Bitcoin: another bubble or the next big thing?
How would your finances look if you had gotten a 640% return on all your investments? It's easy to see why Bitcoin and other cryptocurrencies have been grabbing headlines. That type of profit makes some people desperate to jump in while the prices keep climbing. At the same time, some reasonable people, like Warren Buffett, are on the sidelines scratching their heads at what to them seems like a bubble full of hot air. How you look at Bitcoin or any other "next new thing" probably says more about your own thinking style than about the thing itself.
At FiClub, we have been slow to jump on the cryptocurrency bandwagon because of a dread of being late to the party and already having missed the run up in price, coupled with a lack of familiarity with how to open an account and store the Bitcoins, ether or whatever safely. As you can probably tell from the "know your thinking style" blog post, FiClub recognizes that we each have a different way of approaching financial decisions. We recently heard from a FiClub friend, Heather Russel, who told us her first person story of how she bought Bitcoin and you'll see the type of thinking style it takes to jump on an idea:
Why I bought Bitcoins. My intuition directed me to become interested in buying Bitcoins in May 2017. A month prior, I ran into a friend who had bought hundreds of them way back in the day for pennies on the dollar.
My president of my company also had bought them and he had a good instinct for money and business. My mentor said that cryptocurrency was the currency of the future. I researched the top sites and landed on coinbase. I bought Bitcoins, Ethereum, and Litecoins. I bought the coins for about $1700 and up to $2400. 3 months later they were worth $3800. I learned that it took a while to put the money in. There is a weekly cap of $2500. Granted I worked in the tech industry. I knew the shadiness of the underground dark web and criminality, like Bitcoins was a great place to launder drug money from drug lords. In a flash speaking to my friend, all doubts disappeared. It was a global exchange of currency for the people minus all the bankster fees. It was also a stable currency that wasn’t able to be manipulated by markets. It is programmatically created to only have a limited amount sold. Japan and Australia legally legitimized the market.
Anyhoo, so bitcoin was worth way more per ounce than gold. It can earn money for you even on the weekends – 24 x 7. Getting a bitcoin online payment is instant. I noticed there was a Bitcoin ATM currency exchange in the Oakland Airport. How progressive is Oakland. So I came upon the brilliant idea of just putting my basic checking money into bitcoins and then when I needed more money to pay bills I can just cash out the precise amount and transfer money back into my bank. Meanwhile, my money has already earned me way more money than sitting in a bank in the 30-day cycle it takes to pay that monthly bill. I came here to build an empire.
That's an example of the bold, go-with-your-gut style of investing that may not be for everyone. My investing style tends to be to look for the hot ideas after they've had their run-up and then have been hit with some bad news and have gotten hammered into the dirt. It's a more patient approach, and though it rarely catches high-flying returns, I believe it avoids getting burned entirely. An example was buying Lending Club shares for $5.25 long after their IPO (at $25 per share) because their CEO had gotten fired allegedly for unethical tactics that inflated how much business the company was doing - I'm up about 15% on the trade, The other example was buying solar stocks after they'd had a horrible 10-year run. Actually their alleged darkest hour, which was the Trump election, turned out to be a great time to get into that position. You can see that chasing after Bitcoin is not my style, but it doesn't mean we have to ignore cryptocurrencies and get left out in the cold entirely.
The way the patient approach would work is to wait for significant bad news and waiting out the panic-selling that it would cause. It would take something major to break the uptrend in the coins. As more people hear stories of their neighbor getting rich on crypto, they are going to want a piece of it and the general public is going to drive up the price when it spreads beyond the early adopters. That's the case that optimists paint, at least.
On the other hand, the case against jumping into Bitcoin or the next new coin that is being created, is that they don't have any inherent value - they are just a means of exchange, not a store of value. They are useful just to facilitate transactions, whether that be at Bitcoin equals $500 dollars or Bitcoin equals $5,000 the net benefit to society as a means of exchange is the same. By the same token, there is no real scarcity because new currencies can be created at any time.
Let's describe now what the cautiously optimistic patient approach of playing the cryptocurrency asset class might look like: First off, you don't want to get in while the hype is overblown, you would wait until there is a big negative event that takes place before jumping in. Consider at least a 25% decline to be worth making your move, So that means buying when things are ugly, but not so ugly that you would give up your overall assessment that crypto is inevitably the next big thing and that it's just a matter of time.
Set your limits ahead of time and document them. What would it take for you to question your bullish assumptions? What if an exchange gets hacked and millions are lost to cyber-fraud? Lessons from the past: when the Mt Gox exchange was hacked in 2014 and $400 million worth of the cryptocurrency was stolen, that caused a big drop in the price of Bitcoin that day as owners sold. That is what a buying opportunity looks like, since the price quickly recovered and Bitcoin went on to make new highs after that.
Unfortunately, as the saying goes, you never get to step in the same stream twice - the market learned and it's likely that a new similar hack would not have the same price impact. But what about a government taking action to knock Bitcoin by outlawing it or taking some other punitive action? The Chinese government is in process of doing just that by intentionally outlawing new offering ("initial coin offerings" or ICOs). Well, what did you expect? That governments were going to roll-over without a fight and that they weren't going to defend their monopoly to produce fiat currency? Hardly likely - even the very optimist case for Bitcoin adoption should factor in some resistance. That's what a buying opportunity is going to look like.
How to get ready to invest:
You don't always have much time to jump on these opportunities, so it is worth it to be ready. How you do that is by setting up an account with one of the major exchanges like Coinbase.
I would recommend avoiding the newest exotic currencies that may not have proven broad adoption yet. Stick with the established big three, Bitcoin, Ethereum, Litecoin. Link a bank account and then wait patiently. You may be limited in how much you can invest per week - that's not a bad thing. It will limit your potential loss to something reasonable and also force you to consider dollar cost averaging by spreading your purchases over time, in case you got in too early and prices continue to decline. Obviously, this type of speculative investment is not for everyone. Consider your risks carefully and only allocate what you can afford to lose.