There is little doubt that cryptocurrency is having a significant impact on the world around us. Indeed, cryptocurrencies are so popular one literally needs to work to not hear about them on a daily basis. It is no wonder the public is clamoring to invest in the next big crypto coin. As Warren Buffet famously said about investing in speculative assets, “People start being interested in something because it is going up, not because they understand it or anything else. But the guy next door, who they know is dumber than they are, is getting rich and they aren’t.” Warren Buffet is the 6th wealthiest individual on the planet. When he speaks, it pays to listen.
Objectively speaking, there are pros and cons to cryptocurrencies and the blockchain technology it is built upon. This technology will likely be part of our future for many decades to come. However, does this mean we should invest in a single cryptocurrency or even a broad set of cryptocurrencies? We think the answer is no, at least not for now.
From our perspective, there are several compelling reasons why investing in cryptocurrencies is not prudent or wise:
- The excitement, profit chasing, and volatility of these currencies have all the hallmarks of a speculative bubble. A speculative bubble is a spike in asset values within a particular industry, commodity, or asset class to unsubstantiated levels, fueled by irrational speculative activity that is not supported by the fundamentals. This fun video explains how the Tulip mania of the 17th century arose.
- Although people say cryptocurrencies are difficult to hack, the fact remains there are significant questions about the cyber risk posed by these currencies. Cryptocurrencies are completely unregulated assets. There is little doubt the people who invented cryptocurrencies are smart. But as we all know, cybercriminals are often just as savvy and sometimes even more innovative than the craftiest inventors.
- Cryptocurrencies, unlike stocks or bonds, do not pay interest or dividends. Any gain from holding these assets comes purely from price appreciation, and if the price does not go up, you will actually lose money to inflation.
- There is a significant chance if digital forms of currency become too successful, the government will simply ban them as a systematic threat to the existing fiat monetary system. For example, the Indian government recently threatened to completely outlaw the use of cryptocurrency in any form. Can you imagine what would happen to the price of cryptocurrencies if a future U.S. government outlawed their use? Several countries, including the US and China, are developing their own digital currencies.
- From an investment perspective, because cryptocurrencies are so new, there is little evidence they are an effective diversifier in a global portfolio or a hedge against inflation.
- Although some intrepid institutional investors have dipped their toes into the cryptocurrency waters, there remain significant barriers to investing in these assets, such as liquidity risk, volatility, regulatory, and operational risks.
- In their current form, cryptocurrencies are an environmental disaster. Bitcoin mining, just one of many digitally-mined currencies, uses more energy than the entire country of Norway. Elon Musk recently reversed his earlier decision to accept bitcoin as payment for its cars, citing the environmental concerns.
For every negative argument around cryptocurrencies, there can be counterarguments as to why these assets could be viable investment vehicles. Our job as professional investment advisors with a fiduciary duty to our clients is not to debate the merits and viability of cryptocurrencies. Instead, our job is to be a steward of our clients’ hard-earned money. A good steward does not chase speculative investments, moving from one hot idea to the next, hoping to sell an asset to a greater fool.
If you believe in the merits of cryptocurrency, we highly encourage you to treat this investment as a speculative activity. There is a difference between speculating or betting on the short-term movements of individual assets and investing for long-term wealth. There is nothing inherently wrong with speculating, other than the overwhelming evidence that suggests it is nearly impossible to do successfully over the long term. So, if you must invest in cryptocurrencies, our advice is to keep your position size small relative to your net worth and do not invest any money you are not wholly comfortable with losing.
Even though mainstream America appears to be going crazy for crypto, the fact remains, these assets are the Wild West of the investment world. If you tread in is these waters, be prepared for surprises. Finally, if you want a funny take on crypto investing, click here.