For as long as investors can recall, the stock market has been the greatest creator of wealth. Historically, the stock market has returned 7% a year, inclusive of dividend reinvestment and adjusted for inflation. But recently, that notion has been turned on its head thanks to the emergence of cryptocurrencies like bitcoin.
Since the year began, bitcoin has rallied by more than 880%, with coins of the most popular virtual currency touching a record high of $9,496 during the afternoon of Nov. 26, 2017. That's right -- an 880% gain in less than 11 months. Amazingly, bitcoin is actually underperforming its peers in 2017, with the aggregate cryptocurrency market cap soaring from $17.7 billion to begin the year to $293 billion as of the afternoon of Nov. 26. That's a return of more than 1,550%, which has taken the broad-based S&P 500 decades to accomplish.
The story behind bitcoin's incredible run
Bitcoin, which makes up about $155 billion of the $293 billion in aggregate market cap, has been rallying because of a confluence of factors.
To begin with, investors are excited about the potential offered by blockchain, the underlying technology of most virtual currencies. Blockchain is the digital and decentralized ledger that records transactions without the need for a financial intermediary like a bank. And because they're usually open source, altering that logged data without having someone else find out is almost impossible. This allows blockchain to be especially safe yet incredibly efficient.
Bitcoin has also benefited from weakness in the U.S. dollar. Investors with cash on the sidelines had typically sought the safety of gold in years past, since gold is a finite resource. In other words, the gold that's been mined and is still buried underground is all we're ever going to have on this planet. Investors have viewed bitcoin in much the same way, given that protocols limit the number of coins that can be mined to 21 million.
There's also excitement surrounding bitcoin's payment potential. Japan OK'd bitcoin as legal tender earlier this year, the CME Group recently announced the imminent listing of bitcoin futures, and payment processor Square is letting some users of its money transfer app Cash buy and sell bitcoin with a swipe of their finger.
Three dangerous bitcoin stocks
Nonetheless, bitcoin still bears quite a few risks, and so do the stocks investors can buy that are, to some degree, tethered to bitcoin. While all three of the following stocks have handily outperformed the market this year, they look downright dangerous to this writer.
Bitcoin Investment Trust
There isn't an equity with a stronger correlation to the price of bitcoin than the Bitcoin Investment Trust (GBTC -0.81%). Operated by Grayscale, the Bitcoin Investment Trust owns a relatively fixed amount of bitcoin, meaning it's incredibly easy for investors to calculate the net asset value of these holdings. As of the end of October, approximately 172,144 bitcoins were being held, which at the recent record price of $9,496 works out to $1.63 billion.
However, the Bitcoin Investment Trust ended with a market cap of $1.84 billion this past Friday, Nov. 24. Mind you, this was before bitcoin gained around 15% over the weekend. As of Friday's close, the Bitcoin Investment Trust was valued at a 30% premium to its owned bitcoin assets. It has consistently been priced at a 25% to 125% premium to its owned assets, which really doesn't make much sense. Yes, there's the potential for added liquidity via brokerage trading, and yes, you can "own" bitcoin without having to purchase it through a decentralized cryptocurrency exchange this way, but the premium simply isn't justified. I'd suggest keeping your distance.
First Bitcoin Capital Corp.
If my arm were twisted and I were forced to choose the most dangerous bitcoin stock, it'd be First Bitcoin Capital Corp. (BITCF 100.00%), which has seen its shares increase in value by 2,650% over the trailing year.
First Bitcoin Capital's profile suggests that it develops digital currencies and novel blockchain technology and operates digital currency exchanges. But if that's the case, it has virtually nothing to show for it so far. During the second quarter, the company managed just $22,763 in sales and generated just $7,333 in gross profit over expenses. Hardly worthwhile for a company that once commanded nearly a $1 billion market cap a few months prior. It's also worth noting that the cryptocurrencies it has brought to market hardly have any volume over the previous 24-hour period, suggesting there's little interest among investors.
What's more, it has almost nothing in the way of assets that can be monetized. It has $360,000 in mineral rights in Venezuela from when it was involved in the gold industry, before 2014, and carried just $5,887 in cash as of the end of the second quarter.
As far as I can tell, this is a company that's benefited solely from having "bitcoin" in its company name and as such should be avoided.
A third bitcoin stock you'd probably be best leaving for short-term traders and speculators is Overstock.com (OSTK -2.60%). Though Overstock has an online retail business that's been its bread and butter since its inception, the company has made waves by being the first to accept all major forms of digital currency, including bitcoin, Ethereum, bitcoin cash, LiteCoin, Monero, and Dash. It's also developing the Medici t0 blockchain, which is a blockchain-based securities lending system designed to take on Wall Street.
While Overstock's acceptance of virtual currencies has made it a Wall Street darling among crypto-enthusiasts, it really hasn't done anything for the company's top- or bottom-line results. During its recently reported third quarter, Overstock still wound up losing money (albeit $0.09 per share less than the year-ago period), and its net sales dropped by 4% to $424 million. In fact, the company's work on the Medici t0 blockchain wound up resulting in a $1.9 million loss. Had it not been working on this blockchain, its retail business would have netted the company a $1.1 million quarterly profit.
It's unclear just how quickly blockchain technology will be adopted by big businesses, especially considering how competitive the landscape has become. As such, I believe it'd be wise to keep your distance from Overstock.com.