Bitcoin for Beginners: 3 Things to Know Before You Invest
Bitcoin has been luring some investors with potentially huge rewards—and scaring others away with equally big risks. Should it be on your investment shopping list on Black Friday?
The cryptocurrency can certainly be volatile. Earlier this month, for example, it plummeted 25% over five days after concerns grew that a new currency called Bitcoin Cash, which promises to speed up transactions, would make Bitcoin itself a less attractive payment option.
That fear didn’t last long. Over a subsequent two-day span, investor sentiment reversed and the price jumped up 18% from its lows; by Thanksgiving, Bitcoin had soared to new highs.
Not many investments engender the differences in opinion that Bitcoin and other cryptocurrencies create. It’s that volatility, and uncertainty about the technology’s long-term viability, that breeds whirlwind days. The currency has turned evangelists and hackers into paper millionaires overnight, while others see it as a fad, doomed to fade as countries add regulations onto what’s currently a stateless, bankless Wild West of payment tools.
Still, it’s hard to argue with the short-term results. On New Year’s Day, a single Bitcoin was worth $964; by Black Friday morning its value had passed $8,200, a gain of nearly 800%. Taken together, the market capitalizations of all the world’s cryptocurrencies, including other prominent players like Ethereum and Ripple, have risen even faster this year.
This growth has pushed mainstream institutions to take notice and capitalize. CME Group, the world’s largest options and futures exchange owner, announced it would offer Bitcoin futures by the end of the year. That move would give Bitcoin a level of credibility that established currencies have, and also provide an infrastructure for developing exchange-traded funds (ETF). Money manager VanEck recently developed indices to track a group of cryptocurrencies’ movements, which could be used to develop index funds. And Mike Novogratz—a former manager at the hedge fund Fortress Investment Group who says he has 10% of his net worth in cryptocoins—recently estmiated it would be six to eight months before investment firms start to offer cryptocurrency products, like ETFs, to their clients. When they do, he added, it will make the buying process easier, allowing for the price “to go much higher.”
It’s too early to say whether Novogratz is right. But the currencies’ popularity is generating more interest in the high net worth space. John Maher, an advisor and CIO at CCR Wealth Management, says that he now has numerous clients coming to him, asking about how to invest in the currency. Meanwhile, UBS CEO Sergio Ermotti recently told Bloomberg that the wealthy have shown an increase in curiosity, even if they haven’t bitten on the investment.
It’s easy to understand the intrigue and hesitancy. Here are three important things to know about investing in the space.
Cryptocurrencies trade like volatile commodities
Traditional currencies aren’t a vehicle that most mainstream “retail” investors own. You don’t take a large stake in Euros, for example. State-sponsored currencies tend to move with inflation while the primary goal of long-term investing is to beat inflation. Some mutual funds own positions in currencies as a way to hedge against the impact of exchange rates on their returns, but the currencies are seldom used to actually generate returns.
But cryptocurrencies don’t really trade like currencies at all. One of the primary reasons for that is that there’s a cap on the number of coins that any given currency will ever have in circulation. Central banks like the Federal Reserve can and do print more money to manage inflation and support their countries’ economic policies. Bitcoin, on the other hand, will eventually have a maximum of 21 million coins in circulation, based on the algorithm that controls distribution.
This makes many cryptocurrencies much more like commodities, since there’s a finite supply, like with gold or oil. “It’s difficult to look at Bitcoin as a currency,” because of this supply issue, says Maher. And the limited supply is one reason for Bitcoin’s volatility. (That could change some day if more institutions embrace the asset.)
Volatility is also increased by the fact that the overall cyrptocurrency market is still tiny. All this trading and speculation is happening in a field where the total market cap is currently only about $260 billion. (Apple alone has a market cap of about $900 billion.)
Is it winner-take-all?
The technology behind Bitcoin—the blockchain—has people convinced it will last long-term. But nobody is sure how many of the currencies that rely on blockchains will survive and thrive.
Bitcoin’s current value and price is partly based on the belief that it will continue to grow as the predominant cryptocurrency in the world. Yet it only accounts for just over half of the crypto market capitalization, as new currencies are developed, launched and spent. The competitor coin Ethereum, for example, launched in September 2015 and is now worth $440 per coin.
“We simply don’t know the winners,” says Gabor Gurbacs, director of digital asset strategy at VanEck.
The Bitcoin cash scare only highlighted Bitcoin’s loose hold on the space. There’s many ways another player could up-end it (think of the way that Facebook’s rise led to MySpace’s demise). Some commentators believe traditional currencies could someday adopt blockchain-like characteristics, which would cut into cryptocurrencies’ mainstream acceptance—potentially crushing their value.
Cryptofunds will cost you
Institutional investors, and some of the wealthiest individual investors, already have some options for playing the cryptocurrency market. Through mid-October, 84 new crypto hedge funds that invest in the currencies have emerged, up from 11 in 2016, according to cryptocurrency research firm Autonomous Next. As the numbers suggest, however, these funds don’t have much of a track record. And many of these hedge funds charge hefty management and performance fees (often 2% of assets annually, plus 20% of any profits), eating into returns.
Maher considers any of his clients investing in Bitcoin or the funds “the risk takers,” among his client portfolio, even though he owns Bitcoin and Ethereum himself. Maher often responds to those who want to take a stake by offering the thoughts of Mark Cuban. If you want to invest in cryptocurrency, Cuban said, then “pretend you’ve already lost your money.”
If you can stomach that kind of risk, you can handle trading in this market.