Cryptocurrency: Smart Investment or Risky Gamble?

Over recent years, Brooklyn Coop has seen a rise in our members’ interest in cryptocurrency.  We strive to always be a trusted source of financial information for members, so we want to talk to you about how crypto works both in this blog post and in the Cash IRL workshop for this month.  What is it? Is it a good investment?  Are there good ways to invest in crypto and bad ways and how can you tell the difference?

Coming up with guidance is difficult. For one, although the current presidential administration is quite friendly to crypto [1], this may not always be the case in the future. For another, although some forms of cryptocurrency have appreciated significantly and allowed crypto holders to significantly increase their net worth, there have been many [2] well [3]-publicized [4] cases [5] of crypto scams [6], collapses [7], and failures [8]. Since there is so much uncertainty about the future of cryptocurrency, there are still many unknowns about its usefulness. Note, we are not giving financial advice–rather, we are trying to guide your further research.

Cryptocurrency is a network-based digital currency “that is not reliant on any central authority, such as a government or bank, to uphold or maintain it,” according to Wikipedia [9]. The original one is Bitcoin. Along with Ethereum, these two cryptocurrencies are really the only two success stories of the genre for two main reasons: first, there are the network effects of millions of people investing a lot of normal dollars in them. Second, the way these cryptocurrencies are designed–built-in scarcity, blockchain tech, secure transactions–have earned them the trust of the buyers. However, there are significant issues as well. Because crypto is not backed by a government, governments do not consider it a currency, but rather a commodity like stocks.

Additionally, because the continued success of the asset requires a high degree of trust, they are more prone to bubble-bust cycles. Because there is little to no transparency regarding who owns most cryptocurrencies or the cryptocurrency exchanges themselves, individuals face significant moral hazard [10], more so than other commodity types because these assets are lightly regulated and completely intangible.

The last point is important. Since there is no actual tangible asset underneath the commodity, crypto is extremely reliant on other participants to maintain its value. If trust among participants is lost for any reason, the value will deflate. A failed crypto exchange will have few real assets to offer to customers to repay their investments. Moreover, as an asset class, crypto doesn’t generate dividends or interest; it only pays out if you sell for more than you purchased. If the value of your investment tanks before you can sell it, that money is gone. And because no one requires crypto to pay taxes, buy things, or save money, there is no guarantee you will be able to sell it at all.

 

That being said, cryptocurrency does present some benefits. Crypto generates far fewer liabilities than other investment asset classes, such as real estate (property taxes, insurance) or traditional stocks and bonds (annual broker fees). The only significant liabilities a crypto customer needs to worry about are the initial exchange fee at purchase and the capital gains tax at sale. Additionally, many people who have small amounts of money to invest may not have enough money to purchase real estate; since investment in crypto is possible with a small dollar amount, it is attractive for people with lower incomes.

 

In my opinion, the weaknesses of crypto as an asset class outweigh its potential upside, and I would not advise people to buy it.  I discourage speculation in general and trading in crypto is no different. However, understanding that some people will invest in crypto regardless, I would advise speculation only in the most successful coins, i.e. Bitcoin and Ethereum. These are the assets that are least likely to fail, as they have a worldwide user base and relatively widespread acceptance as a medium of exchange. I would strongly advise against other, more obscure crypto types which are much more likely to bubble and pop, or worse, be outright scams. In any case, whenever investments are occurring, remember it is up to the investor to perform a due diligence, whether for an intangible asset such as crypto or for a regulated asset, such as land, or even an insured certificate of deposit. Everyone has a different risk appetite [11]; only you can decide what investment best fits your particular risk profile. Good luck in your future investments.