January 21, 2022

What Should Investors Make of Bitcoin?

Max Martin

In the past two years, Bitcoin has jumped from a niche digital currency to a mainstream investment contender. Its rise in popularity has also come with increasing volatility, with one Bitcoin being priced anywhere from $3,000 to $61,000 during that two-year span. Like any other investment with a rapid 2,000% price increase, Bitcoin has left investors grappling with how to react to the craze. Is Bitcoin a fad, or is it really the future of currency?

The one question that all investors must ask themselves before putting money into an investment is if the expected returns justify the risk taken on. With many investors putting money into Bitcoin as if it were a security, it is important to examine the cryptocurrency in this light. Bitcoin, however, doesn’t offer the hopes of innovation and growth in the sense of a traditional security. In other words, holding one Bitcoin today does not entitle investors to more Bitcoin in the future. In fact, the only way currencies can provide any sort of positive return is when they appreciate when compared to other currencies. In this particular case, many investors in Bitcoin are betting on a widespread adoption of the cryptocurrency.

This widespread adoption, however, has been hit with more and more uncertainty as the Bitcoin craze has progressed. Companies that were initially accepting Bitcoin as a form of payment, such as Tesla, have fallen back to requiring more traditional payment methods. Additionally, the Chinese government has taken steps to penalize Bitcoin and cryptocurrency related activities within the country, opening the doors for government regulation of Bitcoin around the world. With widespread regulation Bitcoin would lose much of its core identity as a decentralized currency.

Other investors see Bitcoin as a way to hedge against inflation and as a store of value. There is a hard cap on the amount of Bitcoin in circulation, which prevents any government or centralized bank from manipulating the number of coins created. In this light Bitcoin seems comparable to a digital form of gold. However, Bitcoin’s historic volatility brings this use into question. Is a currency whose value can drop by 40% in response to a single Elon Musk tweet really the best investment option to store value?

Despite all these questions, there is a chance that Bitcoin could prevail as a global currency. Perhaps it really is the future of payment, an anti-inflationary currency that cannot be disrupted by any government. If that is the case, then any investor who puts their money into Bitcoin today will be greatly rewarded down the road. With that being said, it is impossible to know what the role of Bitcoin or any other cryptocurrency will look like in the future. This is why it is important for investors to diversify their portfolio. Diversification takes the guesswork out of differentiating the specific companies or cryptocurrencies that will take off in the future from the ones that will crash, all while realizing the gains of the market as a whole. In this light, while it might not be advisable for investors to pour their life savings into Bitcoin and other cryptocurrencies, to believers in Bitcoin they can make sense as a small and balanced piece of a portfolio.

If you have interest adding a small position in cryptocurrencies to your portfolio, call me at 630-232-9097 or email me at  jeff@kdminvest.com.