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Should I Invest In Cryptocurrency?

Unless you have been living on a different planet it is likely that you have some awareness of cryptocurrencies. Their value has sky-rocketed over the past few years which has attracted more and more investors (speculators).

Before I give my 2 cents (or should it be ‘2 Cryptos’?) worth on whether crypto is an appropriate investment, let’s start with the backstory.

What is Cryptocurrency?

Bitcoin is the original and most well known of the cryptocurrencies. Created back in 2008 by Satoshi Nakamato it, like all cryptocurrencies, is an electronic, decentralised currency. In other words, they aren’t physical notes or coins and they aren’t issued by central banks as fiat currencies are. There is also a limited supply of each currency, which have to be electronically mined in order to be released and traded.

It is the limited supply that adds to the price increase (because high demand and low supply = rising prices) but the appeal is also in the fact that they are independent of any government. Those of an anti-establishment persuasion see that as a positive because it means control lies in the hands of the owners, not the issuers.

All transactions of cryptocurrencies are recorded using blockchain technology. Although still nascent, the concept of blockchain is interesting and is quite probably the future of recording transactional data for the global financial network; it is encrypted, date stamped and can’t be modified making it, in theory at least, a reliable way to record financial transactions and data.

Since Bitcoin’s launch, it has risen by over 12,200% at the time of writing and it has led to a wave of alternative currencies; Ether is the main competitor and even one, Dogecoin, based on the meme of a cartoon dog (which should send certain signals in itself!).

Is It A Worthwhile Investment?

Whilst the value of cryptocurrencies has gone stratospheric the journey has been a roller coaster ride with large and sudden falls in value, often for non-fundamental reasons, and often because Elon Musk has tweeted something. There will be a lot of people who have made a lot of money on Bitcoin and its counterparts but many more who have lost money because they have fallen for the oldest lesson in the world of investing.

There is a big difference between speculating and investing. Speculating is betting on future changes in the price of an asset, usually over the short term.

Speculators rushed to own gold in the US in the 1850s and are doing so now to own cryptocurrencies.

Investing is a long-term commitment to back an asset because you believe in the fundamental characteristics that make it worthwhile. You appreciate it won’t be a straight-line journey but you have the patience and discipline to accept short-term variations for long-term gains.

Is It The Future?

I believe that cryptocurrencies have created a paradigm shift in how we think about and may ultimately transact in the future. It does offer a transactional system that operates much more quickly, transparently and at a fraction of the cost of the current layers of the banking system. But, there are a number of reasons why I don’t believe it is the immediate solution.

For any monetary system to work it needs to be trusted and widely accepted by everyone. Fiat currencies (those issued by central banks) work because the governments backing them provide stability and trust. We know that whether I have a wallet full of £50 notes, $100 bills or £millions in a bank account, I can exchange goods and services because there is sufficient trust and stability in the system for my money to be accepted. A £50 note might only cost the Bank of England pennies to mint but we all know it can buy us goods and services to the value of £50.

The global economy recovered from the banking crises because central banks were trusted lenders of last resort who were able to pump trillions of pounds and dollars into the financial system to right the (rapidly) sinking ship. Decentralised cryptocurrencies offer neither the trust nor the mechanism to act as lender of last resort.

Neither the blockchain technologies nor the cryptocurrencies they support have been tested yet to know that it will work in times of crises. It is reliant upon a small number of anonymous and private players to operate the whole system which does not form a reliable foundation for a ubiquitous financial system.  I would much rather my life savings were held on a system backed by the UK Government rather than one that is hidden somewhere on the web.

Ironically, for it to really take over as the leading system of exchange for goods and services it requires the very thing that it was created to avoid: centralised systems of governance to provide the trust to support the infrastructure.

Neither are cryptocurrencies available to everyone. Whether I am a Russian oligarch or unemployed and on benefits, we have access to the same financial system by spending the money we have in our wallets. Bitcoin and its peers are not widely available (yet) to provide this universally.

Cryptocurrencies are also a bet on which technology will win. Bitcoin has the first-mover advantage and is by far the largest digital currency, but the Ethereum technology which supports the Ether currency enables faster transactions and has applications beyond the digital currency.

Lessons from previous technological breakthrough can teach us here:

For those old enough to remember Betamax, it was always said to be the better technology but VHS was the victor, partly down to being available at a lower price.

Think also of how the iPhone was the nail in the coffin for pagers which never really took off as a consumer product. Or the advent of YouTube and streaming services and how they prevented BlueRay from ever succeeding as expected.

What will history show to be the dominant cryptocurrency? It’s too early to say, indeed the winner might not have evolved yet.

What About the Ethics?

A defender of cash who argues it has the moral imperative might crumble under cross-examination considering how dirty money fuels drug barons and criminal gangs the world over. However, there is a dark side to cryptocurrencies that allows users of the dark web to profit from illegal gains undetected. At least with physical currencies, the cash has to be laundered in order to get it into the banking system which regulatory controls aim to prevent. At present these controls are much easier to circumnavigate using digital currencies.

Beyond the criminal side of the ethics debate, in a world committing to net-zero carbon emissions, the mining of cryptocurrencies is part of the problem rather than the solution. The demands on computer processing power to mine the coins are so great that according to research by the University of Cambridge and the International Energy Agency shows that Bitcoin mining used as much energy (typically using coal) as the whole of the Netherlands in 2019. Renewable power might offer solutions but until that infrastructure improves Bitcoin mining will continue to burn fossil fuels at an alarming rate.

My 2 ‘Cryptos’ Worth

Cryptocurrencies might prove to be a great investment outstripping the global equity markets, but at present it has all the hallmarks of a speculative bubble no different to tech stocks in the late 90s and every other asset class that investors have piled into all the way back to tulips in the 1600s.

It is an uncorrelated asset offering potential but, in my opinion, its huge volatility does not make it a viable currency or investment (yet). If governments start offering their own versions it might solve some of the issues regarding trust and legitimacy but until that time I see it as a gamble.

Like any gamble, there’s no harm in it if you only ‘invest’ what you are prepared to lose. You might make a killing but at least it won’t kill you if it turns out to be a bad bet.

 

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