Should I Invest in Bitcoin and Other Cryptocurrencies?

Stories about bitcoin millionaires and record gains with cryptocurrencies have become commonplace. Chances are that you too have asked yourself at least once whether you should hop onto the cryptocurrency investment bandwagon. Ultimately, you alone can decide whether or not you should invest, and what you should invest in, based on your concrete situation, your wealth, and your risk capacity. But you should understand these basics before you take on cryptocurrency investing.

Cryptocurrencies are riskier than stocks

Cryptocurrencies are considered to be much higher risk than stocks. The exceptionally high volatility of some currencies is just one reason for this. The longstanding existence of the stock market provides a basis which helps investors make decisions and to better estimate risks. For relatively new products like bitcoin and other cryptocurrencies, on the other hand, that concrete data is not there. For example, whether or not these currencies can recover from economic crises in the same way that the stock market has remains to be seen.

There is also the fear that technological developments could make individual cryptocurrencies suddenly lose popularity and with it any value they may have. The stock market gives you the opportunity to invest in companies which have proven their worth over many decades. This creates in trust in the stocks of these companies. Even bitcoin – the oldest cryptocurrency – has only existed for about 15 years, which is a relatively short timeframe.

Nobody knows what bitcoin and other cryptocurrencies are really worth

Many cryptocurrencies are only a medium of exchange – like US dollars, Swiss francs, and other fiat currencies from central banks. They get their value from the community of people who are willing to accept them as payment for goods and services.

That make some investors nervous. The prices of most conventional investment vehicles like stocks are also determined by the market, but they are based on real values (the assets of a company, for example). This value helps you determine whether or not a security is correctly valued. The value of decentralized financial services like bitcoin, on the other hand, is much more difficult to determine. Even conventional fiat currencies have long-term historical data.

Skyrocketing prices are a poor argument for investing

Entering a market just because it is experiencing high growth over a short-term is risky, from an investment perspective. It is a known fact that that the past performance of an asset is no indicator of future performance. On the contrary, when the price of an asset climbs drastically, existing investors may be motivated to sell their assets to earn a capital gain. If many people sell an asset at the same time, the price will likely drop due to the heightened supply.

Example: Meme coin Shiba Inu drew attention in late October, 2021, when its price shot up by hundreds of thousands of percentage points. Existing owners made massive returns. But before the year was over, Shiba Inu had lost half of its peak value. Investors who were drawn by the almost unreal gains and bought in near the peak had to accept heavy losses.

You should understand your investment

What is much more important than tracking the price of an asset is understanding what it is that you are investing in. Conventional stock market wisdom says that you should never invest in a company which you do not understand. This adage also applies to cryptocurrencies, but is easy to forget amid crypto hypes.

Understanding cryptocurrencies is difficult for many small investors. The technical complexity of this topic and individual blockchain products can even frighten off would-be investors. If you plan on investing in a cryptocurrency, it is recommended that you take time to understand how it works, just as you would study a company’s business model before investing in its stock. The better you understand the cryptocurrency, the better you will be able to predict potential returns.

Diversification takes precedence

If you are only just getting started in the world of investing, cryptocurrencies are probably the wrong place to begin. One reason is that the crypto market alone does not offer sufficient diversification, regardless of how many different coins you invest in. Ultimately, there is no way to use cryptocurrencies to hedge against the risk of a decline in the cryptocurrency market as a whole.

On the flip side, diversification can also be an argument for investing in cryptocurrencies. If you are already heavily invested in stocks and bonds, cryptocurrencies provide a further asset class which is largely independent of stock and bond markets. In this way, adding cryptocurrencies to your portfolio can arguably provide a way to protect your wealth against losses in the stock and bond markets. Cryptocurrency proponents cite independence from the banking system as an argument for investing.

No clear proof of protection against inflation

Many cryptocurrencies, including bitcoin, are designed to provide an alternative to fiat currencies from central banks. One of the concepts behind decentralized cryptocurrencies is that their prices should increase when fiat currencies experience inflation. As with gold investors, many people buy cryptocurrencies as a hedge against inflation of fiat currencies.

But how well cryptocurrencies effectually protect against inflation in reality is still unclear. So far, there is no evidence that cryptocurrency investments actually protect wealth from inflation.

The regulatory environment is not yet sound

Decentralized cryptocurrencies have an advantage in that they cannot be controlled by a single state. However, it is likely that countries will begin regulating them more strongly in the future – in order to protect their own currency monopolies, for example. In China, for example, cryptocurrency transactions have already been banned since Autumn, 2021.

Regulations of this sort can influence the price of cryptocurrencies. For example, the price of bitcoin fell by several percent after China’s central bank classified cryptocurrency transactions as illegal. It can be assumed that introductions of new regulations by other countries – and particularly the United States – would create a downward pull on cryptocurrency prices.

Be skeptical

Have you just gotten filled in about a new cryptocurrency you have not yet heard about on YouTube, social media, or some website? Did the information provided include claims that this could be the next bitcoin? Be aware that when anyone tries to convince you to buy a cryptocurrency, there is a high chance that they have their own best interests in mind. Most likely, the author of the video or blog post owns the meme coin or other cryptocurrency themselves and is trying to drive its price up so that they can sell it at a profit.

The crypto market is rife with scams (so-called rug pulls, for example) and pump-and-dump schemes, so taking all such endorsements with a (large) grain of salt is recommended. Do not allow yourself to be wowed by illustrious claims. Instead, take time to carefully research the product in question before you make investment decisions.

More on this topic:
Factors which affect cryptocurrency prices explained
How to buy and spend bitcoin in Switzerland explained
Useful tips for investing in stocks