There is a ton of excitement recently about investing in Bitcoin. This excitement caused the price of Bitcoin to skyrocket dramatically in 2020 (over 300%).
In this article, I'm going to review the pros and cons of investing in Bitcoin and other cryptocurrencies with a focus on long-term investing.
What you'll learn:
- What Is Bitcoin?
- How Are People Buying Bitcoin?
- My Thoughts On Bitcoin As An Investment For Financial Independence
I'll also let you know if I have Bitcoin in my portfolio. So let's start with…
What Is Bitcoin?
Bitcoin is a digital currency also known as cryptocurrency which was created in 2009 by Satoshi Nakamoto. Bitcoin is the largest digital currency with a market cap approaching 600 billion. You can use Bitcoin and other digital currency to buy and sell things but you can also invest in bitcoin using certain investment platforms.
Since Bitcoin and other alternative currency coins are strictly digital, you need a digital wallet to keep your coins safe. Bitcoin transactions are recorded and verified using a public ledger by a process called “Bitcoin Mining”.
Bitcoin mining is also the process of how Bitcoins are made and it involves some heavy-duty computers.
It looks something like this:
Bitcoin mining facility (Greenidge Generation)
Bitcoin can be described as a commodity like gold or can be described as a currency like the U.S Dollar. If we describe Bitcoin as a digital currency it would be similar to a “fiat” currency.
A fiat currency means the value comes from a government or organization establishing that it has value and the people's belief that it has value. So, the U.S Dollar would be a perfect example because it is backed by the U.S government.
However, Bitcoin is not backed by any governments or organizations. If people stop believing in the value of the currency, the money can become worthless since there is nothing to back it.
One intriguing aspect of Bitcoin is that the supply is limited to 21 million coins. Once 21 million coins are created, that's it!
That leads us to what drives the price volatility of Bitcoin, supply, and demand.
Lower Supply & More Demand = Bitcoins Price Increases
Higher Supply & Less Demand = Bitcoin's Price Decreases
Bitcoin's value comes from either a belief that it can one day replace/compete with the U.S Dollar or that it can be a highly sought after commodity like gold.
Investing In Bitcoin
There are several platforms to buy and sell Bitcoin such as Robinhood, Coinbase, Gemini, Bittrex, Kraken, and Etoro.
Increased access to cryptocurrency markets is a big reason why Bitcoin's price is surging.
As mentioned earlier, the 2 most common buyers of Bitcoin as treating it as either a commodity (like gold) or as a currency (like the dollar).
If you buy Bitcoin as a commodity, you are optimistic that it will be a good store of value. Gold has been around for thousands of years as a way to store value during troubling times. So far Gold has survived it all, inflation, deflation, and world wars. Bitcoin has only been around for 12 years and hasn't proven itself as a highly sought after commodity during troubling times.
If you buy Bitcoin as a currency, you are optimistic that it will compete with other world currencies. This might occur in the future but for now, Bitcoin's wild price volatility makes it very hard to use as a currency. Useful currency must be stable for it to be practical. With Bitcoin, your purchasing power can change dramatically from breakfast to lunch.
Case in point: In 2010 someone bought 2 pizzas for 10,000 bitcoins. Now those bitcoins are worth over 80 million dollars!
Pros & Cons
Let's get into some of the pros and cons of Bitcoin:
- Very Accessible (It's easier than ever to buy cryptocurrency on exchanges like Robinhood or Coinbase)
- Potential For High Returns (Bitcoin price is very volatile)
- Security (Bitcoin transactions are very secure due to the public ledger or Blockchain)
- Finite Supply (This allows the price of Bitcoin to continue to rise as long as demand continues to rise)
- Not Practical (You can't really use Bitcoin in day-to-day life right now, you have to convert it)
- Extreme Volatility (Volatility can be good or bad depending on the price you paid for your Bitcoin)
- Replaceable (In the future a newer or better digital currency could replace Bitcoin)
- Security (Lost or stolen Bitcoin from online digital wallets can never be recovered)
- Unregulated (Bitcoin is unregulated, leaving you unprotected should anything go wrong)
Investing In Bitcoin For Financial Independence
The temptation to invest in Bitcoin for financial independence is a hard one to resist for some including myself. However, in my opinion, the amount of risk involved is too high to invest in Bitcoin for financial independence.
