Despite the earliest forms of cryptocurrencies being created in the mid-nineties, the recent mania has seen an explosion in cryptocurrencies totaling almost 50 by my last count.
But with speculative booms comes the potential for spectacular busts.
Bitcoin, perhaps the most talked about altcoin, posted an impressive high of $19,796 per bitcoin on 17 Dec, before plummeting by 40% to $11,590 on 22 Dec, according to data from Coinbase.
Ripple, also known as XRP, rose by a staggering 35,000% over the course of 2017 alone. However, fears of a regulatory crackdown in South Korea sent Ripple’s price crashing to $1.23 per token on 16 Jan 2018, which was an almost 69% drop on its 4 Jan record price of $3.84, according to CoinMarketCap. That was akin to $31 billion of value being wiped off the exchange.
With all the euphoria and volatility surrounding crypto-markets, we have had a number of people ask us whether we’ll be investing in Bitcoin or alternative cryptocurrencies such as Ripple, Litecoin, Dash, NEM, Ethereum, Monero and Zcash — to name but a few.
I’m happy to admit that back when I first started investing, I’d have likely been swept up by this crypto craze. Back then I had no clear investment plan and was guilty of chasing every shiny investment object out there!
Have people made serious money from their investments in cryptocurrencies? Yes.
Will people lose serious money from their investments in cryptocurrencies? Yes.
Will the mania continue to drive prices for cryptocurrencies even higher? Probably.
Speculative bubbles similar to those seen in the cryptomarkets will often prove profitable for the early adopters (who have the discipline to take their profit at or near the top)...and will often end in tears for those who arrive late to the party.
So, will I be investing heavily in cryptocurrencies? The short answer is: no.
It simply does not fit my personal investment plan, risk vs reward profile or criteria for a sustainable, long-term investment. Having a clear plan and criteria for investing has allowed me to comfortably watch from the sidelines as things like the current crypto-craze, the dotcom bubble of the 2000s and the US housing bubble of 2006-2008 go through their meteoric rises and catastrophic falls.
So here are 4 powerful questions I learned to ask myself to help me create my personal criteria for any investment:
- What is the value proposition behind the investment?
- Can I influence the outcome of the investment?
- Is there a strong underlying need for the product or service on offer?
- Can I sleep well at night with the investment?
Now let’s go through each question one at a time from the point of view of cryptocurrencies.
What is the value proposition behind cryptocurrencies?
This is difficult to answer at present. According to Michael Glennon, founder of Glennon Capital speaking to the Australian Financial Review about Bitcoin:
“It's a currency that doesn't do anything, is not backed by any sovereign nation, is not accepted anywhere, is hard to buy and sell, and has no fundamentals supporting it. I get paid no interest on digital currencies, and I can't use them for anything other than to sell to someone else.”
There are also some significant risks that surround the value proposition of cryptos, both legislative and speculative:
- Legislative Risk
For now, the quantity of monies invested in virtual currencies is probably not big enough to concern most governments or central banks.
Randal Quarles, the vice-chair for supervision at the Federal Reserve, said 1 Dec that while the central bank has no policy toward regulation of bitcoin, it’s “worth thinking about”. The volume of cryptocurrencies could at some point matter when it comes to monetary policy, Powell said in answering a question at his Senate confirmation hearing in November. For now, he said that "they’re just not big enough".
However, due to the high potential for money laundering, excessive speculation and tax evasion, governments and central banks around the world may choose to clamp down on cryptos at some point in the future, effectively shutting down their ability to operate. In that case, the value of cryptos would likely plummet. The Chinese government’s rolling clampdown has rocked global markets for Bitcoin and other digital tokens over the past few months.
Similarly, South Korea is currently debating its stance on cryptocurrencies. Responding to a parliament member at the national policy committee meeting on 18 Jan, Choi Jong-Ku, head of South Korea's Financial Services Commission, said the government “is considering both shutting down all local virtual currency exchanges or just the ones who have been violating the law.”
- Speculative Risk
Bank of Japan Governor Haruhiko Kuroda said in December 2017 of Bitcoin that "if it’s a question of whether it’s functioning like currencies as a form of payment or means of settlement, I don’t think it is. [...Bitcoin] is being traded for investing or for speculation,” he said.
Cryptocurrency market price can be influenced in the short term by things like herd mentality and speculative mania.
However, in the longer term, all asset prices eventually find a pricing level based upon the true, underlying fundamental of the asset class. Given the relatively recent explosion of interest in cryptocurrencies, it is likely to have created a speculative bubble that may have these assets priced well above their longer-term fundamentals. On the other hand, some argue that the current price is still well below its long-term value. Who will be right? Only time will tell.
