Why I’m Not Investing in Cryptocurrencies like Bitcoin

Early RetirementIn my recent article on our financial resolutions for 2018 I mentioned I did not want to invest in bitcoin, or any other cryptocurrencies, this year.

It’s not because I’m against making money.

It’s not because I don’t see the potential value in blockchains.

And it’s not because I think all cryptocurrencies won’t have any value five years from now.

But there are several reasons why I’d personally be very uncomfortable investing in cryptocurrencies right now, which I’ll outline below.

I don’t have any competitive advantage in determining which cryptocurrencies will ultimately be successful

Bitcoin. Ethereum. Ripple. Litecoin.

I know several of the names.

But I don’t know what makes one better than another. And right now, I don’t have time to do the research to figure it out.

If I was confident all of the digital currencies would ultimately be successful, making sure I was in one of the right ones wouldn’t be imperative.

But twenty years ago, when I was browsing the Internet with Netscape Navigator, searching and consuming content via Lycos, and connecting to the world through Prodigy – all on my Gateway 2000 desktop computer, by the way – I probably would have assumed all of those companies would be major players for many years to come.

Technology changes fast. There have been many new initial coin offerings (ICOs) over the past year.

Which one will be the most valuable in five years? I don’t know.

Which will be essentially worthless in five years? I don’t know the answer to that either.

But I’d be willing to bet that some of them will be worthless in the future. With around three dozen cryptocurrencies currently having market caps of at least $1 billion according to coinmarketcap.com, there’s a lot of money to be lost by investing now in the eventual losers.

The recent frenzy is reminiscent of the dot.com bubble

Nothing seems to get cryptocurrency investors more fired up than hearing the word bubble.

But as someone who both made – and lost – money investing in technology stocks in the late 1990s, some of the similarities between now and then are striking.

According to the New York Times, in 1999 shares of Qualcomm rose in value by 2,619%, and 12 other large-cap stocks each rose over 1,000%.

According to Citi Research, last year Bitcoin’s price increased by 14x, while Ethereum’s value rose by 100x and Ripple XRP climbed almost 350x.

In the late 1990s, companies could increase their market caps almost instantly by adding a .com to their name, firing off a press release announcing they were focused on B2B solutions, or changing strategies to become an incubator for Internet companies.

In recent weeks, we have seen Eastman Kodak Company more than triple its market cap after announcing it was developing KODAKCoin, a photo-centric cryptocurrency, and Long Blockchain Corp. double its value after changing its name from Long Island Iced Tea Corp. and shifting its focus to blockchain from sweet beverages.

No, the recent actions by KODK and LBCC don’t mean that all cryptocurrencies will end up worthless. But you still need to make sure you end up investing in the Amazon.com of digital currencies, not the next Pets.com.

And you also need to keep in mind that after Amazon.com peaked in 1999, it took more than eight years for one of the great success stories of all time just to get back to that level following the burst of the dot.com bubble.

It’s easy to HODL for days, weeks, maybe even months.

But after a bubble truly bursts, you may need to HODL for the better part of a decade, just to get back to where you once were.

And that’s if you pick an all-time winner, like Amazon.com.

I don’t know how to value cryptocurrencies

When it’s time to invest in a stock, I am familiar with many ways to assess value.

Price/earnings ratios.

Discounted cash flows.

Peer multiples.

Dividend discount modeling.

EBITDA multiples.

PEG ratios.

All of these methods, and many others, have their strengths and weaknesses. There are different situations when one or another might be more or less effective, but I have decades of experience using a variety of techniques to try to assess both intrinsic and relative value when considering an investment in a company.

With the cryptocurrencies, I have no clue where to start. They don’t generate cash flows. There are no detailed financial statements to analyze. In many cases there are no hard assets backing them up.

I’ve seen a number of proposed valuation methods for cryptocurrencies, and most require major assumptions I’m not qualified to make, like what percentage of the world’s economic activity will ultimately be conducted through a specific digital currency, or how valuable cryptocurrencies are relative to all the gold in the world.

