Whether it’s a tweet from Elon Musk, or an announcement from the US Treasury, cryptocurrencies like Bitcoin are seldom far from the headlines. The question everyone seems to be asking is Should I invest in cryptocurrency?
This first blog focuses on what investors are actually getting for their money when they buy cryptocurrency. Later posts will consider whether buying cryptocurrencies can be classed as an investment, as well as the surprising environmental impact they have.
What’s the technical definition of a price bubble? The old adage was if a London black cab driver told you he’d invested five grand in such and such a share because ‘you can’t lose’, then those were the shares you immediately sold. The reason being that many investors, believing they couldn’t lose, had inflated the share price to an artificially high point — a bubble basically — which could easily burst and send the price tumbling down.
The modern day version of the taxi driver is when someone’s son or daughter comes home from uni and asks Should I invest in cryptocurrency? All my friends are doing it! and shows the parent a cryptocurrency post from a finfluencer on TikTok or Instagram.
Asset price bubbles are not a new phenomenon (crocus bulbs anyone?) crypto is merely a more modern way of representing the same issue, when fear of missing out (FOMO*) overtakes other thought processes.
Now, it is very difficult to talk about cryptocurrencies, or more specifically, about the appropriateness of them as an investment, especially for novice or inexperienced investors without sounding like the Fun Police. Perhaps the best way is to explore two of the key words: invest and currency.
Starting with currency, it is important to be clear exactly what prospective investors are considering putting their money into. Buying currency can sound like an activity most people are familiar with. People buy currency for holidays, shop around for the best rates and compare notes with friends to see where they can get the best deal. So, we understand the principle of this, right?
Dead wrong in fact. Currencies, including holiday currencies, all have several things in common.
Firstly, they function as a store of value. If holiday currencies exhibited the swings (especially the drops) in value that cryptocurrencies have exhibited recently (bitcoin fell 30% in one day in May), no one would even consider buying them to take on holiday in case their value plummeted before arriving at the destination. We would choose a more stable currency, probably US dollars, and take them to use instead.
Secondly, currencies act as a medium of exchange. In other words, we can exchange them for goods and services instead of having to rely on bartering. Yes, there are several companies that will accept bitcoins (one of the many cryptocurrencies) as a medium of payment, but not many.
The highest profile example being Tesla, which recently rowed back on its commitment to accept them citing environmental reasons. Think, however, of the economic reasons — few companies will accept payment for their goods and services in the form of something that can lose huge chunks of value the day after they accept it. Similarly, few owners of cryptocurrencies will use them for routine purchases because…yes, FOMO strikes again, why buy a coffee with something that might, just might, be worth loads more tomorrow? All which limits, for now, the potential of cryptos to grow as a medium of exchange.
When is a pound, not a pound
From that perspective, cryptocurrencies are not really currencies at all. Yes, they are a form of asset, that people hold as a speculative investment. In terms of exactly what type of asset — cryptos aren’t property, equities, cash or bonds. They are in fact a commodity, a virtual one and a highly volatile one that exhibits swings and levels of unpredictability way in excess of other commodities.
The chart shows the swings in value of bitcoin are far in excess of gold, another commodity, or the S&P 500 Index. The S&P 500 is widely regarded as the best gauge of the value, or share price of the 500 largest US companies that you can buy shares in. Yes, bitcoin does have lots of spikes where its value has shot up, but these spikes are short term and have been followed by troughs where its value has fallen sharply.
So, if the original question Should I invest in cryptocurrency? actually read ‘Should I invest in an unpredictable commodity, where the price swings wildly and I might lose everything I put in overnight?’ what would your answer be?
*FOMO is also defined as a fear of regret, which may lead to concerns that one might miss an opportunity for social interaction, a novel experience or a profitable investment. Source: Wikipedia