This is the second blog in the series looking at cryptocurrencies. The first looked at the currency aspect and what investors get when they buy cryptocurrency. This one will consider whether buying cryptocurrencies can be classed as an investment. The third and final post will look at the surprising environmental aspect of cryptocurrencies.
Returning to our original question Should I invest in cryptocurrency? The second key word in our question is invest. An investment is an asset or item that is purchased with the hope that it will generate income or appreciate in value at some point in the future.*
Risk v reward
The key point to take from the definition is that there is no guarantee. Investment involves a trade-off between potential returns, risk of loss and the relative probability of each.
Investing in any single item puts a clear focus on the potential and risk associated with that single item. If, for any reason, that single item fails or has a large fall in value, the investor is directly affected by the full value of that fall.
However, if the investor had split their stake and invested in two different items that behave differently, that would halve the risk. Investing in three reduces the risk still further and so on… this is called diversifying or spreading the risk.
The risk can be spread still further by investing in not just companies (equities) but other types of assets such as bonds issued by governments, cash and commodities etc. This is known as a mixed or multi-asset fund. To learn more about how funds work, visit our Compare+Invest web site.
Knowledge is key
Investors sometimes choose to invest in funds rather than picking equities themselves, leaving the detailed research and ongoing monitoring to fund managers and their teams of analysts.
However, there are also individual investors who feel they can make their own decision about which equities to pick. The key point here is they have enough knowledge and understanding to allow them to make an informed choice. Granted, they don’t always get it right, but to invest in a single item, you need to have enough information to make a similar balanced decision.
In terms of understanding of the risks and potential returns specific to cryptocurrencies and bitcoin, there are multiple factors that can affect the price. However, in the short term there are three factors that are likely to have a big impact on value. Ask yourself if you know what any of the following is going to do next and when:
- The Chinese Government
- The US Treasury
- Elon Musk
If the answer to any of these is No, there is nothing to stop you from buying cryptocurrency, but it’s not investing. It’s taking a punt on something they do not fully understand, and very much like picking a racehorse from a list of runners in the Grand National because you like its name the best.
Fancy a flutter?
Now, putting a bet on a horse, or cryptocurrency for that matter, might be fine if it’s a flutter for fun, but would you bet all your savings or house deposit on a horse just because you liked its name? Of course not.
Social media has examples of celebrities or influencers talking about making money from cryptocurrencies — but remember that those who lost money will never advertise the fact! However, it’s important to remember that though they may have invested relatively large amounts, those amounts are a tiny fraction of their overall wealth.
It would be like you and me putting in a £50 or a £100 at best — they can easily afford to lose the money without compromising their lifestyle. The same is not true for us ordinary mortals.
It’s akin to a speculative accumulator bet at the Euros, 50/1 but only a £1 bet. Losing £1 won’t affect your lifestyle, you don’t expect anything back from it, but you’re pleasantly surprised if luck is on your side.
To finish the same way as we started, with the question, Should I invest in cryptocurrency? All my friends are doing it! Have a bet on it if you want to, but you wouldn’t gamble the house deposit on a horse, so why would you gamble it on cryptocurrencies?
If you are interested in investing sustainably, over the long term you can visit Compare+Invest to find out which type of investing best suits you. One thing is guaranteed, there will be no mention of racehorses or cryptocurrencies!
*Source: Investopedia
Photo by Keenan Constance on Unsplash
