Believe it or not, it’s been over a decade since the world was first introduced to the concept of cryptocurrency, with the creation of Bitcoin in 2009. Since then, we’ve seen a tidal wave of digital currencies sweep across the globe, turning traditional notions of finance on their head.
Sure, the world of digital currencies and blockchain can be intriguing with its potential to democratize finance, break down borders, and even change the way we do business. However, as with all things that glitter, all is not gold. Investing in cryptocurrencies brings its own set of unique challenges and risks, from regulatory uncertainties to high volatility, a prevalence of fraud and scams, and sudden bankruptcy.
What is cryptocurrency?
It’s a type of digital or virtual currency that uses cryptography for security. Only those with a unique key can decrypt it, making it a secure way to conduct transactions. Crypto can be purchased either on a cryptocurrency exchange or through a peer-to-peer network. You must also have a cryptocurrency wallet to buy, sell, or use crypto for transactions.
Each cryptocurrency, alternatively known as a coin, has its own blockchain technology with varying characteristics. Of course, the most famous example is Bitcoin. Ethereum is also a forerunner due to its groundbreaking technologies, such as smart contracts and proof-of-stake validation method.
What is blockchain?
Blockchain is the technology behind cryptocurrency, serving as a ledger where all crypto transactions are confirmed and recorded. But this digital ledger isn’t in any one place or on one server – instead, it’s replicated on thousands or more computers worldwide. It consists of ‘blocks’ that contain the transaction records.
It’s a symbiotic relationship – cryptocurrencies are the asset, and blockchain is the system that allows those assets to be moved securely and transparently. Each time a user conducts a transaction, the whole blockchain communicates with each other to confirm it and then records it.
Additionally, neither the government nor a traditional financial institution, such as a bank, is involved in this transaction, meaning you’re placing all trust in the technology itself rather than in a higher authority that is regulated by a body that represents the people, for example, the SEC.
Should I Invest in Crypto?
John Maynard Keynes posited that there are two basic yet fundamental forms of stock valuation; the Castle in the Air Theory and the Firm Foundation Theory. The Firm Foundation Theory takes a sober approach to company valuation to justify or deter the purchase of a stock by calculating its intrinsic value through a careful analysis of its cash flow, dividends, and other measurable factors.
The Castle in the Air Theory doesn’t bother with the bookish stuff, instead focusing on investor sentiment, i.e., the likelihood of investors purchasing or selling a stock. This is how bubbles form – the fear of missing out strikes investors. They’re sure the stock will rise in value, but they just need to purchase it before other investors do. And it often does, but eventually, someone is left holding the bag once that bubble bursts.
I go into this because it’s precisely these ‘castles in the air’ that drives the growth of cryptocurrency. In fact, the Castles in the Air Theory is the only possible way to value cryptocurrency. Bitcoin doesn’t have a balance sheet, dividends, or anything intrinsic to measure, besides the energy consumption used to create a new block. You can’t physically use crypto for anything besides buying, selling, and holding. Yes, that may remind you of regular fiat currency, but that’s an article for another day.
Therefore, you rely solely on the hope that others will believe it will increase in value once you have purchased it. This is akin to gambling, and as professional investors, we value security of principal and steady snowballing gains more than anything.
Of course, this may be a bitter pill to swallow. Many of us have heard of a friend who knows a friend who bought Bitcoin when it was a few dollars a coin. Those cases are exceedingly rare, akin to those lucky few who purchased Apple when it was still a startup. That’s the FOMO (Fear of Missing Out)kicking in, and it will only lead to investing mistakes.
That’s why a financial advisor is so important. Frequently, the path to financial ruin is paved by making easily avoidable mistakes. A financial advisor can guide you away from making critical mistakes with a clear-cut financial plan. Coins are volatile, risky, aren’t backed by the good faith of the federal government, and don’t hold intrinsic value. Therefore, justifying their place in a diversified and safe portfolio is difficult, if nigh impossible.
Also, even if you do get lucky and pick a decent coin that skyrockets in value (to the moon in industry speak), you’re still stuck with the fact that, even though blockchain is entirely secure, your crypto wallet or exchange may not be. As with any new industry, the crypto industry is fraught with fraud, scams, and instability. You have to know what you’re doing to keep your money safe. This means keeping a ‘cold’ wallet disconnected from the internet when not in use, making your coins somewhat illiquid. In the case of a financial meltdown, you may not be able to unload your coins before it’s game over.
Alternative Crypto Investment Strategies
Now, it’s not that there’s no money to be made in this fantastic technology. If you genuinely believe in cryptocurrency, there are more indirect ways to invest, such as purchasing a crypto-oriented ETF. Alternatively, you can look into mining, staking, or yield farming. However, be aware that these strategies come with their own unique risks and may be expensive to get into. You should know that the mining of some currencies, such as Bitcoin, requires enormous amounts of energy and cause significant ecological damage, and many countries have even banned it.
If those strategies don’t cut it for you, then there’s nothing wrong with taking some play money, purchasing some of your favorite coins, and trading them as a hobby. Liken it to playing the slot machines in Vegas or buying a lottery ticket, though. Again, only use money that you don’t mind losing and isn’t a part of your regular, advisor-approved plan.
Will Investing in Crypto Ever Become Viable?
Even though Bitcoin appeared over a decade ago, blockchain is still in its infancy. As the technology progresses and becomes more mainstream, complete with regulation and a step away from the wild west environment it currently operates in, we may see cryptocurrency become a viable investment.
The use cases are numerous and shouldn’t be ignored. Just a few are:
Real Estate
Real estate transactions often involve a complex web of records, contracts, and intermediaries, leading to inefficiencies and fraud. Blockchain can streamline this process, making transactions more transparent, efficient, and secure. Smart contracts allow for immediate closings on a property, drastically reducing transaction costs and paperwork.
Medical
Blockchain can bring about a significant shift in healthcare, particularly in managing patient records and data security. The technology’s ability to store information securely and transparently can help streamline patient records, ensuring data integrity while facilitating better data sharing across platforms.
Accounting
Blockchain allows for tamper-proof, completely transparent, and automated records that can be easily cross-checked with documents, drastically reducing the time necessary for labor-intensive audits.
Voting Systems
Blockchain’s security and transparency features can even be used to create tamper-proof voting systems. Votes can be tracked in real-time, results can’t be manipulated, and voter fraud becomes nearly impossible.
And many, many more. Even more exciting is the advent of artificial intelligence, which can amplify the possibilities and benefits of blockchain technology. Even today, you can use AI to search a blockchain’s records and again use AI to cross-check it with a database specially created to be used by AI. The sky is the limit with these new technologies.
In Conclusion
Blockchain and cryptocurrency aren’t going anywhere. In fact, we should get used to them becoming a more ever-present factor in our lives as the technology progresses and regulations become implemented. Until then, however, purchasing coins is more similar to buying a lottery ticket than investing. If you want to have some fun with some extra funds and explore the ins and outs of gambling, knowing you can quickly and easily lose it all, go for it. But don’t replace it with a plan crafted by a fiduciary financial advisor with your best interests in mind.
