If you've been watching the skyrocketing prices of Bitcoin
lately, you already know that they’ve made a spectacular,
almost-gravity defying run in 2020. In fact, a single Bitcoin
was valued at about $7,300 at the beginning of 2020 and
by the end of 2020, it was valued at almost $29,000. And
the record-run continued into 2021, as Bitcoin prices
rocketed to a new all-time high of almost $42,000 on
Jan. 8, only to then plunge over the next few days to
about $31,000 on Jan. 11 and then moving to about
$33,000 the next day.
Those who invested in Bitcoin a year ago are likely patting
themselves on the back. But should
you join their Bitcoin party? Or should you be
allocating to Cryptocurrencies as part of your investment
Currencies are traded on the foreign exchange
market – Forex, FX or just the currency market –
a global, decentralized market for buying, selling
and exchanging. Forex is comprised of institutional
investors, governments from around the world, large
corporations, banks, as well as currency speculators.
Forex differs from the stock markets that you’re
familiar with in that those markets are housed in central
physical exchanges, whereas Forex is an
over-the-counter, decentralized market completely
In terms of trading volume, Forex is by far the largest
market in the world. In fact, according to the Bank for
International Settlements, foreign-exchange trading
averages more than $5 trillion a day – which is about $220
billion per hour (it’s open 24-hours a day in different parts
of the world). Comparing it to the volume of the NYSE – 30
days of trading on the NYSE equals one day of trading on
As you might suspect, the US dollar makes up most
of all Forex trading volume, followed by the Euro and then
the Japanese Yen.
And along came Bitcoin
First invented in 2008 on the heels of the financial crisis of
that year, Bitcoin is different from other currencies traded
on Forex in that Bitcoin does not require and is not backed
by a central authority. Instead, Bitcoin is a peer-to-peer
system for online payments that runs on a decentralized
network of computers around the globe that keep track of all Bitcoin transactions, similar to the decentralized
network of servers that makes the internet work.
You can buy Bitcoins with dollars or euros, just like
you can trade any other currency. You then store your
Bitcoins in an online “wallet.” And then with that wallet,
you can spend Bitcoins online as well as in the real world
for stuff. But there are no intermediaries – it doesn’t go
through your bank or someone else’s bank.
Currency of the future?
That’s hard to say of course, but the reality is that if you
have a bank account or credit cards or even use PayPal you
are already using digital currency. Same thing goes for
when you trade stocks – you’re using digital currency.
Let’s say you and I placed a trade to buy 100 shares of
Apple stock. I’m not expecting you to show up to my office
with a bag of money that I can then go deliver in exchange
for your Apple shares, right?
The reality is that unless you actually use real cash
– and how many of us use cash today? – every time
you swipe your credit card or debit card, you have
to go through an intermediary like your bank or
credit card company. And they of course have fees
for this service.
Bitcoin, on the other hand, sets up a system where
the buyer and seller deal with each other directly.
Or a currency for the shady?
Throughout its existence, Bitcoin has been in the news
after a few ransomware attacks. The malicious software
locks down computers and files and won’t lift the lockdown unless they are paid a ransom in Bitcoins. Why
Well, because with Bitcoins, the transactions you
make are completely anonymous. Instead, whenever you
trade a Bitcoin, you use a "private key" associated with
your “wallet” to generate computer code that is then
publicly associated with your transaction – but with no
personal data. For criminals, this makes Bitcoin very
Thinking of investing in Bitcoin?
As a financial advisor, Bitcoin represents a few very
interesting thoughts. One of the first, and maybe most
interesting, is that Bitcoin could prove to be the model for
digital currency going forward – if it’s not already. But
there are still a lot of things to be ironed out and those are
topics to be covered at another time.
While there are a lot of things to consider when thinking
about buying Bitcoin or making Cryptocurrencies part of
your asset allocation plan, here are five very fundamental
questions you need to ask yourself.
Question #1: Bitcoin or Cryptos?
The first question you should ask yourself is whether you
want to invest in Bitcoin directly or Cryptos as an asset
class? Did you know that there are over 2,000 Cryptocurrencies besides Bitcoin?
Here is an analogy: in 2020, Tesla was the best performing
stock on the New York Stock Exchange with an eye-popping price change of 743% in 2020. Tesla is categorized
within the Consumer Discretionary sector of the S&P 500
and the Consumer Discretionary sector gained over 32% in
Should you consider a single component of a sector (like
Tesla) or are you bullish on the entire sector (like
Consumer Discretionary)? The answer to those questions
then leads to additional questions, like which sector or
sectors do you reduce.
Question #2: What about inflation?
When you invest in Bitcoin or any other currency or
commodity – including gold, oil or pork bellies – you are
investing on the prospects of price appreciation alone.
More specifically, you are investing on the prospects of the
price of Bitcoin rising relative to the U.S. dollar. And while
the recent price surge makes inflation look silly, you
should evaluate currencies and commodities with respect
Question #3: Can you tolerate extreme volatility?
The price appreciation of Bitcoin in 2020 underscores the
extreme ups and downs. Consider this:
Bitcoin went from $7,300 to $29,000 in 2020. But
it also dipped to about $5,000 in mid-March
during the beginning of the pandemic.
Bitcoin rocketed to a new all-time high of almost
$42,000 on Jan. 8. But then it plunged to
about $31,000 on Jan. 11.
That’s two bear markets in less than a year.
Need more proof of volatility? Well, think about this:
In early 2017, the price of Bitcoin was under
By the end of 2017, it was almost $20,000; and
By the end of 2018, the price was about $3,700.
Question #4: Do you really understand it?
This one requires you to be completely honest. Do you
understand how Cryptos work or even why Bitcoin’s price
has skyrocketed? Do you understand Bitcoin mining and
how it works? Can you explain it beyond the headlines or
the 5-second stories?
Here is one of the best stories:
The first Bitcoin payment occurred in Florida on
May 22, 2010, when a man bought two Papa
John's pizzas worth $25 for 10,000 Bitcoins. At
that point, four Bitcoins equaled one penny.
Today, those 10,000 Bitcoins would be worth
$350 million (give or take a few million and using
the price as of Jan. 12).
If you don’t really understand an investment, should you
make it? And if you can’t explain an investment to a 5th
grader, should it be one of your investments?
Last Question: Why?
It’s impossible to give blanket advice on any investment to
a large group of investors. Everyone has different risk
tolerances, goals and plans. But it’s not impossible to
remind investors that most of the time they will be a lot
better off if they choose a long-term investment strategy
that isn't dependent on a single security and is not quite so
Investors should always diversify as much as they can, so
they don’t ruin their portfolio if one investment heads
south real fast.
Could Bitcoin or Cryptos make sense as an investment for
you? Sure, it could. But you should strongly consider
limiting your investment to an amount you can afford to
lose and prepare yourself for a long and choppy ride.
Important Disclosure Information
This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information. Diversification does not ensure against loss.
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