By Brian Boughner
“Should I own a cryptocurrency?” is by far one of the questions I’m asked most these days. Go to any party or soiree and you’re bound to find someone talking about all the money they’ve made in crypto. With cool names like Bitcoin, Ethereum, Ripple, Tron, and Aion, who wouldn’t want to own a piece of the crypto world?
Whenever people ask us this question, we reply with another question: “What were currencies invented for?” Their response is usually something like, “Currencies were designed to transact goods and services. They helped us move past bartering where we can now assign a value to something and then have a common means to transact.” Exactly! So we ask, “If currencies are designed for transactions, why would you invest in a currency with a hope of it increasing 1,000 percent? Wouldn’t that defeat the purpose of having that currency? How can you use it to transact if the price of the currency is bouncing around at volatile levels?”
We then take them through a five-minute primer on how investing is where you actually own something that is creating cash flow and value. Your investment typically will produce some type of value through a growing cash flow. When it doesn’t, your investment then becomes speculation. We also try to remind folks of the famous words of one of the world’s greatest investors, Warren Buffett: “Invest in what you know, nothing more.”
Very few investors fully understand how blockchain and cryptocurrencies actually work, yet are more than willing to fork over their money to invest in it because it’s the “next big thing.” Rarely has that ended well for investors. Bottom line, cryptocurrencies in their current form are horrible at either creating a store of value or as a means to complete financial transactions.
That being said, we don’t discourage people from buying crypto. We just caution them to use only an amount of money they are willing to lose (like going to Vegas to gamble) if prices go to zero. In spite of the big run-up in 2017, this year has been a different story.
This entire publication could just be about crypto and barely even scratch the surface of what’s going on in that market. So for brevity’s sake, here are five things you need to keep in mind when speculating with cryptocurrencies.
The exchanges are not regulated. If the platform you are using to buy these crypto assets goes under (and this has been happening in the market), you have no recourse to get your money back — none.
Liquidity can completely dry up. Because these exchanges are not regulated, there aren’t any market makers whose primary job is to provide liquidity for trades. This is why there have been very volatile swings in these markets.
There are now 1,641 different cryptocurrencies. Initial coin offerings seem to be happening almost every day. Firms are simply trying to capitalize on the crypto craze and inventing all kinds of new currencies. Half of all ICOs fail within a year. That’s a lot of money down the drain. And because this isn’t regulated, there is no recourse.
Blockchain is the future. The technology underlying the cryptocurrencies is really the future. We believe that this technology will eventually revolutionize financial transactions throughout the world. Big firms like Goldman Sachs and JP Morgan are spending billions to utilize blockchain for their business.
Very few understand crypto. I continue to be amazed in how very little crypto investors know when I ask them to explain to me exactly what an ICO is and how their currency works. Most crypto owners have no idea how these markets work.
I encourage you to study and learn more about blockchain and cryptocurrencies, as this technology is already changing the way we transact and store data. The Crypto Canon is a good place to start: https://a16z.com/2018/02/10/crypto-readings-resources/. At the same time, please be very careful in buying a cryptocurrency. Use only the money that you are willing to lose, and accept that this is a speculative trade and not a long-term investment. Blockchain technology is likely here for a long time; however, the currencies are likely to experience intense volatility and uncertainty.
Brian Boughner CFA, CMT