Famous investor Warren Buffett said “bitcoin will end badly” and “bitcoin is rat poison squared.” This is his general view of all cryptocurrency.
Warren’s a smart guy. I value his opinion, and so should you. Is he right?
He’s a self-proclaimed “value investor” who built his fortune by finding well-established, undervalued companies and making big bets on their future success. Most of my wealth comes from equity in real estate. He’s famous. I’m not. He’s had eight decades to build his wealth. I’ve been doing it for less than one. His investments have done really well this decade. Over the same time frame, my investments have done better (without including cryptocurrency). He’s the son of a wealthy Congressman and a homemaker. I’m the son of a public attorney and an ESOL teacher. He’s worth $40 billion. I’m worth…a lot less. He’s from the silent generation. I’m a millennial. He has his own family office to manage his wealth. I have Personal Capital manage my wealth (try them at Personal Capital).
He does him, I do me. To say we have a different philosophy about investing would be…
Warren Buffett and I share the same general philosophy around investing. I’ve even read some of his books. Our shared viewpoint: find “things” that seem undervalued, buy them when they’re undervalued, and hold them for a long time.
While we share the same philosophy, we have different perspectives. I see new technology as exciting and I like to spread my bets among novel competing projects to see who wins. He sees established businesses as exciting and he likes to spread his bets among businesses that have economic moats preventing meaningful competition.
Who’s the more credible source of investment opinion?
I consider myself as credible as any other random person posting information on the internet. While I’m not qualified to give financial advice and I can’t help you trade cryptocurrency, I can offer my perspective below. At first I hesitated to publish this—who am I to say what’s a good approach? What expertise do I have?—but people asked for my opinion. I hope you enjoy reading it.
(If you’re interested in the potential social and economic value of cryptographically-secure, time-stamped distributed ledgers that allow people to exchange things using digital currency, read my book, Consensusland. This post is solely for people who want to make money selling cryptocurrency for more than they bought it for.)
Two Things Before You Read More
If you have no money, the last thing you should do is buy cryptocurrency as an investment. You have no expectation of profit and no way to recover your losses. Either buy cryptocurrency with the intent to use it or just stay away. Build a little wealth with something safe, like a cash savings account or a properly-financed rental property, then come back to cryptocurrency. While you may miss out on some gains, you benefit from having something of value in case cryptocurrency fails. Crypto is a very speculative investment.
Also, please keep in mind, I am actively invested in private equity and real estate, long-term, illiquid investments with tax advantages and legal protections for investors. Basically the opposite of cryptocurrency. While these investments involve more work, costs, and risks than other types of investments, they pay off far better than cash and equities and carry far less downside than crypto—and if things go bad, you have the government on your side, not Wall Street’s. I tend to have more patience, more tolerance for risk, and a more long-term timeframe than most people who offer opinions about cryptocurrency.
I also own stocks, bonds, cash, and commodities but I don’t know how to invest in those assets so I give that job to my awesome financial advisor, Keith Jones. You should, too. Sign up with Personal Capital and ask for him. You can use Personal Capital’s investment tools for free and I believe there’s no minimum if you decide to open an account. You can try it for free and get $50 for signing up using this link.
Why Everybody Needs to Own Some Speculative Assets
Many researchers have compared cryptocurrency to other types of assets like cash, gold, real estate, stocks, and bonds. They’ve all concluded that price movements in cryptocurrency markets do not correlate to price movements in those other markets. Morgan Stanley confirmed this in its summary of the investment industry’s view of cryptocurrency and I think the most readable explanation comes from Yale, summarized in an interview with one of its researchers.
As a result, cryptocurrency makes a perfect addition to any investment portfolio that’s built around Modern Portfolio Theory, which demands you spread your wealth among assets that don’t move up or down at the same time or to the same extent. This means setting aside some portion of your wealth to risky investments others may consider “gambling.”
When you spread your investments this way and rebalance over time, you get better returns with less overall volatility than simply buying stocks and bonds or keeping your money in a savings account. Harry Markowitz won a Nobel Prize for discovering this phenomenon and it’s now a standard approach to building wealth.
