Investing in cryptocurrency like Bitcoin is akin to playing the lottery and investors must practice caution when including speculative asset classes in their portfolio.
Cryptocurrency has largely escaped regulation to date, as its popularity continues to attract huge speculative investments on its price ($1,7 trillion to date) in the hope of quick riches. However, those days appear to be numbered as governments around the world, including South Africa, look to regulate this largely unconventional asset class.
This is according to Saliegh Salaam, Portfolio Manager at Old Mutual Investment Group, who says that there are many parallels between cryptocurrency and playing the lottery. Discussing a recent article by Bloomberg columnist David Finkle, “What 16th Century Venice teaches us about crypto”, Salaam says the widespread usage of speculative assets magnifies the potential for adverse public consequences.
“Just like with the lottery or gambling where the house always wins, cryptocurrency buyers stand a chance to win big and some investors have profited handsomely from their Bitcoin acquisition,” says Salaam. “However, as with any game of chance there remains a bigger probability that investors could lose their money.”
Bitcoin is a digital currency that’s entirely online, has a fixed supply, and runs on a technology called Blockchain. It’s one of the kinds of cryptocurrency that exists today.
Regulators are also taking note; with US Treasury Secretary Janet Yellen warning about the dangers that Bitcoin poses both to investors and the public, calling it a “highly speculative asset, that is extremely volatile”.
Salaam says it is this volatility of cryptocurrencies that can lead to financial losses. “Since 2013 we have seen that the price can go up hundreds of a percent, and equally can fall back in a very short space of time as well, which makes it a very difficult mechanism to predict or use as a transaction tool.”
“While there are many long-term Bitcoin holders who believe that it will take time to build as a method of transaction and a store of value, many who are now exploring it do so under the illusion that they are guaranteed quick and easy profits,” says Salaam.
Short-term investors see the price rising and, expecting the gains to continue for some time, buy in with the aim of cashing in on the higher price when they sell it. This vulnerability to speculation and even market manipulation is what catches out the unwary investor.
In addition to the volatility, much uncertainty remains around cryptocurrency. After more than a decade, concerns continue around the security of the technology to hackers; and the energy intensive impact of cryptocurrency mining.
Salaam says expert opinion on whether cryptocurrency qualifies as a new asset class varies widely because its underlying value cannot be quantified. “Take art investment as an example. The artwork has intrinsic value to the individual who buys it, but it has no income or cash flow stream for the investor. In a sense crypto falls into that camp, it does not offer a rental stream of income or dividend. While some argue that it doesn’t give you cash back, others argue that like art, it has perceived value.”
The big advantage for cryptocurrency is that the blockchain technology which underpins its perceived value is here to stay. In June El Salvador, which started using the U.S. dollar as its currency more than 20 years ago, became the first country in the world to pass legislation allowing the use of Bitcoin in any transaction. While this move is unlikely to become widespread in the near future; it does indicate that the blockchain technology has immense potential for transactional applications.
American billionaire investor Ray Dalio earlier this year lauded the Bitcoin-led revolution as a feat of technological genius but acknowledged that cryptocurrency “looks like a long-duration option on a highly unknown future that I could put an amount of money in that I wouldn’t mind losing about 80% of.”
Salaam says most importantly investors must conduct adequate research to satisfy themselves that they fully understand the investment they are making.
“Those considering crypto must make sure that they don’t get scammed by the many websites and people trying to sell Bitcoin investments. Always go through reputable companies and get sound advice as part of your investment portfolio. Cryptocurrency may be a part of your long-term investment mix, but relying on it for short-term profiteering can lead to significant losses.”