Is Cryptocurrency a Good Investment?

Is Bitcoin a good investment? What about other cryptocurrencies like Ethereum and Dogecoin? If you’ve watched the meteoric rise (and fall, and rise) of cryptocurrency prices, you might be wondering how, or if, this should be a part of your investment plan. It’s a great question and worth consideration, whether you’re hoping to get in on the excitement or simply reading headlines and wondering what all the fuss is about.

Let’s look at a brief history of cryptocurrency, how it functions as a currency or investment, and if it deserves a spot in your portfolio.

What is cryptocurrency?

Cryptocurrencies are digital currencies that cut out the traditional banking system, relying instead on a decentralized digital ledger called a blockchain to record transactions. Founded in 2009, Bitcoin grew in popularity largely due to blockchain technology, which can reduce fraud risk and cuts out many processing fees incurred in most banking transactions. Like traditional currencies, there are many types of cryptocurrencies. Etherium, Dogecoin, Litecoin, and many others have followed Bitcoin.

But practically speaking, what is it? Money? An investment? Both? And if it’s an investment, is it a good one?

Is cryptocurrency a good currency?

To answer this questions, let’s first look at what currency is intended to do. Money serves one or more of three purposes:

• Medium of exchange. It must be widely accepted enough that you can rely on being able to use it to buy goods and services. More companies are accepting cryptocurrency, credit card companies like Visa are working to enable crypto purchases on their platform (though they would be converted to dollars, not exchanged directly), and U.S. regulators have indicated openness to allowing banks to provide cryptocurrency services, all promising for the future. Its security and potential for instant settlement are also promising. Today, however, you’ll have hard time using it to gas up the car or restock the refrigerator.
• Measure of value. It is used as a standard to value other goods. If you ask the price of a car, you likely expect to hear an answer in dollars because they are our most common measure of value. Today, cryptocurrencies like Bitcoin are relatively valued in dollars or other currencies, rather than being a standard of value. Established currencies like the dollar and pound are valued against one another, but their values rarely experience large swings because they are widely accepted and are involved in millions of transactions every day.
• Store of value. It is durable and widely recognized as valuable. Gold has been recognized as valuable for thousands of years, though its value fluctuates. It’s also scarce and must be mined to increase the amount in circulation. Bitcoin and other cryptocurrencies have similarities to gold in this way but don’t carry this historical stability yet, which brings both risk and opportunity.

If Bitcoin and other cryptocurrencies continue growing in popularity and acceptance, we’re likely to see more price stability follow and it could function better as a reliable form of money. However, up to this point, it’s been quite the opposite. According to CNR, Bitcoin has experienced six corrections of more than 50%, while the S&P 500 has experienced just three in the last 90 years. Volatility has a place in your investment portfolio, but you probably don’t want it in your bank account.

Is cryptocurrency a good investment?

Though cryptocurrency is intended to be an alternative to fiat money (money issued by a government but not backed by gold or another commodity), its wild price swings have attracted investors and speculators hoping to profit from the volatility. Some have made millions, while others have lost millions, including the now famous story of a man who lost nearly $300 million in Bitcoin (as of the date of this writing) when he took an old hard drive to the town dump.

So, is cryptocurrency a good investment? To answer this question, we’ll pull a few lessons from our article Investing vs. Speculating and Why it Matters.

• Investment is acquiring an asset with the goal of generating income or appreciation in the future. They also have intrinsic value. Stocks represent shares of companies who are making a profit. Bonds pay a fixed income. A rental property sends a rent check each month. In most cases, you can make a profit holding onto the investment.
• Speculation is a financial transaction with substantial risk of total loss, but with the expectation of significant gain. In many cases, you profit only by buying low, selling high, and dodging significant loss.

The goal of investing is to grow wealth while reducing the risk of total loss. Speculation, on the other hand, requires the risk of total loss for the chance at higher gain. Are some people making a profit from buying and selling cryptocurrencies? Absolutely. It’s a volatile world, but some have made small fortunes in crypto. However, looking at the above criteria, cryptocurrencies don’t fit the bill of a good investment, though they can certainly be an exciting (and profitable) speculation.

Should I put money in cryptocurrency?

There’s a place for speculation, just not with your nest egg – the funds you’ll need to retire. Interested in how to create a speculation strategy? Check out the “speculate responsibly” section in our Investing vs. Speculating article for our top three tips!

Sources – CNR, Capital Group