Whether you’re a newbie or seasoned investor, cryptocurrency holds a lot of appeal as an alternative investment class. You might have heard about the sudden boom in value in cryptocurrency and decided you wanted to get in on the gains, or maybe you’re intrigued by the technology itself. The question remains: should you invest in cryptocurrency now?
The history of cryptocurrency
A famous piece of investing advice from Warren Buffet is to only invest in businesses and technologies you understand. It might be beneficial for potential investors to understand what cryptocurrency is and how it originated.
In October 2008, Satoshi Nakamoto published the bitcoin whitepaper, which introduced the idea of bitcoin to mainstream media. “Satoshi Nakamoto” was the pseudonym for the yet-unknown creator of bitcoin. He is the person who popularized the idea of a “peer-to-peer” payment network that forms the backbone of bitcoin and cryptocurrency technology. And what is bitcoin? According to bitcoin.org,
“Bitcoin uses peer-to-peer technology to operate with no central authority or banks; managing transactions and the issuing of bitcoins is carried out collectively by the network. Bitcoin is open-source; its design is public, nobody owns or controls Bitcoin and everyone can take part.”
Cryptocurrency is a relatively new innovation that was designed to replace the current process for financial transactions. It aims to democratize banking by making the process more transparent and open.
You might already be familiar with bitcoin, which is a type of cryptocurrency. It is in fact the world’s largest cryptocurrency by market cap. Cryptocurrencies are financial applications of blockchain technology and are virtual currencies that are almost impossible to counterfeit and outside the scope of any central or government authority. In addition to bitcoin, there are thousands of other cryptocurrencies.
The benefits of cryptocurrency
As we mentioned above, cryptocurrencies are a type of financial application and asset. There are benefits to using cryptocurrency at a business or individual level:
Essentially, cryptocurrencies aim to make it easier to transfer funds directly between two parties, without the need for a trusted third party like a bank or credit card company. This could lower fees and costs of transactions, making instant transfers much cheaper than anything currently being offered by banks. A payment made with bitcoin cannot be reversed after the fact and cannot be used for fraud or lead to identity theft. Finally, cryptocurrency represents an opportunity for the decentralization of financial power—this would lead to equality in financial infrastructure access across boundaries and serve minorities and other underrepresented groups.
The potential applications go beyond just the customer and corporate level. Countries with deflated currencies or hyperinflation could move to cryptocurrency to stabilize their economies. Additionally, there could be lower-cost, faster transactions across borders to revitalize global trade. While a lot of applications on a large scale are speculative right now, functionality and popularity are growing as cryptocurrencies develop.
Why invest in cryptocurrency?
As a fairly new and complex technology, cryptocurrency has seen wild swings in valuation and popularity in the financial sphere. Even today, it is considered a risky alternative asset class and is largely relegated to the portfolios of the rich and controversial.
However, the barriers to entry for investing in cryptocurrency have never been lower. There are many reasons to consider investing in cryptocurrency:
Diversification: Crypto can provide diversification benefits to your investment portfolio. Because the returns are not correlated to any specific industry, investing in cryptocurrency can reduce unsystematic risk
Alpha returns: While past returns cannot be a predictor for the future, it is no secret that bitcoin led to many overnight millionaires in the past few years. While we would not encourage hasty and irrational investing, holding cryptocurrency could lead to alpha returns in your portfolio
Opportunity to invest in an upcoming technology that is set to grow explosively over coming years
Why cryptocurrency may not be right for your portfolio
You have to know yourself as an investor before deciding what asset classes should be in your portfolio. As tempting as it can be, there are good reasons not to invest in cryptocurrency:
Growth is subjective: When you buy shares of a company or invest in real estate, you know that the value of that asset can increase or decrease due to a range of reasons. If a company you choose to invest in makes a bad financial decision or is in a declining industry, you’ll know the reasons behind the company stock losing value. The same cannot be said for historical cryptocurrency returns, which rose or fell rapidly based on speculation
It is not universally accepted: There might be a time where cryptocurrency is synonymous with fiat currency, but our economy is not at that point yet. Depending on your investment platform, even if you do choose to invest in cryptocurrency you often have to exchange it back into USD before withdrawals.
It is not a lottery ticket: Under no circumstances should you go “all in” on any kind of investment, no matter how many overnight millionaires it claims to have made. With cryptocurrency, it can be tempting to see the constant growth and think about what it could add to your net worth. Your portfolio should be constructed with long-term goals and growth in mind, and as of yet any kind of long-term trend in cryptocurrency remains to be seen.
Cryptocurrency can be a valuable asset class investment if it fits within the overall goals and risk profile of your complete financial portfolio. Its growth and returns cannot be studied in a vacuum, and potential investors need to ask themselves what they are hoping to accomplish by investing in cryptocurrency. Finally, new investors who have not built up an emergency savings fund or are hoping to pay off debt by making quick returns on cryptocurrency should consider starting with investment types that are more stable and long term.