Bitcoin and Cryptocurrency – three things to consider

  • We believe that investors should invest only in things they understand
  • Bitcoin is a speculative bet that has no reliable basis for its valuation
  • Many bitcoin investments have a limited history and are complex in their own right

Bitcoin is a digital cryptocurrency based on blockchain technology, where new units are generated by solving complex mathematical problems. Unlike conventional currencies, it is not issued or managed by a central bank.

It has recently made headlines as the price increases from just under $ 9,000 a penny in early 2020 to over $ 40,000 in early 2021.

However, we remain very skeptical about the cryptocurrency as an investment and see very significant risks. In particular, we believe that there are some important questions that investors should ask themselves when buying any cryptocurrency.

Do I understand bitcoin and cryptocurrencies?

We always say that investors should invest only in things they understand. That is as true of bitcoin as shares or funds.

Without an understanding of your investments and what drives performance, you have little chance of making informed decisions.

Cryptocurrencies are very complex animals and you need a fairly detailed understanding of coding to get your head around properly.

Adding to the complexity is the fact that the rules of the game can change. While all users must use the same software for bitcoin to function, with no central authority overseeing potential changes, there is no one to ensure that these changes are in the interest of common bitcoin holders.

Since bitcoin doesn’t pay back interest or interest, its price is driven entirely by supply and demand.

It seems likely that much of the demand has been from people hoping to benefit from future price rises rather than using bitcoin as a means of exchange. That is, it is purely speculative.

In that respect cryptocurrency is a lot like speculative bubbles we saw in the past – a most famous tulipomania of the 17th century, when a single tulip bulb changed hands for the equivalent of a 10-year salary.

We certainly do not understand the price of bitcoin – except as classic speculative mania. If that is the case, it is very difficult to predict the point at which demand slopes and prices begin to fall, if not impossible. That makes buying and selling decisions just as challenging.

Am I comfortable with the rise and decline of bitcoin?

It’s easy to look at the bitcoin graph and see the progress. But don’t lose sight of the decline.

The latest price increase means it is barely a blip on the chart now, but between 17 December 2017 and 15 December 2018 the price of bitcoin fell from $ 19,783 to $ 3,195 – a decrease of 83.8%. It did not return to its peak in 2017 until December 2020. Bitcoin is certainly not a one-way bet.

Bitcoin has also been very volatile. Daily swings of 10% or more, up and down, are not uncommon. It’s worth asking yourself how you would feel if you lost 20% or even 50% of your money in a few days, because this is totally possible.

These price changes occur because there is no widely accepted way to price bitcoin. Unlike shares, bonds or cash accounts, bitcoin does not pay dividends or interest. With no underlying ‘value’, the price is driven solely by the interaction of supply and demand. From a purely theoretical perspective, a $ 2 price tag makes as much sense as $ 200,000.

The Financial Conduct Authority (FCA) – which is responsible for regulating financial services firms in the UK – recently said that cryptocurrencies do not have a “reliable basis for pricing” and that is an opinion we strongly support.

That makes bitcoin a speculative bet rather than an investment in the conventional sense. It is important not to confuse the two.

Is there a way to invest in bitcoin that works for me?

There are many different ways to invest in bitcoin. However, it is important to be aware of the risks associated with each.

The most obvious way to invest is to buy the currency directly. However, that makes individual investors responsible for the security of their bitcoin – since the key is stored on your computer.

There have been many examples of hackers stealing keys from bitcoin and miner exchanges. With the increasing value of bitcoin, individual investors are becoming more attractive targets, especially since they lack the sophisticated internet security of large companies.

The FCA has again actively warned of the “prevalence of market abuse and financial crime” in the market. Crucially, because cryptocurrencies are unregulated, purchasers cannot apply to financial regulators for assistance if something goes wrong – either in terms of compensation or to counteract mis-selling.

We also have concerns about liquidity.

It’s also the ability to convert investments back into cash when you want. Over the past year it has been common for less than $ 200m of bitcoin to be traded worldwide in a given day. By comparison $ 6bn of Microsoft shares can trade in a day. This means at a large sale you may struggle to find a buyer for your bitcoin, leaving you stuck with it even as the price drops.

Where does that leave bitcoin?

Given how difficult it is to appreciate bitcoin, it’s almost impossible to call on the current price or its future direction.

However, cryptocurrencies in general are clearly subject to their own risks, in addition to the risks of more mainstream investments. It is important that investors are aware of them.

As with any highly speculative investment, if you decide to invest we would suggest that cryptocurrency should be no more than a very small proportion of your total portfolio. Nor should you invest any money you cannot afford to lose.

Ultimately, we think the FCA sums it up nicely. “If consumers invest in these types of products, they should be prepared to lose all their money.”

This article is not personal advice. If you are not sure whether an investment is right for you, you should seek advice.

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