Warren Buffett Just Ripped Cryptocurrency to Shreds
Bitcoin and other cryptocurrencies are making regular headlines these days with their big price moves, mostly to the upside. But does that mean you should jump on the bandwagon? Probably not.
The issue isn’t just about Bitcoin or other digital financial assets, which have taken speculators on a wild ride. It’s also about regret — how much you would bemoan lost opportunities or kick yourself for sustaining possibly numbing losses. The potential for regret also factors into other financial decisions, but it’s front and center with these digital assets, given their growing popularity yet inherent unpredictability.
Bitcoin and many of the other cryptocurrencies — there are more than 1,000 — appear likely to stick around permanently, as is the underlying “blockchain” technology. But how things ultimately unfold is anyone’s guess.
These currencies are assets that exist in digital form. New bitcoins are created or “mined” by computers that solve complex mathematical problems. They’re stored in “digital wallets” — a type of virtual bank account but without anything resembling deposit insurance — from which they can be tapped to buy things. Transactions take place and are recorded in computers around the world in a public ledger, the blockchain. You can buy coins on cryptocurrency “exchanges.”
Bitcoins and their cousins can be used to make purchases anonymously, which partly explains why they have been linked to money laundering and other illegal activity. Cross-border payments are “easy and cheap because Bitcoins are not tied to any government or subject to regulation,” noted Jeremy Kisner, a senior adviser at Phoenix-based Surevest Wealth Management, in a commentary. “Bitcoin’s most important characteristic … is that no single institution controls the Bitcoin network.”
Confused yet? If so, that could be one reason to steer clear. One of the most fundamental rules of investing is that you should understand what you own. Surveys have shown that the public routinely struggles on quizzes that ask simple questions like: What happens to bond prices when interest rates rise? Cryptocurrencies take the knowledge requirement to a much higher level.
Here are some other reasons to remain wary:
The economics are dubious
One reason digital currencies have surged is that they’re difficult to create, ensuring modestly slow increases in supply that have “added to the fear of missing out,” Kisner said.
Bitcoin, the biggest and best-known cryptocurrency, recently was worth around $160 billion, wrote Nathan Erickson, chief investment officer at MRA Associates in Phoenix, in a commentary. That made it more valuable than most companies in the stock market.
Yet corporations generate millions if not billions of dollars worth of revenues and profits by supplying important products and services. Digital currencies, for the most part, don’t. Besides, profits, cash flow, revenue and other measures can be analyzed to determine a fair value for a company. “Bitcoin doesn’t have profits or cash flows, making it extremely difficult to determine a value,” Erickson noted.
Pricing has gone parabolic
This is another way of saying prices have risen so sharply that they could be overheated and unsustainable. When you look at a chart of recent Bitcoin prices, the steeply rising upward curve is shaped like the underside edge of a football. With other assets in the past, such rapid price appreciation has often preceded numbing crashes.
With no cash flow or tangible assets to value cryptocurrencies, it could come down to hoping someone else is willing to pay more than you did, Erickson said.
“Those who are buying today are simply hoping to sell it to someone else at a higher price,” he wrote in his commentary. “Without a mechanism for valuation or stabilization, it represents an extremely risky and speculative purchase.”
Regulators probably can’t help
The Securities and Exchange Commission and other market watchdogs are showing more interest in digital currencies from an anti-fraud perspective, but that doesn’t mean they can make investors whole in case of foul play. In fact, a recent SEC statement on this matter was fairly clear: You’re on your own.
Even having your computer stolen or losing your password could effectively wipe out your investment. “There is a risk if the cloud computers get hacked or your computer (holding) your digital wallet crashes or gets lost/stolen,” wrote Kisner. “The Bitcoins would still exist, but you would never be able to access them without the digital encryption key.”
Investing for the wrong reason
The big lure for investors is the ability to make money. But some people might be motivated as much by emotional insecurity — a fear of missing out.
You hear other people brag about how much money they’re making, so you start worrying about being left behind or, worse, being called stupid for not jumping on the bandwagon. Such feelings aren’t good justifications for risking your money.
“Historically, whenever human beings allow emotion to be part of a financial decision, the outcomes are rarely favorable,” observed Erickson. “(Fear of missing out) can cause investors to buy at the top of markets after watching an investment increase in value . . . and hearing about the (supposedly) great performance experienced by friends and neighbors.”
One way to frame the issue is by examining your potential for regret. Ask yourself whether, years from now, you would mainly regret missing out on a big gain if Bitcoin continues to skyrocket? Or would it be more painful if you instead suffered a huge loss?
A desire to minimize regret weighs on all sorts of financial decisions, but the potential with cryptocurrencies is intense. Hence the importance of analyzing what your motivations are — not just with financial choices but with other life challenges including career paths and relationships.
“Although you never know in advance how a decision will turn out, people rarely have regrets when they spend their time and resources in ways consistent with their values and priorities,” Kisner observed.
If you still decide to take the Bitcoin plunge, minimize your potential for regret — and actual financial damage — by limiting any financial stake to an amount you can afford to lose. If the frenzy persists, a modest stake still could grow into a big profit. But if it fizzles, you would still have the bulk of your investment portfolio, and sense of self-worth, intact.
Reach Wiles at firstname.lastname@example.org or 602-444-8616.