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Cryptocurrency is gaining a lot of attention in early 2021. Many people will have been intrigued by headlines about Bitcoin soaring in value since last September, where it stood at $10,764 per Bitcoin. By the 10th March 2021, the price had exceeded $54,458. Such rapid, huge returns are astonishing. Moreover, other (more obscure) cryptocurrencies have also attracted attention. In particular, Dogecoin – originally created as a joke and featuring a Shiba Inu dog mascot/meme – as its logo – has soared 1,400% over a year-to-date rally to a total market cap of $9bn.
This kind of investment growth makes the returns from traditional stocks and bonds – the “bread and butter” of financial planning and investment planning – seem weak in comparison. Yet what is going on with cryptocurrencies? Are they a sound investment and, if so, how should investors include them within a portfolio?
Our financial planning team here at Cedar House offers some reflections on these questions below. If you’d like to find out more or discuss your own financial plan with us, please contact our team for more information or to access personalised financial advice:
020 8366 4400 or enquiries@cedarhfs.co.uk
How do people make money from cryptocurrency?
Perhaps the most well-known approach to crypto investing focuses on capital gains. In other words, you buy a certain amount of cryptocurrency, like Bitcoin, and sell it to someone else later after it rises in value. You can then “cash out” the profit (e.g. into fiat currency like GBP), or you can reinvest the capital – perhaps into another cryptocurrency, using an online exchange. This is the cryptocurrency investment approach we are most concerned with in this article.
However, there are other ways people seek to profit from cryptocurrency markets. One method is via “crypto mining”. This involves building a specialist PC (or “mining rig”) – e.g. in your home – and dedicating its computing power to help verify the transactions occurring within a given cryptocurrency. For the effort, the miner is occasionally rewarded with a certain amount of the cryptocurrency – which they can then cash out, or reinvest.
Finally, people can choose to invest in the shares of companies involved with the technology underpinning cryptocurrencies. Coinbase, for instance, is a cryptocurrency exchange that has recently announced plans to go public. If it does, investors will be able to invest in its stock and hope to profit – perhaps via dividends, or by selling owned stock later at a higher price.
Cryptocurrency – a speculator’s game
To help decide whether buying crypto is a good idea or not, it’s important to try and recall some of the distinctions between gambling and investing. After all, what are the differences – since they both involve risking capital? As financial planners, we’d answer ask follows:
- Time horizon. Most gamblers seek to make a “quick win” in a casino, whilst successful investors patiently seek to generate returns over 5, 10, 20 years or more.
- Risk allocation. How do you minimise your chances of getting a poor hand in a game of Poker? There are few ways to do so. With investing, however, you can mitigate risk by spreading your capital across different companies, currencies and asset classes.
- Odds. When you go to a casino, the odds are generally stacked against the gamblers. After all, it would collapse financially if the latter kept winning! Investors, however, are not locked into such a system (e.g. in the stock market).
- Data. Professional gamblers can, certainly, get an “edge” over opponents by researching their opponents’ histories etc. However, with a stack of playing cards, what has come up in the past has no bearing upon what will happen in the future. With investing, however, past performance of a company can give an indication of its future prospects – although these are not guaranteed. With many investment opportunities, there is more historical performance data to make informed decisions.
Which of these two categories does buying cryptocurrency fall into? It is not easy to say. At the very least, however, we can say that it generally carries a much higher level of risk – possibly justifying the label: “Speculative”. After all, how can you tell which cryptocurrency will likely rise in value – and when? With many bonds and stocks, however, it is much more possible to make reasonable judgments about returning a profit (e.g. by looking at company fundamentals and analysing the prospects/outlook of its sector).
Dogecoin is a case in point. After hitting an all-time high in early February (thanks, in large part, to Elon Musk’s endorsement on Twitter), the cryptocurrency had dropped 20% by the evening of the 14th February. At the time of writing in March, Dogecoin has still not returned to its previous pinnacle on the 8th February – and it is not clear where it will go now. Much of its movement has been driven by internet forum discussions (Reddit) and celebrity endorsements, which could change at a moment’s notice.
Conclusion
Some people with a higher risk appetite will still want to take a punt at cryptocurrency investing. In which case, consider speaking to your financial adviser. Regardless, be careful not to commit more than you can afford to lose – given the high volatility nature of most cryptocurrencies.
Interested in discussing your financial plan with an experienced financial adviser? Get in touch today to discuss your financial plan with a member of our team here at Cedar House via a free, no-commitment consultation:
020 8366 4400 or enquiries@cedarhfs.co.uk