If you’re like most investors paying attention to headlines, then you’ve given at least some thought to adding popular cryptocurrencies like Bitcoin into your growing portfolio. You might know a friend, family member, or colleague who has already done it. And, with Bitcoin’s historic run last year, it seems like crypto investing could be a profitable opportunity.
But, should we even be thinking about cryptocurrencies as a type of investment? If so, how does it compare to other investments like stocks, bonds, and real estate?
Cryptocurrency is Currency
Think about it this way. You’re planning to visit Europe for a two-week vacation and convert $1,000 USD to euros. How closely do you pay attention to the exchange rate? Chances are it won’t factor into your decision as much as the overall timing of your vacation based on your wants, needs, and available vacation days. If the exchange rate becomes more favorable when you convert back, and you end up with a $5 profit, you wouldn’t consider that a return on your investment. Nor do many investors have a significant stake in foreign currency as part of their overall portfolio (though it is known to happen).
At its core, despite being digital and groundbreaking in several unique ways, Bitcoin and its contemporaries are still just currencies. They’re intended to be used like currency as a form of exchange for goods and services. This makes them different from most investments. For example, they are more akin to property. You can buy a stake in a public company or purchase a piece of real estate. Then, you can financially gain from your ownership of those stakes.
In terms of strategy, many investors are treating cryptocurrency like other investments. They apply their trading strategies, for better or worse, to coins as if they were traditional stocks or ETFs. If they believe the price will rise (or, to be more exact, the exchange rate), they’ll buy more. If they believe a decline is on the horizon, they’ll sell. Long-term investors focus on the ultimate potential of the currency. In contrast, short-term investors focus on daily fluctuations.
Avid Bitcoin supporters may use the currency as intended. Overall, public perception has made cryptocurrencies more investment-like in terms of investor behavior.
We can also compare cryptocurrencies to traditional investments in terms of how they’re bought or traded. There are three main ways to “invest” in cryptocurrency:
- Mining is the biggest departure from conventional investments. Though this method isn’t always profitable (due to compensation for competition and energy costs), the idea is that any dedicated user can contribute their processing power to the blockchain in exchange for currency credited to their account. In this way, cryptocurrency functions like currency. It’s distributed in exchange for a service (i.e., paying for mining instead of paying an hourly wage).
- In cryptocurrency exchanges, Bitcoin and altcoins can be traded very similarly to stocks and bonds. The prevalence of these exchanges has played a part in establishing the dominant mentality that cryptocurrencies are similar to other investments.
- Finally, it’s possible to invest in crypto using a more traditional format. This is done by purchasing shares of a Bitcoin- or altcoin-tracking ETF. The idea is that you’re investing in a traditional investment asset whose price reflects the changing prices of the currencies it tracks.
Potential Gains and Risks
In terms of potential gains and risks, Bitcoin is distinguished from things like stocks and bonds. Bitcoin is known for its extreme volatility. In the span of a year, it went from under $1,000 to more than $20,000 before settling in the middle. There are penny stocks that might see a similar line of volatility. For the most part, stocks will steadily rise and fall while bonds will yield a steady return.
This makes cryptocurrencies more like commodities than other types of investments. In some ways, they are more of a gamble. The fact that cryptocurrencies are a new concept, combined with limited historical data and the fact that crypto valuations are based entirely on public perceptions, makes it incredibly hard to predict its growth or decline.
One of the biggest problems with treating crypto as a type of investment is a critical element of the traditional investment process: holding. If you’re a short-term investor, you want to hold an asset until you can trade it for a higher price. If you’re a long-term investor, you want to hold that asset indefinitely and possibly forever (in the case of dividend investors).
This creates a unique dilemma for either group if they attempt to invest in crypto in a similar fashion. Cryptocurrency is currency. This means exchanging it on a semi-constant basis. If it’s not being used, its inherent value goes down. If it’s constantly being exchanged for real goods and services, its inherent value goes up. More people “investing” in cryptocurrency in the traditional sense is bad for the currency’s long-term value.
The Diversification Factor
Also, some people treat cryptocurrency as a type of investment solely as a way to further diversify their holdings. Rather than doing a simple 70-30 split between stocks and bonds, they might spread their holdings out to more unconventional investment types. This includes commodities, gold, and notably, other foreign currencies.
In this way, cryptocurrency is treated as an investment. However, this is only to the point that other “real” or pseudo currencies are. For these investors, cryptocurrency is no more likely to appear as a holding than euro or yen.
The Bottom Line on Crypto Investing
The main point here is that we shouldn’t treat cryptocurrencies as a type of investment in the same category as stocks and bonds. The reality is people have been and will continue doing so. There are three important takeaways to note:
- If you believe in the currency, don’t treat it like an investment. You may be able to invest in crypto like a traditional security or asset. Yet, if you truly believe in the future of digital currencies and want to support that future, try to use currencies as currency. The list of vendors accepting crypto has been growing consistently for years.
- Be prepared to gamble if you believe it’s a get-rich-quick-scheme. Cryptocurrencies can skyrocket overnight. However, it can also plummet.
- We should all restructure how we talk about crypto. As writers, investors, and ordinary people, we’ve all made the false comparison of talking about cryptocurrency like a traditional investment. We can all change these habits to treat crypto investing more like a conventional currency. This can create an environment where Bitcoin and its contemporaries thrive.
Of course, none of this may constitute sound crypto investing advice. Instead, it’s to clarify the role of cryptocurrencies in our economy. Think carefully about how you’re treating cryptocurrency before proceeding. Then, solidify your position on its future. It may affect your success rate more than you realize.