There’s a lot of buzz about cryptocurrencies such as Bitcoin these days. The topic is likely crossing your radar whether you’re reading about it in the news, monitoring Elon Musk’s tweets, or hearing about it in social circles. Given that the most common first question is “what is it?”, we offer a general overview along with our thoughts about cryptocurrencies as an investment consideration.
What is a cryptocurrency?
A cryptocurrency is a digital currency that can be used as a medium of exchange to purchase goods and services. Unlike traditional currencies such as the US Dollar, cryptocurrencies are not issued by any centralized government.
Are cryptocurrencies regulated?
Cryptocurrencies are not regulated by any government authority. The lack of regulation is attractive to some investors, but it also presents investment concerns, particularly if governments such as China, Japan and the UK continue pursuing efforts to thwart or ban cryptocurrency use.
How widely used are cryptocurrencies?
Some businesses allow cryptocurrencies to be used to transact purchases. However, the bulk of today’s cryptocurrency transactions are for investment purposes versus commerce. The ups and downs of cryptocurrency pricing (discussed later) could be a large impediment to future utilization as a practical, day-to-day digital currency.
What’s the environmental impact of mining cryptocurrencies?
“Mining” is the process that is used to create and account for some cryptocurrencies such as Bitcoin. Miners use powerful computers (called rigs) to solve complex math puzzles. These rigs consume staggering amounts of energy, similar to massive data servers. Bitcoin is reported to consume more electricity than the entire country of Argentina. Miners look for low cost energy locations to construct and operate their rigs, but many are in areas of the world that aren’t utilizing environmentally friendly energy resources.
What is the current cryptocurrency craze about?
Cryptocurrencies have gained significant interest in the past year. Some people think that digital currencies are the wave of the future. Others are attracted to the fact that they’re not regulated like traditional currencies. Celebrity involvement has helped spread the hype on social media. We believe that some of the current craze aligns with pandemic-related fears, including concerns about inflation and government debt levels.
While inflation is rising and government debt levels are real, this doesn’t necessarily mean that cryptocurrencies offer investment protection that some might be seeking. In fact, volatility in cryptocurrencies could result in even greater financial risks.
A quick look at Bitcoin
While there are many cryptocurrencies, Bitcoin is considered to be the most popular and widely utilized cryptocurrency. A chart of Bitcoin’s price going back to 2013 is shown below. As you can see, the vast majority of Bitcoin’s historical gains were achieved in the past several months with a staggering uphill ascent followed by a precipitous decline, representing more than a fifty percent loss.
The huge price upswing earlier this year definitely sparked investor interest. For some, it created a “fear of missing out” effect, worrying about missing out on the next hot investment opportunity. Elon Musk played a large hand in the price fluctuations. Bitcoin soared in February after Musk made a sizeable investment, but then took a large fall when he downplayed his support of the cryptocurrency while reportedly retaining his investment due to environmental concerns.
What is the impact of cryptocurrency volatility?
While variables such as Elon Musk’s investment interests play a large role in cryptocurrency pricing, the reality is that all cryptocurrencies are far more volatile than traditional currencies. You simply don’t see wild price variations in traditional currencies such as the US Dollar, the euro, the yen, or the like.
In fact, imagine if you did see the US Dollar or a major currency double in value or cut in half in a matter of months. Would you be comfortable holding large amounts of the currency and transacting your personal finances in that currency? The answer is likely no, which could represent the largest future investment hurdle to cryptocurrencies. Their inherent volatility simply makes them difficult to effectively take hold as a currency of choice.
Are cryptocurrencies fairly valued?
Another challenge is determining a fair price for cryptocurrencies. How does an investor determine their fundamental value? The reality is that the bulk of cryptocurrency pricing is based upon assumptions of future use versus actual current use. Furthermore, how does volatility play into fair valuations? These important questions provide only one concrete answer: cryptocurrencies are speculative investments.
How does cryptocurrency fit into an investment portfolio?
If you’re thinking about making an investment in cryptocurrency, we believe it’s important to carefully evaluate risks. We view cryptocurrencies as speculative due to challenges in rationalizing a valuation framework, volatility and lack of regulation.
All investments entail an element of risk, but most traditional investments are made in the pursuit of participating in expected profits. Speculative investments entail even higher levels of risk, including the understanding that the investment could result in failure. For this reason, we recommend limiting any potential investment to an amount you can afford and are willing to lose.
Hence, any potential investment should only represent a small percentage of your investment portfolio, one that won’t affect your ability to pursue your financial goals if it doesn’t work out, while still letting you participate in the current crypto frenzy for enjoyment, and perhaps, just perhaps, long-term profit.
SageVest proudly serves as a fiduciary investment and wealth advisor. Our fiduciary responsibility obligates us to place your best interests at the forefront of our decision making. As a result, we focus on investment and financial strategies designed to help you achieve your financial goals with confidence and success. Please contact us to learn more about our services.