Crypto Craze: Is it a Bubble or Here to Stay?

Bitcoin...Dogecoin...Binance Coin. It's all science fiction to me. But even a conservative investor like me is curious about the future of cryptocurrencies - are they a digital smoke and mirrors act or the future of our economy?

NOTE: Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.

Q: I’m not new to investing but am thinking about jumping into crypto. Is this a good time to do so and which ones would you recommend?

When I think of cryptocurrencies, I automatically think of the 17th Century tulip bubble, the 20th Century dot-com bubble, and the 21st Century ostrich and housing bubbles.

What is a bubble? Let's explore.

Bubble Economics

According to Will Kenton, a bubble is “an economic cycle characterized by the rapid escalation of the market value of an asset, followed by a rapid decrease in value often referred to as a 'crash.'"

A bubble is created by a surge in price driven by exuberant market behavior. Former Federal Reserve Board chairman, Alan Greenspan, coined the term “irrational exuberance" during the dot-com bubble of the 1990s. It was widely interpreted as a warning that the stock market might be overvalued. During a bubble, the asset trades within a price range that greatly exceeds the asset's “intrinsic value”. For example, history (or perhaps historical fiction) recounts that a single tulip bulb became so expensive in the 17th Century that it exceeded the price of an average home.

Crypto Exuberance?

I know very little about cryptocurrencies…and being risk-averse, don’t plan to learn much more.

Is Bitcoin just a word? It’s certainly not something an investor can touch or eat…or use as a consumer good…or produce things with, like gold as a base element for jewelry. Where’s the intrinsic value? Or is it purely an irrationally exuberant speculative bubble? Who knows for certain.

Yet, despite all the speculative hype, it seems that professional investors are coming around to the idea of investing in Bitcoin – knowing that cryptocurrencies are largely unregulated, highly volatile, and the infrastructure for accessing, holding custody, reporting and billing on digital assets seems gravely lacking in maturity.

A couple of weeks or so back, Bitcoin dropped about 17%. According to data provider, CoinMarketCap, that dip spurred a loss of $220 billion of cryptocurrency value in one hour.

Crypto Cheat Sheet

Being a conservative investor, I’m opting out, except to pass on a few thoughts from Kiana Danial, CEO of Invest Diva. According to Danial, who penned a Cryptocurrency Investing for Dummies Cheat Sheet, there are some important tools an investor must have before “jumping into cryptocurrency”. Her list (in her words) includes:

A cryptocurrency exchange or a broker where you can buy and sell cryptocurrencies.
A secure cryptocurrency wallet to store your cryptocurrencies.
Knowledge about cryptocurrencies’ fundamentals.
A thoughtful investment strategy that’s unique to your risk tolerance.
And, most importantly, money you can afford to lose.

Regarding the knowledge factor, Danial discusses (again, mostly in her words) several important “Things to Know about Cryptocurrency Investing,” some of which applies to any form of investing:

Cryptocurrency is a cross between a currency and a digital asset, which can be used to pay for things, and like a digital asset, you can invest in it for long-term gains…and losses.
The well-known Bitcoin is not the only one - there are more than 2,000 other cryptocurrencies out there.
And please note, you’re not buying a currency; you’re buying the idea behind the coin – an idea supported by an underlying blockchain technology (a distributed ledger that records a growing list of data).
Keep in mind that cryptocurrency investing is relatively new, and that its investment resources are constantly evolving.
Be wise about reading the background of a cryptocurrency, its underlying technology, its management, and its community before investing. What problem is it trying to solve, and does that solution really matter in the grand scheme of things?
If you’re buying a cryptocurrency to hold long-term, you’re looking for capital appreciation. If you’re frequently trading it, you’re speculating. Keep in mind Warren Buffett’s sage advice to all - and particularly young - investors: If you try to trade in and out of the market, your emotions will defeat you totally. Short-term betting is not a good way to go).
The cryptocurrency market is extremely volatile, invest money you can afford to lose.
Unlike the stock market, you can participate in the cryptocurrency market 24 hours a day, 7 days a week.
Diversify your portfolio with at least 10 cryptocurrencies from different categories to manage risk… supplemented by investments in stocks with exposure to blockchain technology and the cryptocurrency market.

And to those who actively trade (the very thought makes me shudder), Danial suggests that you buy the dip, but don’t panic when prices drop. That might be a good buying opportunity. On the other hand, don’t be lured into a hyped-up market, particularly when the price has risen dramatically in a short amount of time.

Not My Cup of Tea

Despite the fact that more and more esteemed financial advisors… even some longtime skeptics…are expressing interest in owning cryptocurrencies for themselves and their clients, keep in mind the multitude of complicating issues associated with this evolving digital asset class.

Fad or no, cryptocurrencies don’t appear to be going away and, in fact, are rapidly entering the mainstream. For conservative investors (like me) not inclined to participate in speculative bubbles, the primary risk is what might happen to the richly valued mainstream market should the cryptocurrency froth finally dissipate. Will a broad market correction join it in sympathy?

Perhaps cryptocurrencies are our monetary future… perhaps they are here to stay. But they're not for me.