Cryptocurrency is also an asymmetric bet. If you buy a little bitcoin—maybe 1 percent of your total wealth—you can sell some the next time it booms to book an easy profit. If bitcoin goes to zero, you don’t worry about losing 1 percent of your wealth. You can lose that much in the stock market any given week, sometimes in a day. While bitcoin’s price changes a lot, it has ended almost every year higher than the year before, sometimes 1,000 percent higher or more. In fact, even after this most recent collapse in prices, bitcoin is up almost 400 percent from the beginning of 2017 and some other cryptocurrencies are up even higher. You have history on your side.
How does asymmetric betting apply to cryptocurrency?
Here’s an example. Imagine you have $100 to invest. You decide to maybe buy bitcoin. When you buy $100 worth of bitcoin, you will get one of two outcomes at the extremes:
- Option 1: history doesn’t repeat itself, bitcoin dies. You lose $100.
- Option 2: history repeats itself, bitcoin goes up 1,000 percent. You make $1,000 or more.
Option 1 has never happened. Option 2 has always happened. Which is more likely?
Nobody knows, nobody can predict the future. From a purely academic perspective, you have an extremely strong case for buying a little bitcoin. When you lose, you lose a little. When you win, you win a lot. As long as you keep your investment small and sell when the price goes up, you can make money even if you lose most of the time. Your wins will far outpace your losses.
Also consider potential future growth if cryptocurrency gains traction. This earth has at least $200 trillion to $1 quadrillion worth of “things” that can get recorded on a blockchain and bought or sold at any time. All cryptocurrency combined captures slightly more than $100 billion of that market, less than a fraction of a percent. If cryptocurrency is even modestly successful, the potential returns are astounding.
Why you shouldn’t take recommendations from Twitter
Yes, scams abound but that’s not why you need to avoid “Crypto Twitter.”
You should always be careful when taking advice from books or blogs or Reddit, but Twitter is the absolute worst place to get advice. You don’t know who’s getting paid to shill and the tweet format makes it almost impossible to get any depth of analysis or perspective. Social media tends to amplify tweets from people with large followings or clever comments, not sound thinking, sober assessments, or demonstrated history of success. Accounts are anonymous, sometimes fraudulent, and often self-serving. There is no worse source of information than Twitter.
Always heed a bit of advice I learned from a person who used to work on Wall Street: “if they talk about buying, they’ve already bought.”
Why you can’t compare the prices of different cryptocurrencies
You might see a crypto like XLM priced at $.10 and another crypto like WAVES at $3.00 and conclude XLM is cheaper than WAVES.
Truth is, nobody knows. It’s hard to know what’s cheap or not when you’re dealing with a speculative asset like cryptocurrency and it’s useless to use price as a factor. That would be like paying $24 for a Big Mac instead of paying $30 for a filet mignon because you thought the Big Mac was a better deal. In reality, the steak is a fair price and the Big Mac costs $20 more than you would spend if you went to McDonald’s.
Yet many people apply this flawed logic to cryptocurrency.
I’m not sure anybody can assess value in a speculative market like cryptocurrency, where the price isn’t related to any financial metrics. The number of tokens has a big influence on price. When people create cryptocurrencies, they set a formula for creating new coins. Some create all coins at once, which caps the total available supply. Some set a schedule for creating new tokens but impose a cap on the total. Some have no cap. Some reduce the number of tokens over time. Some use a different formula. Price is simply a function of math: the amount of money people have put into a token divided by the number of tokens. More tokens, lower price. Fewer tokens, higher price.
Many cryptocurrency analysts advise using market capitalization, aka “market cap,” a stock market term for the value of a company based on the number and price of all its shares. You can think of “shares” as the tokens themselves and the “company” as the cryptocurrency itself.
I’m not sure this financial concept works with cryptocurrency, but it’s a useful crutch. Once you know the market cap, you can get some sense of whether a token is “cheap” or “expensive” compared to another token by looking at its price compared to its total potential market. An expensive coin with a huge potential for growth may make a better investment than a cheap coin with a massive supply.
