With the introduction of Bitcoin in 2009, much of the world has become fascinated by cryptocurrency. Within its first decade, Bitcoin reached the mainstream, becoming a household name. And more recently, on Sept. 8, El Salvador launched Bitcoin as a national currency. Because of its popularity alone, many investors and financial advisors cannot escape the question: Should we invest in cryptocurrency?
To get to the bottom of this, let’s first start at the top.
What is cryptocurrency?
Cryptocurrency is a digital currency created as a medium for payments that bypasses the traditional banking structure. According to its creator (who has used the presumable pseudonym ‘Satoshi Nakamoto’), Bitcoin was created to be a “peer-to-peer version of electronic (payments) . . . without going through a financial institution.” (bitcoin.org.)
Bitcoin “mining” is the process of finding new bitcoins by using sophisticated hardware to solve difficult math problems. Miners are rewarded for their work with new bitcoins. Most holders of Bitcoin, however, simply buy Bitcoin as an investment, speculating the price will increase.
There are thousands of digital currencies, with Bitcoin being the most widely used, taking nearly half of the market share (coinmarketcap.com/charts.)
How much has it grown?
In 2011, one Bitcoin was worth roughly one U.S. dollar. By April 2021, Bitcoin reached its highest price (so far) of over $64,000.
When running the numbers, Bitcoin averaged a return of over 200% per year over the last decade. Compare this to the annualized return of the S&P 500 stock market index – which had a stellar decade – of about 16% per year (finance.yahoo.com, Morningstar.com.)
Is it for you?
While these returns are certainly incredible, we encourage you to keep several things in mind if you are going to invest in Bitcoin.
Valuation. Traded entirely on sentiment, cryptocurrency lacks economic fundamentals to support any valuation. Stocks, on the other hand, have underlying value based on company profits, giving a logical basis to invest. While some may state that buying cryptocurrency is a way to invest in blockchain (the technology behind crypto), owning Bitcoin doesn’t give ownership in the underlying blockchain technology.
Performance. While cryptocurrency may continue its upward trajectory for some time, it is important to remember that past performance does not indicate future results.
Risk. Cryptocurrency is a highly volatile investment. Prices may dramatically fluctuate, even within seconds, and therefore the risk is very high. Investors need to feel comfortable with the risk of loss.
History. What if tulip bulbs each cost more than the average annual salary? “Tulipmania” really happened in Western Europe in the 1630s when Dutch investors began buying tulips and dramatically drove up the price only to see prices collapse. Or how about the dot-com bubble of the late ’90s? The Nasdaq index quadruped in five years and subsequently fell by 78% within two years.
Whether or not you decide to invest in Bitcoin, our objective as a financial advisor is to help carefully guide your decision-making regarding a speculative investment. Always feel free to reach out to a financial advisor to discuss further or for general investment and planning advice.