So Bitcoin has crossed the $10,000 threshold and is up more than 100-fold in 2017. Should you invest in it?
Keep in mind that a range of people from storefront investors in Korea to institutional traders on Wall Street are loading up on the cryptocurrency. No one quite knows what the downside is, but everyone is giddy about the upside.
Since I never invest in anything blindly, I work through the Socratic method of asking critical questions.
— How Can I Hedge My Investment? This is perhaps one of the easiest questions to answer. The CME Group will list futures contracts for “Bitcoin Reference Rates” on its exchange.
Although mostly designed for traders, the CME contracts will be part of a regulated process to clear trades, although the currency itself won’t be directly regulated by any government agency — yet. These contracts will allow you to bet on the upside and downside of Bitcoin prices.
— Is There a Good Vehicle For Bitcoin Investing? If you’re thinking about a low-cost mutual or exchange-traded fund to invest in Bitcoin, you’ll be disappointed.
There are now more than 120 hedge funds investing in Bitcoin, but they are generally not good vehicles for average investors. They charge fees of 2% for annual management plus take 20% of profits. That’s a hefty slice and you really get slammed in a bad year.
— What’s the Downside of Bitcoin? No one really knows, although it’s incredibly volatile. The price has ranged from 700 more than a year ago (Nov. 14, 2016) to around $10,000 as I write this.
My numbers are based on CME data going through Nov. 12, 2017, so the variation is much more that what I’ve noted. Since this data came out, the Bitcoin price took a dip of 20% in one day recently. That’s a huge hit.
Volatility means a lot because it’s pure math and we can measure it through standard deviation. It’s a relative gauge: The standard deviation for the S&P 500 Index, which tracks the 500 largest U.S. stocks, in contrast, is around 14 — for the past 15 years.
When you compare bitcoin to gold prices, which are slightly less volatile than stocks, bitcoin’s standard deviation is 120% (going back to 2010), according to Gold Money. Note: This number represents volatility of daily returns on an annualized basis, which roughly means bitcoin is almost 10 times more volatile than stocks.
The only constant in financial pricing is that the market always moves in both directions. The downside for Bitcoin could be steep and ugly, particularly if governments move to regulate trading.
–– Is Bitcoin in a Bubble? A lot of really smart people think so, including Warren Buffett and Ray Dalio. Certainly when market commentators says “upside is unlimited,” that’s a red flag. But when will the price hit the wall and fall to the floor? Nobody has any idea.
Just keep in mind that any prices that are based purely on sentiment, whether they are tech stocks or tulips, are bound to crash at some point. Even when infused with Keynesian “animal spirits” of pure upside speculation, markets don’t stay optimistic forever.
“It’s a bubble that’s going to give a lot of people a lot of exciting times as it rides up and then goes down,” Joseph Stiglitz, a Nobel Economics laureate, recently told Bloomberg News. Stiglitz also notes that “Bitcoin should be outlawed.”
— Is Bitcoin Really a Currency Hedge? Millions of investors are rightly concerned that wealth denominated in a country’s currency is losing value. From South Korea to the U.K., this has been a tangible fear.
But is Bitcoin really a hedge against a paper currency losing value? Well, since it’s not tangible like gold, or backed by cash reserves, the jury’s still out, although millions of investors are treating it like an anti-currency.
Still, would it hurt to have some Bitcoin or other cryptocurrency in your portfolio? If you choose to invest, don’t trade it, but certainly don’t have more than 10% of your total holdings in it.