Mistakes that first-time investors should avoid
▶ Cryptocurrency’s rally is set to draw new buyers, but recent price swings raise risk levels, writes Stian Overdahl
Even amid the soaring technology stocks of 2020, Bitcoin’s price action stood out, having risen from its March low of about $3,800 to more than $29,000 by New Year’s Eve. It continued to push higher in the first weeks of this year and reached a high of more than $40,000.
To put that in concrete terms: if an American had invested their $1,200 stimulus cheque in Bitcoin in mid-April, it would have been worth more than $7,000 when it reached that high.
But gains in cryptocurrencies can be fleeting, with Bitcoin crashing by about $10,000 in a single day on Monday.
It is these wild price swings that are part of why Bitcoin remains as polarising as ever. To its acolytes, the world’s first cryptocurrency is sound money and a future global reserve currency. Bitcoin can be sent from wallet to wallet around the world, with the possibility of moving billions of dollars’ worth of the asset, while paying just a few dollars in fees and involving no intermediaries.
To its critics, it is a speculative asset and useless as a store of value when wild price swings of more than 15 per cent in a single day are common. Critics view it as a speculative bubble, driven higher by people buying in the hope that someone else will be willing to buy it from them later for a higher price – the greater fool theory.
And while proponents tout it as a hedge against currency debasement, there is the uncomfortable fact that Bitcoin remains correlated to higher volatility assets such as US equities.
“Bitcoin is not a play on the dollar or low interest rates, it is a highly levered riskon vehicle. When the bull market-cum-mania in US stocks ends, Bitcoin is likely to collapse,” says Daniel Mauro, chief investment officer at Army Capital.
But most of this criticism is not new – it was heard in 2014, 2016, 2018 and today. What is new is the major steps taken towards adoption over the past 12 months, including the acknowledgement of Bitcoin and cryptocurrencies more generally as a valid asset class by a number of major asset managers and banks.
Significant steps in adoption include easier access for retail investors to buy and hold Bitcoin via platforms such as Paypal, and purchases from institutional investors looking for alternative investments in the current low-yield environment, says Imad Atwi, principal with Strategy& Middle East.
This year’s record monetary expansion in major economies such as the US could help drive inflation. With Bitcoin’s scarcity baked into its code – there can never be more than 21 million in circulation – it is promoted as a safe-haven asset similar to gold that allows investors to escape the effects of inflation and currency debasement.
“Bitcoin is basically sound, fair money that can’t be manipulated or changed over time when it comes to supply,” says Talal Tabbaa, co-founder at Jbriel Network, a blockchain development company.
However, for investors who have been burnt by Bitcoin in the past, there may well be an unfortunate sense of deja-vu around its recent price action. The cryptocurrency first entered mainstream public awareness back in 2017, when its price barrelled from under $1,000 to $19,500 by the end of the year.
Many investors piled into Bitcoin in the final stages of the bull run, only to witness its price plummet – and their portfolios wither. Ultimately, Bitcoin fell more than 80 per cent from its peak, causing many investors to cut their losses and run.
But some saw a buying opportunity. Javed Khan, 22, a Dubai resident and full-time trader, says he began to buy Bitcoin in late 2018 when the price was about $3,000. He continued to add to his position by buying whenever the price of Bitcoin fell.
He says the biggest mistake a novice can make is to buy when the price is high and then sell as soon as it drops a little.
Many investors forget about Bitcoin until its price begins skyrocketing and it starts generating news headlines. “Wait until it is quiet, when nobody is talking about Bitcoin and there are no headlines; that is a good time to buy,” Mr Khan says.
If it is too late for that, wait for pullbacks to enter the market to take advantage of the momentum wave, he says. Nevertheless, “buying the dip” is risky when the rise in Bitcoin’s price is over-extended, Mr Khan says.
“Back when Bitcoin was at lower prices, the pullbacks were much more obvious. Now at these high prices, it is difficult to tell if it is a pullback or a reversal, so traders are much more cautious when buying because it has already risen so high,” says Mr Khan. Saeed Al Darmaki, managing director at Alphabit, a Dubai crypto fund, says the best approach for investors is to just buy and hold over the long term.
“We know that Bitcoin is volatile in the short term, but over the long term, it has always been profitable,” he says.