For example, XLM, if successful, will capture the market for micropayments and global transactions. How big is that market? Remittances alone total $2 trillion at any given time, and you can assume corporate internal transactions and various micropayments add a significant amount to the market. Let’s assume $5 trillion total target market, which might be a little generous but not unrealistic.
At the time I write this, XLM has 20 billion tokens in circulation at $.10 each—a market cap of $2 billion and equal to 0.4 percent of its target market. Let’s assume XLM one day captures 2 percent of that market, $100 billion worth of commerce. You can expect each XLM token to reach $5 for a 5,000 percent gain. Then you have to discount for the constant release of new XLM tokens (about 1 billion each year). This means you can expect a somewhat less than 5,000 percent gain because your share of XLMs goes down.
Compare that to WAVES, a token for decentralized cryptocurrency exchange, release, and fundraising. WAVES has 100 million tokens in circulation at $3 each—a market cap of $300 million. What is its target market? Everything. At least $200 trillion to $1 quadrillion worth of global wealth. It’s market cap is one-sixth as much as XLM, yet its target market is probably 40 times larger, if not more.
Which is the better investment? Which is likely to go up more? Both are legit projects with bona fide teams and strong value propositions. Both are unproven. If you have $10 in your pocket, is it better to buy 1,000 XLM or 3.33 WAVES?
Assuming both have the same chance of succeeding, WAVES is a much better investment. You take the same amount of risk for much greater reward.
Why Cryptocurrency Can Boost Your Purchasing Power
Did you know you can use your cryptocurrency instead of selling it?
It’s true. As a result, you need to consider purchasing power. It’s hard to understand how purchasing power works because you can’t see it happen, but I’ll oversimplify:
You gain purchasing power when your money buys more things than it did before without having to make any more money.
In other words, your money goes further.
For example, if bitcoin succeeds, 1 bitcoin today may buy 10 bitcoin’s worth of things in five years…even though you still have only 1 bitcoin. You will not have to sell your bitcoin to get this benefit. You simply buy things with bitcoin. In fact, you will not even notice your gains until you look back and realize how much more you can buy than you could before.
You have a chance to gain purchasing power from every cryptocurrency that has a fixed supply and most cryptocurrencies that have another formula for creating coins. This is not something you get with any other investment.
Most people would not consider this a feature of investing, because it doesn’t actually produce new wealth. I consider it a very overlooked and underappreciated benefit of buying cryptocurrency as an investment. Imagine your $1 bill can one day buy a $100 dinner. Wouldn’t you consider holding onto that dollar?
You can never expect that result from your local currency. Haven’t you noticed that you always need to make more money each year simply to keep up your lifestyle, even though your tax bracket and living expenses don’t seem to change? It’s because your money loses purchasing power. All modern government-issued currencies are designed to lose purchasing power over time. The U.S. Federal Reserve uses inflation to intentionally reduce the dollar’s purchasing power slowly over time and it’s quite open about this. A little bit of inflation is healthy for your country—it keeps the economy growing and encourages investment—but it’s bad for the value of your money and it’s something you need to consider as an investor.
While cryptocurrency prices fluctuate from day to day, most cryptocurrencies are designed to grow purchasing power over time. While this won’t matter if you hold cryptocurrency that nobody wants or nobody uses, any cryptocurrency that gains traction will let you buy more things in the future when you use it for its intended purpose. For example, if you buy Steem Power now and the Steem blockchain fulfills its potential as a social networking platform, you will gain influence on that platform without lifting a finger. Your Steem will go further. Likewise, if you buy Basic Attention Tokens now and BAT fulfills its potential as an alternative source of advertising revenue, you will gain advertising power over time, simply by holding your BAT in your wallet. Your BAT will get you more attention than it did before.
Even if nothing else changes.
Why HODL Isn’t the Best Strategy
Have you heard people use the word “HODL” to describe their cryptocurrency investment strategy?
