Should You Buy Cryptocurrency? What to consider first.

I get this question a lot. Should I buy cryptocurrency, or specifically Bitcoin? It’s interesting that so many people are talking about this alternative currency. This is a legitimate question, as the prices of some of these currencies have skyrocketed over the last few years. Is it time to jump in?

Here, my intention is to provide you a brief overview of what cryptocurrency (or crypto) is and then to discuss the implications on your portfolio. First, cryptocurrency is an alternative to traditional paper currency. We don’t typically go to a store and purchase bread with crypto, but we might exchange services or buy certain products online (computer to computer) with them. Crypto is not accepted everywhere, whereas dollars typically are. Dollars (or any national currency) are backed by federal governments and supported with the full faith of the government, which means that in the event of a major default or collapse, the currency will still have exchangeable value and can be freely traded. This support provides some stability and you will notice that on a day-to-day basis we don’t have huge swings of the value of the dollar or the British pound for instance. This standard form of currency comes in paper form and is recognized by everyone universally. 

Cryptocurrency is an alternative form of payment that is primarily in digital form (i.e., there is no physical exchange of cash). Some cryptocurrency is now producing physician coins or paper, but this is rare. Instead, money is traded as virtual coins or tokens exchanged between computers.  “Altcoin” as it is often called, is also purely based on who is buying or selling in the market. Since the government is not officially backing the currency you will notice huge variations day-to-day in the value of any particular crypto. I thought we talked a lot about bitcoin, there are probably thousands of options like Ethereum or Polkadot. Some of these have established themselves as legitimate options to physical (paper) forms of currency. 

There are multiple articles comparing these two very different forms of currency. I don’t want to do that again here. Both have some unique advantages and disadvantages. But from an analyst’s perspective, I’m going to offer these thoughts as they impact an individual’s finances. 

First, important financial bodies such as the Financial Accounting Standards Board (FASB) do not yet recognize virtual coins as cash, inventory, or even a tangible asset. They are recorded as “intangibles”. Some may say this just suggests that FASB and other bodies are behind the times. The IRS does recognize this, but their perspective is largely based on tax revenue collection from gains on sales, so any gains on currency exchange will result in tax implications.  Of course, FASB standards only apply to companies, but they represent a very conservative fiscal view of the perceived value of this particular type of asset. If accounting standards boards don’t recognize these as cash or investment, this suggests risks.

Second, most of the people I know prefer a steady and certain path towards wealth. Volatility, or swings, in prices, causes a whiplash effect. This can cause spikes in prices and significant declines as well. Many of us don’t want to stomach that kind of risk even if the gains might be there in the long run. 

Third, predicting whether any individual alternative currency will increase or decrease over time is virtually impossible given that we don’t have much history to predict based on. The oldest coins have been around only about a decade.  If you were looking for some certainty in a long run–for example, as you can pretty much do with blue-chip stocks (large, stable, mature firms)–then you should look elsewhere. 

With all this being said, there have been many instances where people have made significant returns or even gotten wealthy by trading cryptocurrency. Anytime you have large volatility is an opportunity to make a lot of money. There is also a significant opportunity to lose money and is generally a higher-risk activity. Therefore you need to make sure before investing that you have the appropriate money/risk personality. If you take my Yellowstone risk tolerance assessment (link below) you will see where you stand. If you’re the kind of person who prefers more conservative paths you probably should skip crypto. If you are an aggressive high-stakes investor then consider adding it to your portfolio.

Try my behavioral money quiz here to learn more about yourself.

Either way, think of investment in any currency as a fraction of your total portfolio. A really well-diversified or balanced portfolio should have some mix of stocks, bonds, real estate, mutual funds, and other investments. If you only have $10,000 in total cash available for investing, and you are looking for where to put it, think about balancing that out among multiple areas. A pool of investments will always improve performance and reduce your risks in the long run. Stay diversified to reduce the overall systematic risk!

So to summarize. Yes, you should consider alternative currencies as a portion of your overall portfolio. While we regularly use dollars, we won’t get rich trading on it; whereas, we have the potential to do so with crypto. That’s the nature of volatility. But, most importantly: do your research and understand the risks (downside). Align these risks with your own behavior and risk personality type. Be cautious, think about managing your overall portfolio performance, and be proportionally balanced among multiple types of investments.

Happy investing!

Leave a Reply

Your email address will not be published.