Last Updated on 17 February 2021 by Dan
Hello everyone! Now if there’s been a topic that’s been a big part of the investment community over the past few weeks it’s been Bitcoin, which saw a very rapid price rise. Naturally, you therefore may be asking yourself the question if it’s something you should be considering investing in.
In short I’ve never advocated investing in Bitcoin or any cryptocurrency on this site. I can hear the howls already – “isn’t this site supposed to be about growing your money?” “Nothing has gone up more than Bitcoin and you’re saying I shouldn’t go into it?”
Well yes, but we’re advocates of investing to minimise risk and in things we understand. Today I’m going to be running through why I don’t think Bitcoin meets that criteria. (And you can see a list of investment products and their characteristics here).
Contrary to how this article may sound, I’m actually a believer in the technology behind Bitcoin (distributed ledgers) and can see how it can be transformative – I simply don’t see Bitcoin or Cryptocurrencies as something that represents a sensible investment.
As with all our articles on investment, this doesn’t represent any kind of financial advice and is based on our opinion only – you should always do you own research on anything that you’re investing in! See our disclaimers for full details.
Why I don’t invest in Bitcoin
1. You cannot justify a sensible valuation.
If I’m investing in a single stock equity or a bond, it’s possible to tie something back to it’s underlying valuation. I can read the balance sheet and income statement of a company and understand what value presently sits in a company from a valuation perspective, and use sales data to try and build a model of future valuation based on the cash flows of the firm.
That’s an inexact science of course (otherwise we’d all be rich) but it at least helps a professional get a sense of what an approximate sensible price for a stock is.
Whilst there’s data on increasing use of Bitcoin, it’s not underpinned by these factors and seems more driven by speculation. If it’s fair to say Bitcoin is priced correctly at £5,000 or £30,000 is near impossible to say – it’s much more a case of driven by momentum.
It’s a key rule with any kind of investment – something can have a high price, but represent poor value.
Which brings me on to….
2. The pricing shows characteristics of a bubble
A bubble is where momentum is the key factor driving a price. It’s where there’s nothing really underpinning valuation, but where people are buying an asset simply because prices are going up and there is a psychological feeling this is the next big thing or that you “can’t lose”. Usually, this is demonstrated via a rapid price accumulation of something which is slightly niche becoming increasingly mainstream.
Investment bubbles are not a new thing. In the mid-1600’s for example there was “Tulip-Mania” where as these new flowers arrived from Turkey and were craved by the affluent the prices went up and up, eventually hitting six times the average salary for the time. Suddenly, the market crashes and you could hardly give a tulip away. It happened more recently in the late 90’s/2000’s with internet equity valuations.
Ask yourself, are you buying Bitcoin because you feel it’s genuinely worth the valuation, or because it feel everyone else is? History shows us that in such situations prices drop fast, and you can end up very badly burned.
3. You can’t easily time the market
Ok, let’s say we accept that Bitcoin is a market which we know is volatile and bubbling. We might reach a conclusion instead that we’ll accept this and try and day trade against the volatility. The market dips down, and we buy it up. It goes up again and we sell. Simple, huh?
Except unfortunately it’s not – this strategy tends to work well until it doesn’t. It’s easy to think you’re continuing to keep winning in a market consistently moving in one direction and get lulled into a false sense of security. When the market rapidly shifts and consistent momentum upwards moves into a cliff-drop plunge you can get badly burned.
I saw lots of people get burned the last time Bitcoin surged in 2018 where they bought into what they thought was a dip, and was actually a collapse. To some degree you can mitigate this through stop-losses, but you can still get badly burned.
4. The economic purpose of Bitcoin isn’t yet clear
One of the arguments given for the price growth in Bitcoin is that it acts as an alternative store of value during financial stress, particularly with central banks engaging in quantitative easing which artificially affects the money supply and therefore the value of traditionally currencies. There was a wave of people putting the view that COVID was a huge opportunity as a credible alternative.
The theory isn’t a bad one. A “countercyclical asset” is a valid role which has traditionally been filled by precious metals, and gold in particular.
My own personal view is that the possibility of this happening is still forming for bitcoin. There’s a couple of tests which something being a credible store of value needs to meet. It needs to be reliable, and I’d question at Bitcoin’s present level of price volatility if it could be credibly said to be that. It’s accepted in some places, but you couldn’t describe it mainstream meaning it’s liquidity is still in question. It’s possible, but not guaranteed this will develop.
If it is to develop, it needs a much more consistent price level. A pizza parlour in New York started to accept Bitcoins for example – the problem was you ended up with the effective price of the pizza versus dollars changing so rapidly it was impossible to use for business purposes.
It doesn’t help that unfortunately the cryptocurrency market has also attracted a rife of different scams, which undermine confidence in the overall market.
Warnings on Bitcoin and Cryptocurrency
Continuing on that theme it’s worth highlighting that unlike most more traditional investments that cryptocurrency is a largely unregulated market.
The FCA has warned UK consumers that investing is cryptocurrencies or derivatives linked to cryptocurrencies face a risk of losing all their money.
I’ve mainly referred to Bitcoin in this article as it’s the thing of the moment, but it equally applies to all other variants of cryptocurrency – Ethereum, LiteCoin, Ripple etc. In fact these alternative currencies often have less liquidity in their markets and so the above warnings count double.
This is extra-true for currencies that are even less well established – there is next to no regulation of the ICO (Initial Coin Offering) and this section of the market is particularly rife with scams. Always do your research, and see our general overview on looking out for scams here.
There’s a lot of questions on Bitcoin and cryptocurrency out there in the personal finance market so if you have any additional questions or an alternative point of view, please let us know in the comments section below.