I may be living in the 21st century with a 20th century skillset, but the dramatic price moves we have seen recently seem to me to be driven more by the vagaries of supply and demand than any specific underlying fundamental factors I can identify.

Demand has clearly overwhelmed supply for bitcoin, and many other cryptocurrencies, over the past year.

How long will that remain the case?

I have no idea.

Bitcoin bull Tom Lee predicts a valuation of $25,000 by year end.

Bitcoin bear Mr. Money Mustache believes it is worth about as much as his fingernail clippings.

I’m unwilling to risk my money speculating on which one of them is correct.

Factors well outside my comfort zone and expertise may impact pricing

CryptocurrencyWhen bitcoin valuations plunged last week, the media went searching for explanations.

One of the more interesting ones I found was in this article on Bloomberg by Camila Russo and Nour Al Ali.

The article cites the belief that Asian traders cashing out their cryptocurrencies to travel and buy gifts for the upcoming Chinese New Year contributed to the downturn. The authors note that bitcoin had a similar slump in early 2017.

I have no idea if their theory is correct. But I’m unwilling to invest in something so volatile that an upcoming holiday halfway around the world might be a major factor in a 50% price decline.

That said, if the speculation in the Bloomberg article is correct, maybe you’re supposed to sell cryptocurrencies in early January and then buy them back later in the month. Could there be a new kind of January Effect in the cryptocurrency market?

Future government involvement is hard to handicap

As we’re seeing in the United States with the recent government shutdown, political leaders sometimes make strange decisions.

Cryptocurrencies are ultimately a potential competitor to fiat currencies issued by governments around the world. While some cryptocurrencies were designed intentionally to be anonymous, borderless, and outside of the jurisdiction of government authority, when money is involved governments tend to get involved.

Regulators around the world are increasingly focused on making sure that taxes are paid on profits generated by trading digital currencies, declaring transactions conducted in cryptocurrencies to be illegal, increasing regulation of exchanges, requiring more formal registration and disclosure, and otherwise attempting to get more involved in various aspects of the cryptocurrency market. There are even reports that China is considering issuing its own state-run cryptocurrency.

China and South Korea have recently banned ICOs. Will other countries follow suit? And would it be positive for existing cryptocurrencies by eliminating potential competitors, or negative by foreshadowing increased government efforts to get involved?

Once again, I don’t know.

The market is dominated by insiders, and there have been some bad actors involved

Another reason governments are getting increasingly involved with cryptocurrencies is concerns around market manipulation and fraud.

A recent article in The Atlantic noted approximately 40% of bitcoin is held by about 1,000 users, and the top 100 bitcoin addresses – some of which may belong to the same person – control about one-sixth of issued currency. There are concerns that concentrated ownership contributes to some of the massive price swings seen in many digital currencies.

As you have probably surmised by reading this post, I am not an insider.

The Atlantic also noted that bitcoin exchanges are potential points of failure, citing the 2014 theft of thousands of bitcoins from Tokyo exchange Mt. Gox and the hacking of a South Korean exchange in 2016. Sadly, those aren’t the only examples. And some recent ICOs have allegedly been outright frauds.

Over the past several months, North Korea has been linked to multiple cryptocurrency attacks. Russian hackers have allegedly been installing cryptocurrency mining malware on computers. There have been concerns raised in Argentina, China, Europe, and the United States –  basically all over the world.

There are also fears that cryptocurrencies have been used to facilitate money laundering, funding terrorism, and human trafficking. Moreover, there are growing environmental concerns about the amount of energy being used to “mine” cryptocurrencies around the world.

Summary

In many ways, the market for cryptocurrencies is like the Wild West. And many market participants are packing a lot more heat than I am, in terms of technological knowledge, experience, and insider information, as they explore this new frontier.

That doesn’t sound like a game I want to play.

I recognize I could be leaving money on the table by not getting involved in cryptocurrencies right now.

But that’s a risk I am comfortable taking.

Best of luck to those of you who are involved in cryptocurrencies. I hope it works out for you financially. And I hope you aren’t risking a material portion of your net worth on something I believe is a bubble!

Have you purchased any cryptocurrencies? Why or why not?

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