He advocates buying the digital asset at regular intervals to build up your holdings and average out your entry price. “Like any other investment, you are better off putting in money you don’t have any need for, and you are willing to let it accrue over the next few years, to see the highest returns,” says Mr Al Darmaki. Investors who are in profit can also look to cash out their initial capital to reduce their risk, he suggests. Nevertheless, he cautions that investments in Bitcoin should be considered high risk.
“You should only be investing money that you really are willing to lose.”
Christopher Flinos, co-founder at Hayvn, an over-the-counter sales and custody platform for digital currencies that is based in Abu Dhabi, advocates the simplest approach: buy a lump sum and wait.
Mr Flinos is bullish about the long-term outlook as more and more institutions and professional investors allocate to Bitcoin and other cryptocurrencies. Investors can have a price target in mind or an investment horizon, and look to cash out when either are reached, says Mr Flinos.
Critics say that investors should avoid Bitcoin altogether, with impressive gains also found in traditional investments.
Alex Gemici, the chief executive and chairman of Greenstone Equity Partners, says the lack of logic around Bitcoin’s price movements is a red flag for him. Unlike movements in traditional financial markets, Bitcoin’s price action is incredibly opaque, he says.
“I don’t see any logical tie in the movement of the value, which then moves it to a gambling situation. So, the only reason driving [price increases] is just speculation – total gambling, in my opinion,” says Mr Gemici.
He is sceptical about claims that institutional investors and asset managers are buying Bitcoin themselves, but rather believes they are jumping into the game because of demand from retail investor clients.
And despite Bitcoin’s huge gains, investors could have had similar returns by regularly buying top-performing technology stocks such as Amazon, Alphabet or Tesla – all while avoiding the custody risk that comes with Bitcoin, he says.
Another frequent mistake that novices make is taking on additional risk by entering leveraged trading positions, says Arshad Khan, chief executive of Arabian Bourse. Some crypto exchanges allow inexperienced investors to make trades with up to 10 or even 100 times leverage.
“Novice traders should avoid highly leveraged positions that expose themselves beyond their financial capability. If prices go against them, then they lose heavily – in some cases, their whole position is rounded off with 100 per cent loss,” says Mr Khan.
Another mistake is investing blindly in other cryptocurrencies. These can provide high returns but are also riskier than Bitcoin. Whereas Bitcoin is decentralised, most alternative cryptocurrencies are connected to companies and foundations and are dependent on them. Many have an uncertain regulatory outlook, and some have even been outright fraud.
Mr Al Darmaki suggests that novice investors should look to established cryptocurrencies such as Ethereum but says that investing in Bitcoin alone is sufficient to have exposure to the asset class.
While Bitcoin has unique features that add to its useability – it can be sent from wallet to wallet in just minutes and is itself essentially unhackable – these also create risks for investors.
Bitcoin can be stored on your own wallet, in which case you are responsible for keeping your private key safe. If it is stolen or if you lose or forget the key, your Bitcoin is probably gone. One mistake is storing your private key on your phone or computer that is connected to the internet and which can be hacked, says Mr Khan of Arabian Bourse.
Bitcoin transactions are also irreversible – if you send Bitcoin to another wallet and you enter the address incorrectly, it is likely to be gone forever (a prudent measure is to send a small amount to test the address ahead of the main amount).
Meanwhile, many crypto exchanges remain unregulated or lack the kind of comprehensive insurance that is available with many stockbrokers. And with some investors leaving their cryptocurrency on exchanges where they buy, this is a major risk for the sector given that a number of exchanges have been hacked or subject to fraud.
That makes it important to seek out an exchange that is regulated; some also have forms of limited insurance on holdings. In recent years, institutional grade custody solutions have been developed, which can include full insurance for holdings.
You may also be able to buy Bitcoin through a broker such as eToro or Robinhood, although it may be a Bitcoin derivative, meaning you cannot send it to another wallet or use it for payments, and can only sell it back to the broker.
It is also important to look at the fees when you buy – for example, Revolut, the neobank, allows users to buy Bitcoin within the app, but charges 2.5 per cent for users buying and selling with a basic account, meaning an overall 5 per cent surcharge – far higher than most exchanges.
Mr Al Darmaki remains bullish on the outlook for Bitcoin and cryptocurrencies generally as more and more institutional investors opt in.
“For an asset that has strong fundamentals such as Bitcoin, you should not panic sell if the price drops, or when the price goes up so much, panic buy. You should have a strategy in mind, and actually when something is trading cheaper, you should be buying.”
Wait until it is quiet, when nobody is talking about Bitcoin; that is a good time to buy
JAVED KHAN Bitcoin investor