Perhaps the true value of cryptocurrencies will be found in the technology that underpins them: blockchain.
The blockchain is essentially a decentralised and continuously growing list of records, or blocks, which are linked together and secured using cryptography. They use what's known as distributed ledger technology (DLT) to create an enduring record that can’t be altered. Additionally, the record’s authenticity can be verified by the entire community using the blockchain instead of a single, centralised authority. That is, individual users of the blockchain dictate and validate transactions when one person pays another for goods or services, essentially eliminating the need for a third party (like a bank) to process or store payments.
So, whilst currently largely used for tracking cryptocurrencies, the blockchain technology could be used to facilitate mainstream financial transactions, medical records, logistics tracking, and more.
In fact, it seems that anything even vaguely related to this Blockchain technology is booming. Last month, the Long Island Iced Tea Company – a company which largely makes bottled lemonade and iced tea – simply changed its name to Long Blockchain, and instantly saw its shares soar by around 500%. Nothing else has fundamentally changed, except the name. It’s crazy, but this is the sort of things that happen in speculative bubbles.
Can I influence the outcome of an investment in cryptocurrencies?
Well, unless you want to go and set up your own virtual currency, it is unlikely that you as an individual investor will be able to exert any real influence over whether the price of this asset class goes up or down. This is in contrast to an asset class such as property, where it is possible to exert your knowledge, skill, financial resources and time to add value to the property via renovation, subdivision or development, for example.
Is there a strong, underlying need for the product or service on offer?
The world has operated for a long time without cryptocurrencies, and I suspect that the world could continue along without them if required. Obviously, growing global inequality and distrust in governments and central banks has led some to argue that a decentralised form of currency is required. Yet only time will tell whether governments and central banks themselves will embrace, tolerate or outlaw digital currencies.
Can I sleep well at night with the investment?
Currently, digital currencies are experiencing high levels of volatility. For some investors, these roller coaster ups and downs add to the excitement of investing in this asset class. For others, they find the ride just way too uncomfortable. Knowing what you can tolerate and risk in any investment can help you make better long-term asset class selections.
So, if after reading this, you’re thinking about investing in cryptocurrency, here are my top 5 tips:
- Make sure that cryptocurrencies are a part of your overall investment plan, not your only plan. Like me in the early days, any investor without a clear plan of how, when and why they are investing is more likely to get caught up in speculative bubbles. The challenge is this: our experience shows us that very few investors have clear, written plans for how they are going to create the financial results they want in life.
Want help in this area? Then reach out! We’ve got you covered.
- Become highly educated on cryptocurrencies. If you are going to invest in any asset class, then it pays to understand what it is you’re doing. There are many different virtual currencies on offer and different ways to invest in them, both with and without leverage.
- Only invest as much as you are comfortable to lose. As discussed above, there remains significant uncertainty and risk in virtual currencies. Speculative investing should probably only contribute to a small percentage of your overall investing strategy. So, before you invest your real, hard-earned dollars into cryptocurrencies, ask yourself this: “Am I comfortable losing some or all of that money chasing the promise of quick riches?” Remember, many get-rich-quick schemes often turn out to be get-poor-quick schemes instead.
- Take at least some of your crypto-profits along the way! Whilst it is always difficult to pick a top, and the gambler in each of us is tempted to let it ride for as long as possible, developing the discipline to take profits along the way can be a smart strategy for many investors. For example, imagine if you invested $1,000 AUD into a cryptocurrency at a value of, say, $1.00 per coin. If the price doubled to $2.00 per coin, you might choose to cash out some of that profit. For example, you might like to sell 50% of your coins to recover 100% of your initial investment. Or you might set up a rule: if the investment increases by, say, 400%, you take 10%, 25% or 50% of profits at that point in time.
- Convert your crypto-profits into other long-term assets classes. Now, it’s possible that cryptocurrencies will become a legitimate and legal form of exchange around the world. There may come the day where you could buy everything and anything using a virtual wallet of digital currencies (or a single dominant digital currency?).
But for now, I am personally more comfortable dealing with real and tangible assets, such as property for example. So, if you have been fortunate to have ridden the speculative wave in cryptocurrencies, consider converting some of those digital profits into real assets like property, shares, bonds, gold or actual dollars. We may be in the digital age, but nothing beats out the tangibility of physical goods.
Interested in creating sustainable, long-term wealth? Let’s chat!
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