Cashing In (or Not) on Cryptocurrency Mania!

January 11, 2018 in Blog

Damn!

Bitcoin rose 1,300% in 2017.

Ethereum, another cryptocurrency, rose nearly seven times higher… 8,900%!

Iota went up 500% in a month. Stellar lumens 700% in 60 days…

But all that pales in comparison to ripple, which skyrocketed an astonishing 36,000%!

I learned about cryptocurrencies four or five years ago.

Did I buy some?

No.

Do I wish I had?

Sure.

Should I – i.e., you – buy some now?

That’s what I want to talk about today.

I first heard about the cryptocurrency market from a financial analyst I admired. He was very enthusiastic about the prospects of bitcoin, so I asked him to explain it to me. After listening just long enough not to offend him, I interrupted and advised him, half seriously, to sell his hoard.

A year or two later, a colleague began writing about bitcoin in a newsletter to which I also contributed. This time, I paid it more attention, reading about the blockchain and the concept of mining and the elaborate cryptographic algorithm that supposedly made it so safe.

Much of it went over my head. But I did come away from my reading with the following thoughts:

  • Bitcoin was indeed a currency like the dollar or any other paper currency. It was invented to solve some of the “problems” with paper currency.
  • It was designed to be anonymous, or nearly anonymous. The idea was that you could buy and sell it using a digital code. Your identity was kept private.
  • The number of bitcoins was finite, which meant that its value could not be inflated, as paper currencies can, by making more of them.
  • It could be divided into smaller units.
  • And it was easily transportable.

These are significant advantages. I understood why it was…

Alluring to gold bugs: Because, like the dollar when it was tied to gold, it could not be artificially inflated – i.e., its value could not be diminished by the Federal Reserve/Treasury.

Attractive to Libertarians: Because it existed on an open source platform, it was free from the regulatory mechanisms of the government.

Intriguing to criminals and anyone else that valued financial privacy: Because it was effectively anonymous and enabled parties to transact business outside the view of the law enforcement community and government regulators.

What I didn’t understand was the technology behind it. And since I didn’t understand that, I couldn’t know for sure that these touted benefits were as real or as certain as bitcoin enthusiasts were saying they were.

Nor could I get myself past one persistent objection: The long-term value of bitcoin (or any currency) depends on the number of people willing to use it.

The number of people willing to use bitcoin is growing, but it is still relatively small. For it to become truly useful, it would have to gain the trust of tens of millions of people.

And if it ever became that widely used, the government might see it as a threat to the dollar and make it illegal to trade or even own. (That’s what they did with gold during the Great Depression.)

Here was my thinking back then, as simple as it was…

I’ve been in and around the investment business for 40 years. I never had much interest in the subject, but I managed to learn a few things early on that helped me build wealth safely.

Of the dozen or so rules I follow, the first and most important is: Don’t invest in anything you don’t understand.

Yes, that’s common sense. But like most commonsensical rules, it’s rarely followed.

Most people have little to no knowledge of the companies whose stocks they buy. The same level of ignorance exists for those that invest in bonds or options or commodities. Most of the time, most people invest their money based on stories they read about or hear from brokers. If the stories are good enough, the checks are written.

The price of the stock or commodity or whatever soars. And then, because the increase was based on nothing but a story, the bubble bursts and it drops.

In my lifetime, I’ve seen this happen with gold and with tech companies and then with dot-com businesses and then with real estate. And those are only the big ones. Smaller bubbles rise and fall all the time.

What’s interesting about the cryptocurrency bubble is that the level of ignorance is probably greater than it was for any of the others.

And here’s my thinking now…

I recently entertained a group of friends – lawyers and doctors and educators – by “explaining” the cryptocurrency market to them.

They were impressed by how much I knew. But what I was telling them was only the most superficial details of what I remembered from my reading. My knowledge is far too skimpy to say that I understand it.

That said, I know several analysts that are smart and honest and they are convinced that cryptocurrencies are here to stay. So I feel it would be foolish to turn my back on them completely.

I’m thinking there may be a way for me to stick my toe in the water without risking much and see if that incentivizes me to study cryptocurrencies in a more serious way.

Of course, I would like to have bought – on a lark – five or 10 grand of bitcoin back then and watched it balloon into millions of dollars. But as a conservative investor, I’ve become accustomed to saying no to attractive financial opportunities. During my investing career, I’ve let thousands pass me by. Some of them, like bitcoin, were big winners. But more than 90% of them turned out to be pure crap.

And here’s the thing. When I pull back the petals of my regret, what I find is a fragile little ego, one that wants to claim credit for getting in on what may be the biggest financial run-up in my lifetime. It’s all about self-esteem. I want to be able to brag about how prescient I was as an early investor and how much money I made as a result.

 

This is the little I know for sure…

Cryptocurrencies are currencies. They are not businesses. Businesses produce products and/or provide services. Cryptocurrencies do not Businesses create revenues and earn profits. Cryptocurrencies do not.

As I’ve said, cryptocurrencies are in some ways better than paper currencies. But ultimately their value depends on how many people use them.

When you buy a cryptocurrency now, you are making a bet that it will eventually become a mainstream currency like the dollar or the euro. Its value will increase only if this happens.

So if you have a long-term perspective in your investing, it makes some sense to invest in a cryptocurrency if you believe its user base will continue to expand – and greatly. If you don’t believe that, buying cryptocurrencies is a gamble.

And you should never gamble more than you can afford to lose.

But is there a short-term play?

Despite their advantages, I don’t know if cryptocurrencies are going to replace paper currencies.

The big “if” for me is government.

I keep asking myself, “Why would governments that have the power to control paper currencies give up that power? Why would they give away the ability to affect their economies and therefore possibly affect elections?”

In 1933, when gold was perceived to be in competition with the dollar, FDR declared it illegal to own more than a very small amount.

In 1971, when the gold-backed dollar was perceived to be a threat to the government’s power, Nixon detached it.

Why wouldn’t current or future politicians do the same thing?

Since I don’t have a good answer for that, I’m not willing to buy bitcoin as a long-term investment.

But I do believe that we are only at the early stages of the cryptocurrency mania. I believe we have months, if not a year or so, of the bubble getting bigger.

So I’m cooking up a way to gamble on that. I’ll tell you more about it soon.

PS: As this was going to press I read a news brief about South Korea’s plan to regulate cryptocurrencies. Does this presage my worry? More on that to follow

PPS: Also I’ll give you recommendations for the best essays I’ve read on the subject.

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