Historically, the stock market has been the greatest wealth creator on the planet. Over the very long run, the market has returned about 7% annually (with dividends reinvested). But it's been even more impressive since the beginning of 1980. Including dividends, the average annual total return of the benchmark S&P 500 has been more than 10%.
Then Bitcoin (BTC -4.80%) came along a little over a decade ago. Since its debut, the world's largest cryptocurrency has run circles around the broader market indexes many times over. Just looking at the trailing five-year period, Bitcoin is higher by close to 13,800%.
Why is Bitcoin thriving? The perception of a fixed token count (21 million) is one reason investors are excited. The belief is that as the U.S. and global money supply increase, Bitcoin will increase in value since its token count is capped.
There's a growing utility argument surrounding Bitcoin, as well. A couple of companies (ahem, Tesla Motors) have begun adding Bitcoin to their balance sheets. Meanwhile, money managers and investment banks are coming around to the idea that portioning some funds for crypto may not be a bad idea.
A case can also be made that Bitcoin will revolutionize the way payments are made. With traditional banking networks, cross-border payments can take up to a week to be validated and settled. If these same transactions are conducted in Bitcoin and on its blockchain, the average settlement time is right around 10 minutes.
Previously, I've made no secret why I'm not a fan of Bitcoin, as well as why I won't be adding it to my portfolio. However, even with this inherent bias, I can understand why certain Bitcoin stocks might offer an attractive value proposition to investors.
This trio of Bitcoin stocks is bad news
At the same time, a handful of Bitcoin stocks stand out as truly awful investment opportunities, relative to just buying the digital currency itself or investing in a tracking fund like the Grayscale Bitcoin Trust. In my view, the following three Bitcoin stocks should be avoided like the plague.
Although it may have been the most anticipated initial public offering of the year, cryptocurrency trading platform and crypto ecosystem Coinbase Global (COIN -2.79%) is first up in the avoid column.
As you can imagine, euphoria surrounding crypto is at or near an all-time high. Bitcoin recently neared $65,000, and meme-based digital-currency Dogecoin rocketed higher by more than 400% in a week. Young investors who crave volatility and the get-rich-quick mentality are having a field day with cryptocurrencies -- and Coinbase's quarterly results show it. The roughly $1.8 billion in revenue that Coinbase generated in the first quarter of 2021 is more than the company brought in during the previous two full years combined.
Unfortunately, this is an operating model that's highly dependent on investors' emotions and the popularity of Bitcoin and Ethereum, which make up the bulk of the platform's revenue. If the price of these two popular digital currencies isn't rising, we've historically seen trading interest drop off significantly. In fact, Coinbase's revenue between 2017 and 2019 was nearly halved as Bitcoin lost around 80% of its value. With volatility a precedent in the crypto space, Coinbase's revenue could be susceptible to wild swings.
Another obvious concern is that other digital-currency brokerages could undercut Coinbase's trading fees. Though Coinbase has 56 million verified users as of the end of March, we watched the same price wars unfold with traditional Wall Street brokerages over the years.
Long story short, Coinbase appears grossly overvalued for the services it provides, which is what makes it one of the most dangerous Bitcoin stocks.
Enterprise intelligence software-solutions provider MicroStrategy (MSTR -3.45%) is another extremely dangerous Bitcoin stock that would be best avoided.
The lure for investors has been the conviction of CEO Michael Saylor in Bitcoin. Taking into account the $1.03 billion investment MicroStrategy made into Bitcoin in February 2021, Saylor's company is now holding 90,531 Bitcoins on its balance sheet at an average cost basis of $23,985 per token. Put another way, MicroStrategy's $2.17 billion investment in Bitcoin is now worth nearly $5.1 billion. That's a hefty return investors have come to appreciate.
However, it makes no sense at all for investors to buy into an enterprise software company that's being treated as a Bitcoin tracking company when investors could more accurately track the movement of Bitcoin by purchasing it directly or buying a tracking fund. Furthermore, MicroStrategy is in the midst of a six-year sales decline.
Even though the company has been profitable on an adjusted basis, paying almost $1.7 billion above and beyond the value of the company's digital assets for a business that's been in constant decline for over a half-decade doesn't seem prudent. It's also a bit unnerving that Saylor has spent his time promoting Bitcoin on social media, rather than figuring out how to turn around his company's stagnant enterprise intelligence segment.
But the most egregious thing of all might be that MicroStrategy has taken out more than $1.6 billion in convertible debt to raise the cash necessary to buy its Bitcoin. It's one thing to use excess cash on a company's balance sheet to buy Bitcoin; it's an entirely different story when a company is burying itself in debt to buy a highly volatile digital asset.
The third and final Bitcoin stock to avoid like the plague is cryptocurrency miner Riot Blockchain (RIOT -5.46%).
Cryptocurrency miners are people or businesses that use high-powered computers to solve complex mathematical equations that validate groups of transactions, known as a block, on proof-of-stake networks. For being the first to validate a block as true, a block reward is paid. Riot specifically targets Bitcoin, which pays out a block reward of 6.25 tokens (worth around $350,000). Thus, the lure of Riot Blockchain is that it'll generate juicier rewards if the price of Bitcoin keeps climbing.
On the other hand, there are big-time issues with investing in crypto miners like Riot. For starters, there's virtually no barrier to entry. Any business with sufficient capital can purchase the equipment needed to mine Bitcoin. This suggests competition is only going to increase if the price of Bitcoin keeps heading higher.
Another concern that can't be overlooked is that the block reward for Bitcoin halves every couple of years. Instead of increased returns over time, Riot Blockchain is fighting with more and more businesses for a piece of an increasingly smaller pie.
Plus, it's not even clear if cryptocurrency miners like Riot Blockchain can survive over the long run. Bitcoin had three separate drawdowns of at least 80% over the past decade, and Riot Blockchain is essentially devoid of innovation and wholly reliant on Bitcoin to head higher. If you want Bitcoin exposure, Riot Blockchain isn't the way to do it.