Cryptocurrency: Bad Investment, Great Speculation

Do you hate cryptocurrency? Does bitcoin make your skin crawl? Does the idea of buying cryptocurrency seem like a total waste of money?

Warren Buffett said, “bitcoin will end badly.” He’s a smart guy. But is he right? Or do all those bitcoin millionaires have a point?

If you’re only interested in making money, none of that should matter. Set your emotions aside, put your thinking cap on, and look at the risks and rewards of cryptocurrency as a way to build wealth.

(If you’re interested in the technology of cryptographically-secure, time-stamped distributed ledgers, this post is not for you. I will write about this aspect of cryptocurrency in other posts.)

Instead of looking at the investment case for all 2,000+ cryptocurrencies, let’s focus on bitcoin. It’s the easiest to buy, easiest to use, and most popular. It’s also the oldest, which means we have some price history to look at. Bitcoin’s long price history reveals patterns that will likely repeat. Same as you see patterns in the prices of conventional investments like stocks and bonds, you can see patterns in bitcoin’s price.

Let’s look at bitcoin’s price from mid-2010 to fall 2018:

This logarithmic chart helps you see all the movements in bitcoin’s price, even relatively small ones. Compare this with the logarithmic chart of the US stock market since 1971, using the S&P 500 as our benchmark:

I stripped out the usual adjustments for inflation because the bitcoin price chart didn’t adjust for inflation either.

For sake of comparison, here are the charts for gold, dollars, and S&P 500 from mid-2010 until fall 2018 in case you want to see price movements of different assets over the same time frame. Scroll down if you already realize there’s no sense in comparing assets by time frame.

Gold

Dollars

S&P 500

I use charts for only one reason: they put price changes in context. Different assets have different “normal” movements up and down in price. A 5 percent annual increase in the price of real estate is phenomenal, you’d worry that the market’s overheating. In stocks, 5 percent would be a down year but nothing to worry about. In gold, 5 percent is meaningless, you could sneeze and the price could go up or down 5 percent before you could wipe your nose. These charts allow us to filter out the differences in volatility, which makes for a clearer picture and a simpler, more accurate analysis.

Once you get rid of the noise, the media hype, the bubble, the crash, the boom, all that emotion, what do you notice about the price of bitcoin?

It goes up.

Not straight up, but up.

Hidden in that chart are upswings of 1,000+ percent and declines of 80+ percent. Left out of that chart are thousands of articles about how bitcoin is dead and how bitcoin is the greatest thing ever.

Again, set that aside and put your investment cap on. You have $100 to invest. Do you buy cryptocurrency?

Here are the possible outcomes for your $100 investment:

• Option 1: bitcoin’s pattern stops, history doesn’t repeat itself, bitcoin dies. You lose $100.
• Option 2: bitcoin’s pattern continues, history repeats itself, bitcoin goes up 1,000 percent. You make $1,000.

Option 1 has never happened. Option 2 has always happened. Which is more likely? Impossible to say. That’s the problem with investing — you never know what the future will bring. You need to get some sense of viability, the likelihood bitcoin will have a reason to increase in value over time.

Bitcoin’s technology, blockchain, allows the world to exchange $200 trillion to $1 quadrillion worth of “things”  without many of the risks and costs of traditional money. Yet, bitcoin has captured only .035 of that value and less than a half-percent of people own any bitcoin. The number of people using bitcoin has grown steadily year over year and interest is growing, too. Switzerland, Japan, Malta, Singapore, Hong Kong, and Estonia have rules and laws to help the technology flourish. The United States will probably see its first cryptocurrency bill passed during this session of Congress.

Does that sound like a bad investment?

Yes, it does. We agree on that. Cryptocurrency is unproven and underdeveloped. It’s slow and complicated. Developers haven’t agreed on common standards. Nobody wants to learn how to use it. Past performance is no guarantee of future success.

Cryptocurrency is a speculation, not an investment. As a speculation, it’s an excellent one because if history repeats itself, you should expect to come out way ahead.

Hold on, Mark, if you’re so sure about this, why don’t you have all your money in bitcoin? Put your money where your mouth is!

I didn’t say I’m so sure about this. Frankly, I’m not so sure about this. I just look at the history of cryptocurrency, the value of its underlying technology, and the current situation. I also consider risk/reward: if you win, you make 10-20 times your money, possibly much more but if you lose, you lose all your money. I’m not willing to lose all my money.

I simply point out, based on my observations, how cryptocurrency is a fantastic speculation, possibly a once-in-a-lifetime opportunity to make a lot of money without a lot of work. It takes maybe 5 minutes to create your bitcoin wallet, 10 minutes to gather your KYC/AML documents so your bank will let you buy bitcoin, and maybe a year or two of waiting for the market to go up again, as it always has. Other cryptocurrencies are a little more difficult to buy, but you’ll figure it out quickly once you get the hang of bitcoin.

If you don’t want to buy now, that’s ok. Nothing bad will happen to you. Cryptocurrency may end up being totally useless (if it isn’t already).

I only caution you on one thing: when the price goes back up and everybody’s talking about cryptocurrency again, please don’t buy. Buy now, or after the next boom. Otherwise, you’re doomed to lose your money.

Remember, cryptocurrency always has big swings up and down. It’s a pattern seen time and time again, with a decade of history behind it. This pattern is as reliable as “real estate always goes up in value over time” and “the stock market goes up 3 out of every 4 years” (both true statements).

If you’re willing to invest based on those patterns, why wouldn’t you invest based on the patterns I just showed you?

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Also published on Medium.