Don’t invest in what you don’t know is a core tenet of investing. Defying it can be one of the quickest ways to lose money for investors of all levels. Yet a week ago, I started a small position in Bitcoin and Ethereum, both members of the emerging cryptocurrency asset class, which very few individuals can claim to fully understand. It would be disingenuous of me to pretend that for all my research, I understood the intrinsic value of cryptocurrencies or the intricacies of the blockchain which support them. After weeks of research, the central question remained – should I invest in bitcoin?
*I understand that the principles behind the need for cryptocurrency can invoke passionate responses on both sides. The ideal behind a concept rarely aligns with everyone’s perception of reality. What some might see as an attempt to solve a problem that does not exist, others may see as instilling a safeguard to ensure it never becomes necessary. Please add your voice to the conversation but be respectful of your community mates on both sides.
I understand some of the problems cryptocurrencies are attempting to address. Too much centralization of control and the abuse that often inspires. The need for a universal way to transact without borders or exchange rates. I can also recognize that with a new asset class comes some unique issues and concerns. As an asset class cryptocurrency is still very new and untested.
Four Reasons I Should Invest in Bitcoin
Diversification- a hedge against…Everything?
Since its inception in 2009, proponents of Bitcoin have viewed it as a hedge against inflation and paper currencies. Through its early years, Bitcoin proved itself independent of most other assets classes. Whether gold, rare minerals, stocks, or bonds, Bitcoin began to establish itself as a way to bring further diversification to any portfolio, even at a limited level of investment. A Yale study titled “Risks and Returns of Cryptocurrencies” found that:
With the exception of the exposure of Ethereum to gold, the exposures of all other cryptocurrencies to these commodities are not statistically significant
Further stating:
We conclude that cryptocurrency returns have low exposures to traditional asset classes – stocks, currencies, and commodities.
From <https://economics.yale.edu/sites/default/files/files/Faculty/Tsyvinski/cryptoreturns%208-7-2018.pdf>
As the asset class has matured and more money has poured into the crypto market, its correlation with other asset classes has risen. This trend may continue as more and more institutional-level investors allocate a portion of their portfolio to the space. Bitcoin and other coins continue to be a powerful source of diversification and this looks to continue even as its correlation to other markets raises.
Inflation
Much of inflation is attributed to increases in the money supply. As more and more purchasing power is created the price of in-demand goods will often increase. Bitcoin can somewhat self-regulate as only 21 million bitcoins are envisioned to ever exist. Additionally, the ease with which new coins enter the market gets reduced every four years. A limited supply eventually removes the factor M0 inflation for Bitcoin but does not make it immune to inflation.
Institutional Investment/Acknowledgement is Growing
History has repeatedly shown that the support of individual investors can dramatically change and support an investment’s fortunes. Still, the attention of institutional investors can bring a lot of money, awareness, and validity once their support is earned. From Cathy Woods (the founder of Ark Invest) to Morgan Stanley to on again off again support from the eccentric Elon Musk, money that was once off-limits to bitcoin and its brethren are starting to flow in and support the currencies.
Governments are taking note. Countries led by China and England are investing in creating an official national digital currency. Banks such as JP Morgan and Wells Fargo and companies including Facebook look to follow suit. El Salvador became the first country to officially accept bitcoin as legal tender. This movement attributes some recognition of the validity behind the technology and works towards legitimizing the asset class.
Passionate Supporter Base
It would be shortsighted to discuss the merits of bitcoin and cryptocurrencies, as an investment, without some account of the ideals and hope behind the technology and the disruption to specific industries it could represent. The aforementioned Yale study details that
We have shown that unconditionally investor attention positively predicts cryptocurrency return
From <https://economics.yale.edu/sites/default/files/files/Faculty/Tsyvinski/cryptoreturns%208-7-2018.pdf>
Possible Tailwinds for Cryptocurrency as a Whole
Smart Contracts- will allow for the execution of agreements or workflows to occur immediately upon their conditions being fulfilled. These contracts execute with no manual intervention.
Code and network- updates are already bringing lower transaction time and lower fees while increasing scalability and efficiency.
Universal 24/7 transactions with no borders Could improve the lives of many working abroad to removing the hurdles they currently face to send money home.
Crypto payments inherently provide a level of anonymous transparency. All transactions are permanently a part of the public ledger. The system only exposes your personal details at necessary points in the transaction. More regulation may be on the horizon, with larger transactions already on the regulatory radar.