Reaching financial independence shouldn't be a goal you leave up to chance by investing in such a volatile product like Bitcoin or any other cryptocurrency.
Yes, the returns can be incredible, with Bitcoin skyrocketing over the last few years, but if you weren't one of the lucky early investors, you're stuck wondering if now is a good time to buy or if it's too late…
The answer of course is… nobody knows. Nobody knows what the price of Bitcoin or other cryptocurrencies will be in the future. There is no long term price history as we have for the stock market.
Here are a few more reasons why I've chosen not to invest in Bitcoin…
Not Necessary For Financial Independence
Reaching financial independence is the goal for me and I would prefer to do it with the least amount of risk. The stock market has a track record of returning an average of 10% every year for over 100 years! That amount of return is plenty for me to reach my investment goals, so I won't get greedy.
The goal is to reach financial independence without taking unnecessary risks. Since index funds are a proven way to achieve financial independence at a significantly lower risk compared to gambling or Bitcoin, I will continue to pursue that path to FI.
There's a quote that sums this up perfectly:
“Bulls make money, bears make money, pigs get slaughtered”
Don't be the pig…
Bitcoin Is A Non Productive Asset
Bitcoin is a form of currency just like the Dollar or Euro. I don't have currencies as part of my asset allocation therefore, I won't be adding Bitcoin to my portfolio. Currency doesn't produce anything of value, at best it simply stores value and for most, it loses value over time due to inflation.
Bitcoin might not lose its value due to inflation; however, it can still lose much of its value if people decide to simply stop valuing it. Or as mentioned above, something new and better comes along to replace it.
An example of a productive asset would be a farm or share in a company that brings in a profit. By investing in these assets you can store value, such as the value of the farm or company itself. You are also able to benefit from the production like the harvest from the farm or the company profits in the form of dividends.
Bitcoin, like other currencies, doesn't produce anything.
Therefore, Bitcoin is considered a non-productive asset.
If you've never wanted to invest in currencies before, ask yourself why would you start now?
Tulip Mania Vibes
History has shown us that bubbles are often created by the overwhelming excitement of something new or by believing that the price of an item will continue to increase.
Back in the 17th century, there was a craze for tulip bulbs. This lead to the price of tulips increasing to well over a million of today's dollars (adjusted for inflation). The price rose so much that every person that bought a tulip believed that they would be able to sell it at a later time for more money.
The tulips real value was nowhere near a million dollars but that didn't matter, as long as someone was foolish enough to pay more than the price you paid it was considered an “investment”.
This is called “The Greater Fool Theory” and it always ends in the same way. Bubbles always burst…
This illustration says bigger fool but you get the point…
I don't know exactly how or when that will happen but I really believe this will end in the same way. I'm also not alone in this thought process.
Notable Opinions On Bitcoin:
- Warren Buffett has described Bitcoin as “rat poison squared,” a “mirage,” and a “gambling device.”
- Charlie Munger takes it a step further and says it's “just dementia” or like “trading turds.”
I don't tend to disagree with Warren Buffett or Charlie Munger when it comes to investment advice and I certainly don't plan on starting now.
There's also another quote that comes to mind:
“Those that fail to learn from history are doomed to repeat it.”
– Winston Churchill
In my journey towards financial independence, I will continue investing in productive assets such as stocks, real estate, and building a business. I wouldn't recommend a friend “invest” in Bitcoin so I can't recommend it here as part of a long-term wealth strategy.
Of course, this is just my opinion, and as I mentioned nobody really knows what will happen with Bitcoin and the other cryptocurrencies.
I will admit the technology behind Bitcoin and the blockchain really amazes me and I wouldn't be surprised if in some way it is used in the financial services industry in the future. I just don't believe in owning Bitcoin as an asset.
Again, I am by no means an expert in cryptocurrencies and this is not investment advice. Ultimately, you are free to believe what you want about the future of cryptocurrencies.
If you decide to invest in Bitcoin I hope it's with a small percentage of your overall portfolio. I also hope you are fortunate enough to find a “greater fool” to buy it at a higher price, that way you make yourself some profit.
Just be careful you're not the last one holding the bag…