Portrait by Paul Flessland
I’ve had a few investors wondering recently if now is the right time to invest in cryptocurrencies, commonly known as Bitcoin. What I tell them is that digital currencies are probably the latest example of a speculative craze.
To me, Bitcoin smells like tulips. During the 17th century, speculation drove the value of tulip bulbs sky high. At the height of the market, the rarest bulbs traded for as much as six times the average person’s salary.
In another example, in the 1920s, a handful of investors saw the potential of land in Florida. Speculators quickly in. But there were a series of unforeseen events: a rail traffic embargo, a shipwreck in the port of Miami and then the Great Miami Hurricane.
It’s not that these things have no underlying value – tulips are some of the prettiest flowers around and yes, if you bought the right pieces of land in Florida 100 years ago, you’d be rich. But in the early stages of any market, product or technology, no one can predict the outcome well enough to make an investment-quality bet.
Many people—from LinkedIn founder Reid Hoffman to heavyweight CEOs—are investigating and endorsing the concept of digital currencies and blockchain, the technology that makes them possible. Yet we are so far from knowing the winners and losers among digital currencies that buying such currencies is speculation, not investing. Here are four unknowns that should give you pause before you put investment money into digital currencies.
Which currencies will survive—or whether any of the current ones will—is an open question.
There are hundreds of digital currencies now, and dozens of platforms where you can trade them. Bitcoin, the best known, has risen in value more than 200 percent this year. But all the digital currencies are volatile. And it is easy to issue a new currency so there are more coming out all the time in so-called ICOs, or initial coin offerings.
“Anyone participating in sales such as these will receive tokens, theoretically usable in the future in the markets they create. Like all currencies, any value they have will come from the willingness of people to treat them as a medium of exchange or to see them as a store of value,” writes Richard Waters in The Financial Times.
The currencies are extremely volatile.
News reports show digital currencies, even Bitcoin, rising and falling as much as 10x within months. Because they are relatively unknown, cryptocurrency prices are vulnerable to bad news or to incidents of fraud. They are also at the mercy of governments, which could step in to try to block the adoption of any of them and cause prices to plummet.
“News reports show digital currencies, even Bitcoin, rising and falling as much as 10x within months.”
What investment vehicles will eventually exist to trade currencies, if any? What are the diversification strategies of those vehicles to manage the volatility?
In the United States, the Securities and Exchange Commission (SEC) rejected a Bitcoin exchange-traded fund (ETF) this spring.
The regulators aren’t certain yet how to keep investors safe. At some point, someone probably will develop an investment vehicle that enables you to invest in a basket of cryptocurrencies. That time hasn’t come yet.
How well will you be protected from fraud?
Traditional currencies are issued by governments, but anyone can issue a cryptocurrency and set up a mechanism, which could even be a special ATM, to dispense it onto your mobile phone.
In late June, in the latest example of regulatory action, the SEC filed fraud charges against the New York City-based operator of a supposed Bitcoin platform.
Some people enjoy the excitement of speculating of getting in on the ground floor. That idea is as much a classic as in 1946’s “It’s A Wonderful Life,” where the main character gets an invitation to “get in on the ground floor of plastics.”
You might be one of the early movers and might find the idea of digital currencies appealing. If so, put aside a tiny portion of your assets and have fun, but don’t be fooled into thinking of what you’re doing as investing—it’s speculating. A tiny handful of speculators make money, but many more of them lose as new markets—with all their uncertainty—develop over decades.
In a universe of unknowns, the odds are stacked against you.
To help you decide how much you can afford to bet on the highest-risk, alternative investments—or speculations—consider talking to a CFP professional. Learn more by visiting LetsMakeAPlan.org