Much ado about cryptocurrency
THE very mention of Bitcoin ( pic) evokes a mixture of feelings among the population; never has there been a currency with such polarising effects. Thomas Carper, a US State Senator hit the nail on the head when he said: “Virtual currencies, perhaps most notably bitcoin, have captured the imagination of some, struck fear among others, and confused the heck out of the rest of us.”
Just a few days ago, it came to my attention that a group of young employees from a tech company were raving about Bitcoin, touting it as “the next big thing” and a oncein-a-lifetime opportunity which should not be missed. Suffice to say, they are not the only ones who are eager to pump their life savings into another investment fad.
From the point of view of a wealth management practitioner, bitcoin, or rather cryptocurrency, has reached a “mania” status, similar to what was seen in The South Sea Company phenomenon in 1720. Back then, shares rose to astronomical value, speculations ran wild and huge fortunes were made. However when the bubble finally burst, stocks crashed and people all over the country suffered a catastrophic loss of money and property. The dotCom bubble suffered a similar fate in the United States in the 1990s.
All through history, the underlying theme of “How to make a lot of money quickly!” seems to surface time and again. Logic would dictate that the human race learns from past mistakes but somehow this is never the case. It is this concern that has prompted me to share my views on this “alternative investment”.
Bitcoin 101 – the what, why and how
Some readers who have not been caught up with the cryptocurrency craze and those who are less tech-inclined may be asking what the big hoo-ha is all about. Why are we hearing about Bitcoin everywhere we go and reading regularly about it in the media? As conventional investors, how does Bitcoin affect us?
First of all, Bitcoin is the bestknown example of cryptocurrencies that are currently available; others include ethereum, ripple and litecoin. Cryptocurrencies are a medium of exchange, created and stored electronically. It has no intrinsic value, i.e. cannot be exchanged for another commodity such as gold, it has no physical form and hence exists only digitally and finally, its supply is neither determined nor controlled by a central bank.
In today’s technology-driven market where anything digital is seen as an “in thing” compared with traditional brick and paper alternatives like banks, cryptocurrencies are an online junkie’s dream: there is no linkage to one’s real world identity, no approval or authorisation is needed to transact and everything can be done speedily and globally.
People all over the world are buying bitcoin to protect themselves against the devaluation of their national currency. Even institutional investors are starting to buy cryptocurrencies, much to the concern of banks and governments who now realise that their monetary controls are slipping away.
No doubt about it, cryptocurrencies are changing the world and as more and more of our peers are getting caught up in the bitcoin revolution, it is, needless to say, very tempting to jump onto the bandwagon.
To invest or not to invest in bitcoin? If only there was a simple “yes” or “no” answer. As with any investment instrument, it comes with risks, which are further amplified by its very nature.
Cryptocurrencies belong to a totally separate category on their own, vastly different from stocks, bonds or commodities. They were created out of thin air and exist purely in cyberspace, void of any tangibility.
Price volatility
Bitcoin is an extremely speculative, high risk investment. In the industry, gold is deemed highly volatile, but it is nothing compared to bitcoin with a volatility of seven times greater according to Matt T. Williams.
Since its inception nearly a decade ago, Bitcoin has gone through a series of highs and lows. Between 2013 and 2015, it peaked at US$1,100 only to drop to US$700 a few months later, and subsequently plummeted to US$200. Nothing is preventing this scenario from happening again. From January to October 2017, bitcoin price has risen from about US$900 to US$4,800 – that is more than 400% growth in less than a year. Eager investors are anticipating Bitcoin to go up to as much as US$10,000. Can this happen? Possibly. It is also possible for it to tumble back to US$2,000 or lower this year. Unlike stocks and bonds, there is no telling how high or low bitcoin can go.
Probability of losing your capital
Regulatory risk: There is no central bank or government authority in any country in the world that currently backs the safety or soundness of digital currencies. Unlike fiat-money which is guaranteed in its value by the issuing government or central bank, investors of cryptocurrencies would have no recourse to recoup their capital should its value zerorise overnight.
Because cryptocurrencies are not regulated, there is no telling what might happen if the government of various countries decide to clamp down on it. Chinese authorities have ordered Beijing-based cryptocurrency exchanges to cease trading and immediately notify users of their closure, signalling a widening crackdown by authorities on the industry to contain financial risks. As a result of the crackdown, Bitcoin dropped 9.3% to US$3,077.55 that week.
Warnings issued by UK financial watchdog, the FCA and the Securities and Exchange Commission which regulates the New York financial markets was sufficient to ruffle a lot of feathers in the digital currency industry.
The bottom line is, due to its unregulated nature, the whiplash reaction of bitcoin’s value to any announcements by government authorities is something that potential investors should give serious thought to. God forbid, should any large economy ban bitcoin, the price will collapse and likely struggle to recover.
Security risk: Cybercurrencies face risks of loss due to theft as it is liable to being hacked, which has happened in some Bitcoin exchanges.
Granted, die-hard Bitcoin fans will vouch for its security features that are in place, such as a public key cryptography system that locks away the funds and special digital storage vaults, likening a BTC address to be even more impregnable than Fort Knox.
But let’s face it, anything that is digital may be susceptible to hacking. It may not happen this year or in the next five years, but one day, someone could just find a way to do it. And when it does happen, investors will have virtually zero recourse. Without the backing or protection of any authority and no insurability, the investment will be as good as gone.
No income stream
Unlike most solid investment assets that give you income, you don’t earn anything unless the price of bitcoin appreciates. For example, when you invest in stocks, you receive dividends; bonds provides regular interest payments at a pre-determined coupon rate; If you purchase property, you will earn a monthly rental income. Such a characteristic gives an intrinsic value to an investment asset. It makes it easy for us to attach some form of valuation on the investment asset. In comparison, Bitcoin doesn’t generate any income stream, which makes is a less attractive investment alternative.
Bottom line, with the lack of intrinsic value, Bitcoin investing is a speculation at best, and gambling at worst.
Invest with your head, not your heart
The decision whether to invest in cryptocurrency or not is purely a personal choice. It is just one of the many investment vehicles out there which may or may not be suited to you as an investor. Before you decide on any investment, it is important to know your asset allocation strategy and carry out the necessary due diligence. As with all high-risk investments, we need to tread and proceed cautiously.
You may get remarks such as “would you rather stand by and observe, or be part of history in the making?” or “If you walked away now you might live to regret it.” Peer pressure can be overwhelming when it comes to flash-in-the-pan opportunities as evidenced by the money game controversy that I wrote about previously. Therefore, you need to know your limits in order to strike a balance between being a responsible investor and satiating your desire not to “lose out” on this trend.
I would advise investors to put in not more than 1% of total investable assets into cryptocurrency if they really feel the need to do so. However, if an investor is serious about growing money with high certainty, then my take on cryptocurrency is to avoid it altogether.
It is vital when it comes to decisions involving money that we do not let emotions lead the way. Keeping up with the Joneses is not a reason to invest in cryptocurrency. Just because your family members and peers are in it, does not mean you should be too. Don’t get bitten by Bitcoin.