Bitcoin, and cryptocurrencies, continue to draw attention, partly because of their fascinating underlying blockchain technology, but largely because of the incredible volatility seen in the price of cryptocurrencies. Amazingly, since early February, where the crypto market lost as much as $100 billion in market value in 24 hours, the price of bitcoin has since doubled.
We've all heard the stories of speculative investors making 1,000% returns, or those who pulled out at only 200%. We've also heard of investors losing half their investment in a single day.
The past performance of this product is not and should not be taken as an indication of future performance. Caution should be exercised in assessing past performance. This product, like all other financial products, is subject to market forces and unpredictable events that may adversely affect future performance.
This post discusses some of the factors that may influence the value of cryptocurrencies.
What is an Investment?
At its most basic, investing is understood to be the provision of a financial instrument with the expectation of receiving future profit. When discussing investing we generally think of buying-and-holding - a medium to long term investment with the expectation that value will increase over time (e.g. share trading, ETF trading, property investing). Buying-and-holding's excitable younger brother is day-trading, where the investor makes trades every day in their search for profit. Obviously, the day trader exposes themselves to much greater risks, given the market's inherent fluctuations.
Bitcoin and other cryptocurrencies have drawn a huge number of day-traders due to the ease of trading the asset. This is important, as it may go some way to explain the massive fluctuations in cryptocurrency prices - presumably these investors have had less experience with more traditional forms of investing and therefore may be more prone to emotion and impulse trades.
Let's take a look at two sides to the 'coin' (excuse the pun) and argue the case for and against investing in bitcoin.
Why Crytpocurrencies Could be Considered a Good Investment
Potential to Replace Fiat Currencies
One of the most exciting aspects of investing in cryptocurrencies is the potential for future uses. Could bitcoin one day replace fiat currencies? Unlikely perhaps, but as discussed below, the potential is there, especially given Venezuela has launched their own virtual currency. Likewise, blockchain technology is still relatively new. As refinements and advancements are made, more and more uses will be found, likely leading to increased value in some cryptocurrencies.
Potential for Day Trading
The incredibly volatile market for cryptocurrencies might inspire some to try their hand at day trading. If you're interested in learning how to get started see our article here. Certainly some day-traders have made profit off the day-to-day fluctuations, however as we all know, past performance is not indicative of future performance, and there are never any guarantees when making any investment.
Scarcity is another reason to invest in bitcoin and other cryptocurrencies. For example, only 21 million total bitcoins can ever be mined. The laws of supply and demand dictate that as the available supply decreases and dries up, if demand stays the same, then price will in turn, increase.
Mainstream acceptance of cryptocurrency investing is growing, as a number of traditional investors, including venture capitalist Tim Draper and billionaire ex-hedge fund manager Michael Novogratz, have joined the crowd. Finally, the New York Stock Exchange has filed to bring two bitcoin ETFs to the market in 2018.
Why Crytpocurrencies Could be Considered a Risky Investment
Institutional Wariness and Growing Regulations
Many institutions, crucially governments and regulators, are still unsure how to respond to cryptocurrencies. That's part of the attraction to a large number of crypto supporters who value the technology's privacy and anonymity. However, as potential legal ramifications come to the fore investors may witness a loss of value.
In February 2018 Bank of America, Citigroup, J.P. Morgan Chase and Lloyds Banking Group all banned the purchasing of cryptocurrencies through their credit cards. Earlier in January 2018, Visa Europe closed a number of pre-paid debit cards loaded for cryptocurrencies due to incompatibility with compliance regulations.
The governments of China and Russia are both investigating the regulations surrounding cryptocurrencies. If either of these countries come down hard on cryptocurrencies - expect the price to drop as two massive markets are cutoff.
Unsuitability as a Currency
Part of the reason why investors value bitcoin is its potential to one day replace fiat currencies. That may be true, but not anytime soon.
The lack of infrastructure to support making day-to-day transactions is one obstacle - how would you pay for your coffee with bitcoin? Why purchase a $3 coffee with a transaction fee of $50? Would we use bitcoin "cards" and by extension bitcoin card readers? Phone apps are one current option, typically through the use of QR codes. And even if you technically simple, who would want to pay for purchases with a currency that can lose half its value in a few days?
Additionally, a large factor contributing to our use of fiat currencies is everyone favourite topic - taxes. The tax man only accepts payments in dollars. If you cannot pay your taxes in bitcoins, then bitcoins cannot replace fiat currencies. This may change, but we all know how long it takes governments to respond to new technologies.
Members of the blockchain community also are wary of investing in cryptocurrencies as the founder of blockchain network Ethereum, Vitalik Buterin, recently said on twitter. For these reasons bitcoin should be thought of as a very high-risk asset class.
The upcoming G20 meeting in March may illuminate the world's governments thoughts on cryptocurrency, as some analysts expect discussions regarding cryptocurrency regulations to take place. Whilst bitcoin and blockchain technology is exciting, it seemingly has too many legal and volatility issues to be classified as a safe investment.
Ultimately, your individual situation and investment strategy will determine whether investing in cryptocurrencies is right for you. Always seek personal investment advice and do as much research as possible before making an investment decision.
It's easy to be a cryptocurrency detractor; all in that camp have been wrong so far but as we all know - good things don't last forever.
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