It means “don’t sell when the price goes down.”
This is not bad advice. Any cryptocurrency that succeeds will be worth so much in 10 years, you won’t be able to comprehend how it was ever possible. You don’t want to sell and miss out on all that growth.
I would encourage a different approach. I call it HODL-plus.
Ride the ups and downs. Keep money in the market even when the prices collapse. But whenever you see any cryptocurrency go up a lot, sell some. Take profits. You can even set a formula for yourself, e.g., sell 10 percent each time the price goes up 300 percent. Buy something for yourself or stash your profits in a bank account.
When your $100 worth of Ethereum grows to $300, sell $30 and keep the rest. If the whole thing goes to zero, at least you have $30. If the value of your Ethereum goes to $1,000, sell another $100. Hedge your bets. You need to protect yourself in case cryptocurrency fails as a technology.
You can set a predetermined “sell” price in advance using any cryptocurrency exchange and some wallets.
Maybe you think cryptocurrency prices will keep going up and you don’t want to sell early. That’s a risk. I look at it this way: you bought cryptocurrency to sell it for more than you bought it for. Now you can sell it for more than you bought it for. You got what you wanted. Accept your good fortune and make sure you come away with something of value in case the whole market collapses.
Maybe you think it’s silly to sell such small amounts. I get it, but $30 is $30, it doesn’t matter where it came from. If $30 fell from the sky, would you feel bad about spending it? Would you wait for the sky to drop more money into your lap? Don’t do that! You still have $270 worth of Ethereum off of a $100 investment. That’s an insane return. Unsustainable. Take some profits. The price could drop at any moment.
Why you need to know about taxes
In Switzerland, cryptocurrency is taxed the same way as cash. In the U.S., cryptocurrency is taxed the same way as property. Where you live, it might be taxed differently.
Learn about your local laws and use those laws to your advantage.
While you might think it’s bad that the U.S. taxes crypto like property, it’s not. Complicated? Expensive? Nonsensical? Sure. But not bad. If you’re willing to keep track of your cryptocurrency activities, U.S. tax code gives you ways to lower your taxes when your crypto loses value and protect some of your gains from taxation when the price goes up. You couldn’t do that if the government treated cryptocurrency like cash. Talk to an accountant.
Why you need to know what you value as an investor
People forget sometimes that the value of investments is not to see their prices go up. The value of investments is to build wealth. Price exists on paper. Wealth is real.
Sometimes, you can build wealth even if your investments go down in price. My property values might go down every year until I die, yet I may still build wealth because of the way I structured my investments. My Sega Genesis may lose value every minute it sits on my shelf, until many years from now, when almost all other Sega Genesis consoles are gone and I am one of a few who have a coveted working system with working games, at which point it may be worth quite a bit.
My point: know what you value and invest accordingly.
I personally buy cryptocurrency because I believe successful tokens will gain a tremendous amount of purchasing power in a decade or two, once cryptocurrency has broad usage. I also expect the U.S. will pass a law allowing people to use some cryptocurrency tax-free and exchange cryptocurrency with each other without creating a taxable event. I also worry about a financial or political crisis that will destroy the value of my dollars and my other investments.
I do not plan to sell my cryptocurrency for cash, yet even I sell a little when prices boom or a particular token gets pumped. If the whole market goes super-parabolic again, I’ll sell a lot. The future’s uncertain and I have a family to take care of and good causes I want to support. “A little for today, a little for tomorrow, a little for your children, and a little for others.”
As somebody told my father when he worried about spending his savings after he retired, “you built a ship, you might as well sail it.” When the winds turn in your favor, set sail. Good fortune doesn’t last forever. Enjoy it while you can and prepare for the day it ends.
In other words, relax and enjoy the ride.
Personal Capital—free investing tools
Rich Dad Poor Dad: What The Rich Teach Their Kids About Money—book about building wealth
The Intelligent Investor—book about value investing
All About Asset Allocation—book about asset allocation
Bullish on Bitcoin—book about how to profit from cryptocurrency in 2019