In recent weeks there’s been a lot of hype regarding cryptocurrencies such as Ripple, Dogecoin, and Bitcoin. While we are in no way experts on the matter, it seemed like a good time to check in with what a cryptocurrency is and why investing in them is a complicated matter.
A cryptocurrency is a digital currency that is secured using cryptography, making it difficult to counterfeit. Bitcoin, arguably the most well-known cryptocurrency, came on the scene in 2009. In December of 2017, there were 16.78 million bitcoins in circulation, of the 21 million available to be mined. As of this writing, one bitcoin was worth $11,670.
Bitcoin is released to the public through a process known as mining by individuals and companies who have the computing power and authority to do so. Because the cryptocurrencies are not issued by a governing authority they are considered immune from regulation and manipulation which has both pros and cons. From an economic standpoint, cryptocurrencies offer a very purist approach to monetary exchange because they can’t be shifted around by central banks or other governing authorities to achieve policy-related goals. On the other hand, because they aren’t regulated they are also often associated with illegal activities such as money-laundering. Furthermore, they are also not insured under the Securities Investor Protection Corporation like other regulated investments and they are not eligible to be held in tax-advantaged retirement accounts.
Are they a good investment? I genuinely have no idea. Unlike investing in an asset-backed security or a stock or bond backed by a company, bitcoins are difficult to value. If I wanted to invest in Amazon’s stock, I could look up Amazon’s financial statements and see how their revenue streams are doing, what they’re investing in to grow their company in the future, how they’re managing their cash, and a whole load of other data points. A good investment has to do with the link between price and value; am I getting a good deal for what I’m paying? It’s difficult to answer that question when it comes to cryptocurrencies because there is no basis for value. How much should a bitcoin be worth and why? Those questions are really hard to answer without a basis for valuation. Furthermore, when we can’t answer those questions, investing begins to look a lot more like speculation.
A few days ago, I came across a really great article by another financial advisor that I think provides a really good perspective on bitcoin in the context of financial planning. In the article, he talks about investing being goal based, something we at Cedarstone have espoused from the beginning. He says:
Investing is different from speculating or gambling. Investing is a means to an end, and
that end is our collective financial goals. Beating the stock market, buying what’s hot,
outperforming a brother-in-law — those are not financial goals. Financial goals are
things like having money to send kids to college, buying a house, taking a trip or
retiring someday. This is why we invest.
I couldn’t have said it better myself. We invest to reach achievable goals. That doesn’t mean you shouldn’t be curious about cryptocurrencies or even dabble in them from time to time if that’s something you enjoy for fun. You just shouldn’t view them as a means of achieving your financial goals.
“Bitcoin.” Investopedia. 2017. https://www.investopedia.com/terms/b/bitcoin.asp.
“Cryptocurrency.” Investopedia. 2017. https://www.investopedia.com/terms/c/cryptocurrency.asp.
“Number of Bitcoins in circulation worldwide from 1st quarter 2011 to 4th quarter 2017 (in millions).” Statista. 2018. https://www.statista.com/statistics/247280/number-of-bitcoins-in-circulation/.
Richards, Carl. “Should You Buy Bitcoin? Ask a Different Question First.” The New York Times. Jan. 5, 2017. https://www.nytimes.com/2018/01/05/your-money/bitcoin-investing.html