Bitcoin - Are Cryptocurrencies a Smart Investment?Investing Insights
Bitcoin is garnering significant attention for many reasons:
- Bitcoin has unique features that are enabled by technology
- Bitcoin and other cryptocurrencies are perceived to be the "next big thing"
- For many of the investing populace who feel inflation is a risk, cryptocurrencies like Bitcoin are a novel alternative to traditional inflation hedges
What is Bitcoin?
Cryptocurrencies like Bitcoin have been described as a decentralized, peer-to-peer virtual currency that is used like money – it can be exchanged for traditional currencies such as the U.S. dollar or used to purchase goods or services, usually online.
FUN FACT: The first documented purchase using Bitcoin was in 2010. A Florida software programmer bought two pizzas for 10,000 Bitcoin. Today, those 10,000 Bitcoins would be worth $621 million.
What is behind the popularity of Bitcoin?
Advocates of Bitcoin propose that the technology behind it has the potential to positively impact our global economy. The use of this emerging technology, which is known as blockchain, has the potential to transform numerous industries. This blockchain technology is a specific type of database that enables cryptocurrency users to transact securely, immutably, and eliminate inefficiencies by avoiding “middle-men” like banks or government entities. Simply put, cryptocurrencies were designed with the end goal of creating more affordable and secure digital financial transactions.
What are the dangers?
Investing in or using cryptocurrencies carries substantial and numerous risks. Cryptocurrencies are not considered legal tender, and there are no laws that require companies or individuals to accept them as a form of payment (unlike with many standard forms of government issued currency). This means that cryptocurrencies can become completely worthless at any point in time if no one accepts them. In addition, cryptocurrencies, such as Bitcoin, are bought, sold and used through online “exchanges” where traditional currency is needed to purchase the cryptocurrency. The exchange rates for cryptocurrencies like Bitcoin have been extremely volatile, and subject to wide price swings. It has been known to rise and fall quickly, with drops as extreme as 80 percent. And on at least two occasions (including once last year), Bitcoin’s value dropped by about half in a matter of hours.
The online exchanges where cryptocurrencies are traded are another source of risk. These online exchanges can fail or be hacked, in which case consumers will lose access to trading and/or the use of their cryptocurrency. Further, because they are not backed by any government or bank, cryptocurrencies do not enjoy the protections and guarantees afforded by national currencies. On the contrary, because cryptocurrencies offer complete anonymity, they have increasingly been used in illegal activity by criminals and criminal enterprises. Law enforcement agencies could therefore, at some point, shut down or restrict the use of cryptocurrency platforms and exchanges, which has been done in the past.
What are our thoughts?
You can’t ignore the extraordinary run-up in value that Bitcoin has experienced. Since it’s inception in 2009, it has returned more than five million percent. But it’s important to understand that won’t happen again. Moving forward, the multiples forecasted by even the most optimistic Bitcoin advocates are much more subdued.
There are many valid arguments that support investing in Bitcoin, and many valid arguments that warn investors to completely avoid it.
Our recommendation is to always go back to your financial plan to determine what’s appropriate. For most of our clients, that means investing in a broad basket of proven strategies that have a long term track record. These are strategies that have survived high inflation, dot-com bubbles, and the Great Recession of 2008 and 2009. So we know they work.
Bitcoin, on the other hand, has benefitted from a “green light” investing environment that started with one of the longest bull market runs in history. Markets are now at all time highs, the government is literally giving money away, and there’s a manic “FOMO” (fear of missing out) attitude throwing caution to the wind.
We want to remain just as optimistic as everyone else when it comes to Bitcoin. But using history has our guide, we know that fast-moving markets with heated-demand can lead to costly mistakes.
That said, if you still have a strong desire to gain some exposure to Bitcoin or Bitcoin related stocks, consider using only the money you can afford to lose. This is the money that could be completely taken out of your financial plan and have minimal impact on your future. In most cases, this figure is 1% or less of your liquid wealth. So if Bitcoin should become worthless, it won’t harm you. The loss would certainly be frustrating but it won’t devastate your future. And if it does work out in your favor, then maybe you generate returns that have a meaningful outcome.
So with Bitcoin or other digital currencies, remember to weigh the pros and cons carefully. And don't hesitate to reach out to us. As always, we're available via email, or you can coordinate a quick phone appointment HERE. We would use that time to review your circumstances, and revisit your goals so you can determine whether or not gaining investment exposure to cryptocurrencies would be the right move for you.