Easier Investment Access – Adaption is limited by those who do not believe in, or do not wish to understand, the tech around it. Several prominent companies such as Cathy Wood’s Ark Invest are looking to lower the barrier of entry by creating the first true cryptocurrency funds. The availability of these funds via standard brokers would greatly increase the money available to the asset class and its growth.
Five Key Reasons Why I Should Not Invest in Bitcoin
Not Insured
With no regulation comes no insurance backing. While the FDIC and the SIPC insure against the failure of a bank and brokerage respectively, no such protections currently exist for cryptocurrency exchanges.
Over its lifetime, investors have lost around 20 percent of all tokens. Misplaced passwords, dead or thrown out hard drives have accounted for losses in the millions for individual investors. While instances may slow as the value of these tokens becomes more established and awareness of risks rise, much of this loss will never be recovered.
Payments made through the network are also not recoverable outside of obtaining a refund from the payee.
Extreme Volatility
Bitcoin was once termed digital gold. A store of value with a finite supply. But we have never seen any asset class take the path that bitcoin has in its early history. It is very difficult to assign an intrinsic value to and often moves as much as one’s entire portfolio in a week or even a day. As more and more money enters the ecosystem, volatility should settle down. Until it does, these factors all make it difficult to consider Bitcoin as a haven or stand-in for gold.
Intense Focus Has Led to Some Price Manipulation
Long term, we can hope that a decentralized network will reduce the market’s susceptibility to price manipulation from a singular entity or nation. The current reality, as for any asset with a limited market cap, is that large players can greatly influence the market.
From Tether, to Logan Paul and friends pushing the value of an altcoin Dink Doink created as a joke, to the tweets of Elon Musk and the impact they have shown over bitcoin, the actions of few have impacted everyone. Would-be investors need to account for both the risks and opportunities this can create.
Environmental Impact
Bitcoins, as well as other cryptocurrencies which require mining, are a large drain on the electric grid. Mining activity produces large amounts of carbon dioxide emissions. The demand for GPU power for mining operations has caused prices for individuals and organizations dependent upon these same cards to face significant delays and price increases. Mining has also led to electronic waste as the hardware used for mining operations die or minors throw them out for something more efficient. As the price of bitcoin goes up, so do the demands upon mining hardware. In his Harvard study:
‘Sustainability Analysis of Cryptocurrencies Based on Projected Return on Investment and Environmental Impact’
Olga Martynov concluded that:
1 USD of cryptocurrency coin value created would be responsible for 0.66 UDS in health and climate damages
https://nrs.harvard.edu/URN-3:HUL.INSTREPOS:37365412
Companies are making efforts to mitigate this risk. Because of its location agnostic nature, mining operations can often leverage renewable sources of energy. Alternative coins show promise consuming far less electricity per transaction than bitcoin, but most at a far smaller scale.
The systems it seeks to improve are not free of environmental concerns themselves. The banking industry needs to support local offices across the country that still heavily leverage paper forms.
Tax Complications for Those Who Invest in Bitcoin
Fear of taxes should never drive one away from an investment. If you have taxes to pay on an investment, you’ve won. As an emerging asset class, the standards and understanding around bitcoin and other coins can introduce some additional complexity to one’s taxes.
Any transaction you complete with your bitcoins is considered a taxable event. While some exchanges are beginning to provide tax forms, most do not track your cost basis for you. Anyone old enough to remember investing in the stock market a decade ago will remember with appreciation the day brokerages began to track cost basis for their clients. Currently, cryptocurrency exchanges place this burden on the individual taxpayer.
In Light of Everything Should I Invest in Bitcoin?
After weeks of research, and years sitting on the sidelines, the question remained: as a responsible investor should I invest in Bitcoin? Is all that I have learned enough? In my situation, I believe the investment (at a very controlled level) aligns with my current goals and comfort level. It brings needed diversification and some additional upside to my portfolio.
Over the past several weeks, I have made several small purchases in both Bitcoin and Ethereum. I am working to slowly build a foundation whenever either currency falls under an established threshold. I will allocate part of my income each month as long as Bitcoin and Ethereum hit key buy points. Ultimately, I plan to allocate between 2 and 5 percent of my portfolio to crypto by the end of 2022.
If it grows to a larger portion of my portfolio, part of the appreciation will be used to branch out into crowd-funded real estate. One of my goals heading into 2021 was to diversify my income streams and not be so dependent on the stock market. Starting to invest in Bitcoin is a viable first step.