoin trades are fraudulent wash trades, it is impossible to see cryptocurrencies as a viable investment opportunity.
A further issue with cryptocurrencies is that their proponents seem to want them to be considered securities or currency, whichever is more favorable at the time. The inherent volatility in cryptocurrencies makes them unsuitable for use as a currency (even so-called “stablecoins” are not exempt from these fluctuations, though they tend to be smaller in magnitude). Meanwhile, the lack of regulation and investor protections around them make them unsuitable as an investment. What’s more, there is still no convincing evidence that an investment in a cryptocurrency conveys meaningful ownership of anything at all, let alone anything of value. Does blockchain technology have interesting hypothetical uses in maintaining the security of user information without the need for a central repository? Yes, but currently there is also an issue with “wrong-address” incidents, where in the event of a mistaken transaction the sender of funds is wholly reliant on the goodwill of the recipient to return the errant money. In the financial world, regulators and central agencies play an important role in interceding on behalf of customers and investors when mistakes do occur. For these reasons, I do not envision a world where cryptocurrency will play a role in our client’s portfolios.
Non-Fungible Tokens (NFTs)
At its base level, a NFT is a digital identifier recorded on a blockchain that is used to certify ownership and authenticity. NFTs have been created for everything from digital art to tradeable NBA highlights. Currently, NFTs appear to be a solution in want of a problem. While the concept of a digital contract may be interesting for works of digital art and for creators, it still means that NFTs at best have little more meaning than as collectibles. Crazes around collectibles are nothing new. You may recall the swarm of activity surrounding Beanie Babies in the 1990s as a somewhat recent example. As speculators so often discover where collectibles are concerned, they are only as valuable as what someone is willing to pay for them. A bubble bursting can seriously erode the value of your initial purchase and—while I am certainly not at the forefront of the artistic community and the value of digital art—I do question whether an electronic image is worth $69 million. Collectibles are already considered an unsuitable investment for retirement plans. While I don’t mind the purchase of collectibles for sentimental reasons, I also would caution people against investing in any collectible with the aim of a large future capital return.
Wash trading is also a significant issue with NFTs. A wash trade is the simultaneous purchase and sale of the same financial instruments, creating the appearance of market activity without meaningfully exchanging money. For example, let’s say I minted an NFT of my headshot of the Opus website (and why not? It’s a pretty decent photo of me) and assigned its ownership to an account I own (Account A). Next, I “purchase” that NFT for $25,000 from a separate account I own (Account B). For the minor cost of whatever platform fees I incurred, I have now created an apparent demand for an image of my face for a tremendous amount of money. This can position me to sell the NFT from Account B to an unsuspecting outside party who is looking to speculate on the value of NFTs for a windfall profit, since my cost basis in setting up this scheme was essentially zero.
This last segment differs significantly from the previous two. Mercifully, it has nothing to do with blockchain, cold storage wallets, or photos of my face. Instead, meme stocks are equities that trade on regular indices like the NYSE or NASDAQ that, for one reason or another, develop a cult following with retail investors. Those investors often congregate on social media to discuss their investments and encourage others to invest in the product as well. The most recent high-profile example of this is with home goods retailer Bed Bath and Beyond (NASDAQ: BBBY), which recently filed for Chapter 11 bankruptcy protection as it continues to axe stores and jobs. Consequently, BBBY’s share price has dropped over 99% in the past 12 months. Certain online forums, however, were until very recently full of hopeful investors who thought that any number of particular scenarios (including an angel investor, a merger/acquisition, or a potential “short-squeeze” that would induce a massive buying demand from short-sellers looking to close their positions) might send the stock price skyrocketing. Now that that increase has failed to materialize and the stock is in the process of being delisted, those investors as common stockholders are the last in order of debt seniority in bankruptcy proceedings, meaning many of those investors will never recoup their initial investment.
People making bad stock picks is nothing new. The danger of meme stocks is much more than just making a bad investment selection, however. The real danger around meme stocks are the communities that can shut out dissenting voices, creating an echo chamber where the desired outcome seems certain. This can cause people to over-allocate their portfolio into an investment without fully considering its risks or fundamentals. Worse, they may even decide to leverage themselves to get even more money in play before “the big payout.” Concentrating too much of your portfolio, let alone your hopes for your financial future, on one single investment is seldom a good idea. It is always critical to consider the potential downsides and risks of any investment before you put your money in. It is even more important to try and continue to remain critical so that you know when to walk away from a bad investment.
The Next Big Thing
It’s impossible to say what the “Next Big Thing” in investing is going to be. People love hearing about longshots because they have the highest payoffs. People also tend to forget that that’s because they so rarely actually pay off. In any gold rush, there’s always a stampede of people looking to strike it rich. History remembers the handful who do because they are celebrated, but too often the many who leave empty-handed are consigned to the dustbin of history.
We firmly believe that the road to true wealth lies in building a habit of investing for the long-term in a well-diversified portfolio. Operating by that philosophy may dampen the potential to brag at a cocktail party, but it also means incurring significantly less risk to your portfolio. By working closely with your advisor and having realistic conversations about your risk tolerance and what strategies are appropriate for you, you can not only build a portfolio designed for success over the long term, but reduce the stress you experience on the road from point A to point B.
Andrew Harvey, AIF®, CPFA™ is a Financial Advisor at Seattle-based Opus 111 Group. He created Opus 111 Group’s SYFI (Secure Your Financial Independence) Program for young investors in 2022 and works in Opus’ Retirement Plan Consulting division. In his spare time, he plays the Irish sports of hurling and Gaelic football for USGAA side Tacoma Rangers. Andrew lives in Kent, Washington with his wife Lauren and their cat, Bella.
This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.
Diversification does not assure a profit or protect against loss in declining markets, and diversification cannot guarantee that any objective or goal will be achieved.