INVESTING IN CRYPTO

If you know me, you won’t be surprised to hear me say that I don’t believe people should be investing in cryptocurrencies with their retirement funds.  Crypto is fine for speculators and there is a role for speculators in our economy, but speculating is a dangerous game to play for ordinary investors.

You get a sense of the volatility of crypto in this price chart of bitcoin. The last three years have been a wild ride for bitcoin investors.  The price of bitcoin dropped by 70% in 2021, and it has gained it all back in the last year.

Bitcoin and the other crypto options are new forms of currency that trade on the new blockchain technology.  For simplicity, I will focus mainly on bitcoin in this post as it is the biggest cryptocurrency.

As an investment, it is best to think of bitcoin and the other cryptocurrencies as commodities and not currencies.  They behave like commodities whose prices are mainly driven by supply and demand factors. Crypto prices are much more volatile than traditional currencies like the dollar or the euro. 

The crypto enthusiasts believe that this new form of payment represents a seismic shift in how we are going to handle money in the future.  I understand their enthusiasm, but I have no idea what the future for cryptocurrencies will look like. 

Last year we saw the creation of ETFs for cryptocurrencies, and it is now possible to invest in crypto inside some 401K plans. The introduction of these new ETFs and the approval of crypto for 401K plans has and will increase the demand for cryptocurrencies which drove the price increases over the last year.

Bitcoin has also become popular in countries with high inflation and devalued currencies, such as Venezuela. Additionally, it is popular with those who use it to transfer large sums of money for illicit and illegal activities.

Bitcoin will have a fixed number of coins minted and the supply will stop increasing in 2140.  The number of new bitcoins introduced gets cut in half every four years.  Limited supply is one of the main attractions of bitcoin to speculators.   

Let’s compare bitcoin as an investment to my favorite investment, stocks. 

When you own one stock or hundreds of stocks in an ETF, you own a share of the profits that those companies produce.  On a simplistic level, when the profits of the companies increase, the price of the stock increases and the opposite occurs when the profits decrease.  We know that other things influence the price of stocks in the short-term but in the long-term the biggest factor is profits.

If you are like me and you believe in the long-term profit growth of the companies in index funds representing the S&P 500 or the Nasdaq, for example, you can be very confident that those stock prices will be higher in the future. 

Cryptocurrencies don’t produce any sales or profits on their own.  As a currency, they facilitate sales but there are no income statements to evaluate for bitcoin. 

Buying bitcoin is gambling and not investing.  There is no consistency or predictability of bitcoin as an investment.  And nobody understands why bitcoin goes up or down in value.  Clearly the price of bitcoin is a function of supply and demand, but what drives the demand side of the equation other than people betting on a future dominated by crypto?  Nobody really knows. What if more countries introduce regulations to limit the use of cryptocurrencies?  It is believed that China moving away from bitcoin in 2021 led to the big decline in crypto prices. 

When you truly understand your investments, you understand the risks associated with those investments.  Very few investments come without any risk.  Understanding the strengths and weaknesses of any investment is the key.  S&P 500 Index funds are great investments but owning one of these funds does subject you to the irrational and dramatic ups and downs of the stock market.  Knowing that allows you to be more patient during periods of stock market volatility because the stock market always goes up in the long run.

If you have some “fun” money that you can afford to lose and the idea of speculating on bitcoin appeals to you, go right ahead.  But you should not include bitcoin in your retirement investments.    

Stay Disciplined My Friends,

Phil

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Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.