Are you Thinking About Investing in Crypto Currency?

After three years of hiding out and biding their time, the cryptocurrency comeback kids will be back in full force, and you may encounter one at an upcoming Christmas celebration or dinner, depending on how many younger people you have in your family. Luckily for me, I only have one that I will have to interact with, and I’m looking forward to getting an update from him. After reaching $20,000 three years ago, many of these enthusiasts were talking ad nauseam about how it would be the next best thing to sliced bread and how the whole world would shift towards massive public adoption. They would lay out how crypto would ascend to the top of the economic food chain, disrupting everything using the mythical “blockchain technology.” While 99.9% of enthusiasts can’t explain what is powering these networks and coins, they are convinced that it is only a matter of time before they take over the financial world as we know it.

In the aftermath of the euphoria experienced in December 2017, the cryptocurrencies took a bit of a slumber. By that, I mean that many went down between 75 to 95% in the ensuing two years. This loss was severe, but not the most extensive one Bitcoin has experienced. The rightmost column labeled Max_DD or maximum drawdown in the table below, shows what has happened in previous price corrections.

But this week, bitcoin surpassed its old highs after a long slumber and is currently trading at roughly $23,000 per coin. During the run-up to $20,000 in 2017, we started fielding more and more client questions about the investment merits of cryptocurrencies. It seems that many people were getting approached by crypto enthusiasts or reading articles from investment gurus who, at the time, were showing massive gains in their accounts and were trying to tell everyone they knew about the next big thing. So rather than just dismissing these questions outright, I took it upon myself to learn more about this market to determine if something was there to warrant all the hype. I have always learned from doing so I did just that with cryptocurrencies, but not as a way to strike it rich, retire early, and buy a Lamborghini, but more as an intellectual curiosity.

After reading and following the market for the better part of three years, these are some of the key takeaways that I have developed.

1) This is 100% speculation.

I would never dream of putting anything that I didn’t feel like I could afford to lose into these markets. The crypto world is like the Wild West, where there are few to no barriers to entry to starting an exchange. I fear there is a fair amount of market manipulation happening between the various exchanges.

2) You don’t own anything.

Now, this is a bit technical, but unless you have the wherewithal to download a digital wallet and take delivery (download) these coins onto your wallet, the coins that you in fact “own” are in reality owned by the exchange.

3) Security issues are from users, not the network.

I’m pretty confident at this point that I know just enough to be dangerous, and I feel like I’m pretty adept at using technology, but that isn’t the case with many people. Only through testing functionality with tiny transactions have I built up the confidence to send coins across exchanges and directly into other people’s wallets. But once false move could lead to a permanent loss of your coins.

4) The volatility is brutal.

As shown by the previous chart, there have been times when drawdowns can be over 80%, and the daily swings in the coins themselves are regularly 15-20%! Unless you can stomach watching those types of swings, it isn’t for the faint of heart.

5) The technology is real.

Some projects and networks are trying to solve real-world problems, from payment processing to video streaming bandwidth issues. But, given there are over 4,000 of these with many more on the way, it will be next to impossible to predict which one will emerge as the winner.

6) Regulation is coming.

The Wild West will eventually be tamed. I know that the enthusiasts think that crypto isn’t something that can be regulated, but I would beg to differ. The SEC has been all over cryptocurrencies and has denied several attempts by funds to create exchange-traded funds that would be unleashed to the investment public at large. In 2019-2020, Congress introduced 40 cryptocurrency and blockchain bills. So this topic is definitely on the radar of legislators.

In the end, where I have landed is knowing if some of these projects succeed in creating disruption, I will already have a passive investment in their success. The large companies that we invest in already are keeping an eye on this space and are seeding some of the projects and taking small minority ownership stakes along the way. If cryptos succeed in the long run, the companies that have made these investments could benefit significantly through increased profit margins and growth, which in turn may increase their value.

If this is a topic that you have an interest in and would like to learn more about, please send me an email, and I can point you to some of the reading that I have done over the years.

Nathan Smith is a Portfolio Manager with Rather & Kittrell.