I'm going to preface this post by saying - "I'm no expert in neither cryptography nor currency." But given the recent media hype and the increasing number of people who seek me out specifically to talk about Bitcoin and other cryptocurrencies, I thought I would share my random thoughts on the cryptocurrency craze.
What is Cryptocurrency?
You may not have heard of the term "cryptocurrency" but I'm sure you've heard of "Bitcoin." As the original cryptocurrency, Bitcoin has enjoyed quite a bit of recent media notoriety given how quickly its value has risen. Since January 1, 2017, the value of a single Bitcoin has risen from less than $1,000 to over $14,000 as of this writing. If you want to have some fun, check out Bitcoin PIzza - a twitter account that tracks the current value of the 10,000 Bitcoins that Laszlo Hanyec paid for 2 pizzas in 2010.
"Cryptocurrency" is a mashup of "cryptography" and "currency". "Cryptography" is the study of encryption, basically how to prevent other people from getting to your stuff. "Currency" at the basic level, is simply something you own that can be traded for something else, a medium of exchange. It can be a lot of things, but in our society it usually means money. It's easy to see why a freely traded digital currency that's completely secure from corruption could be valuable. But that leaves out the biggest uncertainty in trade - trust.
In everyday life, we have to trust a lot of different players to complete a trade. Both the buyer and the seller have to agree that $1 is worth $1, you have to trust the banks to transfer the money correctly and the US government to back up the value of the dollar. What I'm trying to say is - it takes a lot of trust. But what if you can engineer that trust into the currency itself using technology? This is where the technology behind cryptocurrency comes in - Blockchain. Here's a short video that explains how Blockchain works.
Why the CRAZE?
Now you have a basic understanding of cryptocurrency and Bitcoin, you may be wondering why its value has risen so quickly in such a short time. There are long detailed reports on why Bitcoin soared in value, But the fundamental fact is this - one Bitcoin is worth exactly how much another person will pay for it. In this way, Bitcoin is no different than that $20 bill in your hand. It has the value of $20 because you believe it does and you hope the person on the receiving end believes it does too. As more people become interested in Bitcoin, more money pours in, Bitcoin's value increases and even more people become interested in Bitcoin. It's a self feeding frenzy. How do you know the craze has achieved bubble status? Well there are lots of historical lessons to learn from:
- Remember the Rockefeller shoe shine story? Well I'm starting to feel that people are becoming irrationally exuberant about cryptocurrency. I cannot tell you how many people have reached out to me to talk about crypto.
- The Bitcoin story sounds surprisingly similar to the Dot-com bubble and the Dutch Tulipmania in the 1630s. Here's a comparison by The Street - Look How Bitcoin's Rise Stacks up Against the Internet Bubble and Tulipmania.
- Whenever simply the inclusion of a word in a company's name can drive up its market value in dramatic fashion - see KodakCoin and Long Blockchain - you know we're in a bubble.
Why I am not investing in crypto
The common theme among bubbles is that they eventually burst. For those who got in when the going is good and got out before the bubble bursts, speculation in new technologies can be very profitable. But I hesitate to call it "investing" because that would imply an appropriate assessment of the benefits and risks had been performed prior to your purchase. And for most, that is simply not the case. There are at least 3 major roadblocks I see to crypto achieving its potential of becoming a universal currency:
- Legal/political risk - most people don't know this but it is illegal to make your own money in the United States - see the Liberty Dollar. While the feds haven't come after Bitcoin or any other cryptocurrency, it's not difficult to imagine a world where they do. In fact, China has already banned cryptocurrency exchanges. And South Korea has recently announced a planned ban.
- Security/technology risk - despite what cryptocurrency proponents may prefer, there is no such thing as a 100% secure technology. Everything is hackable and will be hacked if the rewards outweigh the risks. See the Mt. Gox hack.
- Market/competition risk - Bitcoin may have the first mover advantage, but it's by no means the only game in town. Many other cryptocurrencies have gained momentum in 2017, including Ethereum, Ripple, Litecoin and many others. When the bubble bursts, there will be survivors, just like how Amazon and Google survived the dot-com bubble. But I believe it's very difficult if not impossible to predict prospectively who will be those left standing in the carnage.
So if you are interested in jumping into the cryptocurrency market, I encourage you to treat it the same way you would treat money you are willing to lose at the casinos. Personally, I don't have any cash to gamble, which is why I'm not buying any crypto.
Chad Chubb, CFP ® founded WealthKeel LLC to help physicians navigate the complexities of financial planning. Today, we utilize true financial planning and custom-craft plans for residents and young doctors in the Philadelphia area and across the United States. From investments to insurance and student loans to goal planning, we tailor a plan to address your specific needs and circumstances. We will be by your side, today, tomorrow, and for decades to come to help you plan and build for all of life’s course corrections. Schedule your free introductory call online and see if we are a good fit for you.