Cuckoo for Crypto-Puffs

Bitcoin has been one of the best-performing assets of the past decade. Keep in mind that the last decade has also included record-smashing highs for both the DJIA and the S&P 500. When something is successful, people copy it. Several additional cryptocurrency flavors have joined the ranks since 2013, when Dogecoin, a currency that was initially launched as a joke, hit the market. Despite the dizzying gains, cryptocurrency investments remain highly speculative at this point in time. However, they may be here to stay and are worth understanding. Here is the story on crypto. 

Chain of Fools

It’s hard to understand cryptocurrency unless you have a basic understanding of the platform on which it operates. The thing that makes cryptocurrency possible is the underlying blockchain technology. Blockchain is a type of database that is usually decentralized. That means it is housed on servers in several locations. Whereas the contents of most databases can be altered, blockchain keeps an essentially unalterable, chronologically timestamped record of activity and transactions. Every time a transaction occurs, it is added as a block to the end of the database’s chain-like transaction record; hence the name blockchain. The blockchain database is transparent, meaning the information on it can be viewed by anybody, making it easy to verify records of transactions. Cryptocurrencies are the method of exchange by which users of the blockchain transact business. Each blockchain database houses its own cryptocurrency. The Ethereum blockchain uses Ether as its currency. Bitcoin and Dogecoin also have their own underlying blockchains. While this can be an entirely separate blog topic, the recent publicity of NFTs (non-fungible tokens) and their record-breaking sales prices, is worth mentioning here as an example of how transactions can take place. An NFT is a piece of code that exists on a blockchain that manifests as a digital image. What blockchain the NFT is on determines what cryptocurrency is used to buy it, since different cryptocurrencies exist on their own blockchains. A company can set up a settlement application on a particular blockchain in order to accept payments and make transactions in the blockchain’s currency. If somebody owned Bitcoin but wanted to purchase an NFT on the Ethereum blockchain, they would have to exchange their Bitcoin into Ether, moving the stored value across blockchains, in order to make the purchase. However, there are companies that have brought apps to the marketplace that will make these exchanges and settlements for you, facilitating transactional ease across blockchain platforms.

What Goes Up

Ease of use definitely seems to influence the value of a currency. The week this post was being written, the price of Bitcoin whipsawed several times after a series of statements by Elon Musk regarding Tesla, the company’s holdings of Bitcoin, and whether the company would continue to accept payments for its cars in Bitcoin. In addition, the Chinese government has continued its crackdown on cryptocurrencies and has prevented state-backed financial institutions from providing any type of services related to the trading of the currencies.  On May 19th, the price of Bitcoin fell 31% in the morning, only to recover 33% in the afternoon. At that time of this writing, Bitcoin is trading at $36,007 per coin which is down 40% from its highs a month ago.  What people forget about volatility and risk is that the term doesn’t just encompass the downside. Upside potential also factors into the volatility potential of an asset. Bitcoin was launched in 2009 for $0 per coin. By October 2010, it was $0.10 per coin. This past month, it hit a new all-time high price of $63,729 per coin according to data from Coin Metrics. With so much development still occurring around how cryptocurrencies can be used, it’s no wonder volatility is still on the menu. Very recently, the Robinhood and Coinbase applications gave the average person the ability to invest directly in cryptocurrencies with relative ease. In Canada, cryptocurrency ETFs are also available. Due to regulatory issues, cryptocurrency ETFs are not yet available in the U.S., but are expected to hit the market within the next year.

The Difference

Capital keeps flooding into the marketplace. With fewer publicly traded companies listed on exchanges, investors are looking to park capital wherever they can. Stock prices are driven upwards by the influx of money, as are cryptocurrency prices. However, there are a few key differences between the two that are worth mentioning. A stock is a piece of ownership in a company. It has assets and cash flows backing its value. Since the price of a stock is supposed to be the present value of its future cash flows, it is possible to estimate a price target. Knowing a stock’s price target gives you a measure of how much longer you may want to hold the stock before its appreciation peters out. Cryptocurrency, however, has no company, assets, or cash flow stream assigned to it. Therefore, it can’t have a price target. The price goes up and down based purely on speculation of future value. There are no actual underlying assets propping up the price. So, that’s the rundown on cryptocurrency. If you are considering an investment in the asset class, I suggest we have a conversation first. We’ll want to look at how it fits into your overall financial plan, and make sure the asset class fits in with your risk tolerance and time horizon. It is my opinion that the volatility will likely continue for the foreseeable future. It’s also important to note that a great deal of appreciation has already happened, and it’s not as though there are any balance sheets or cash flow statements to analyze in order to set a future price target, so how high the price may go is anybody’s guess. That type of ambiguity is not appropriate for everybody. I look forward to speaking with you soon to answer the remaining questions. As you can imagine, the rabbit hole on this subject goes pretty deep.