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How high can it go? And in this case the question is even simpler – what the heck is a cryptocurrency?
So, to start at the beginning: what are cryptocurrencies? Put simply, they are tokens that can be mined by solving complex mathematical problems or, as most people do, you can just buy them on an exchange. These tokens are tradable or can be used to purchase real-world items.
Many will say that they are virtual currencies, but I do not agree. The volatility we see makes them very much more like a commodity, except that a commodity has actual use.
Sure, many people will then counter that globally currencies are not underpinned by anything ever since countries stopped pegging their currencies to gold.
This is true, but consider the US dollar, for example. It may not be backed by gold, but it is backed by the US government and that is very significant, so much so that the currency is the largest store of wealth for individuals and countries the world over.
Cryptocurrencies have nothing underpinning them except for demand, and this demand is frankly being driven by greed as prices rocket higher.
Some may say that cryptocurrencies are a safe haven, but this was disproved when North Korea recently tested a nuclear weapon. That same weekend Bitcoin crashed, losing some 20%.
More recently, JP Morgan CEO Jamie Dimon said that Bitcoin “is a fraud”, sending the price crashing again. This does not send the message of a safe haven.
At the end of the day cryptocurrencies are nothing, but that doesn’t mean they can’t be traded. Heck, in centuries past we used sea shells or even bear skins as units of exchange.
But what does an investor do considering all the hype and potential profits that can be made?
Well, the first point is the word “potential”. You could make a fortune buying a cryptocurrency, but you could also lose a fortune, as we’ve seen with the recent collapse.
If you really want to buy cryptocurrencies, I suggest you heed these two rules:
- Go with one of the major cryptocurrencies, not some odd one nobody has heard of but that is being promoted by Paris Hilton. Some cryptocurrencies fly while others die, and knowing which is which is pretty much impossible.
- Go small. Do not invest a significant portion of your net worth into a cryptocurrency. Rather use a very small amount of money to test the waters. And be prepared to lose it all.
If you are still totally confused, then sit this out. Warren Buffett famously never invested in any hot dot-com stocks as he never understood their businesses and he’s done just fine.
Sure, you may miss out on some flying investment, but we’re always missing out. There are literally hundreds of thousands of things we can invest in, yet we settle for just a dozen or two and miss thousands of flyers.
Remember that the cryptocurrency scene can be likened to the Wild West. Exchanges are being hacked and the cryptocurrencies being stolen. At the same time, governments don’t like them, with China having cracked down on them recently.
My advice is that, while there may be money to be made, the best option is to ignore cryptocurrencies unless you really want to take on board some serious risk. Also don’t allow yourself to be driven by the fear of missing out – that always ends in tears.
*The writer owns two Bitcoins he mined in 2010.
This article originally appeared in the 5 October edition of finweek. Buy and download the magazine here.
