Cryptocurrency: A Skeptical Overview
By: Chris Merchant, CFP® BFA®
Introduction
Cryptocurrency has been a buzzword in the financial world for some time now. It has existed long enough that most people have heard of it and may have even considered purchasing some. This digital currency continues to captivate investors worldwide. The meteoric rise of Bitcoin, Ethereum, and other digital currencies has led many to view them as the future of finance.
However, despite the allure, I remain skeptical about their value and suitability for my clients. In this article, I will outline common arguments made by cryptocurrency proponents and provide counterarguments to highlight the risks and uncertainties associated with these digital assets. I’ll also draw on the insights of notable critics and compare these digital assets to gambling, addressing common questions from tech-savvy millennials and emphasizing the importance of adhering to fundamental investment principles.
Pro-Crypto Argument 1: High Potential Returns
Argument: Proponents argue that cryptocurrencies offer the potential for extremely high returns. Bitcoin, for example, has seen astronomical growth since its inception, turning early investors into millionaires.
My Thoughts: While some early adopters have profited significantly, this level of return is not guaranteed and comes with substantial risk. The volatility of cryptocurrencies is extreme, with prices capable of swinging dramatically in short periods. Unlike traditional investments, where value is derived from underlying assets or earnings, cryptocurrency values are primarily driven by speculation. This makes them akin to gambling, where the outcome is uncertain and driven by chance rather than fundamental value.
Pro-Crypto Argument 2: Decentralization and Control
Argument: Another major selling point for cryptocurrencies is decentralization. Proponents argue that cryptocurrencies offer a way to bypass traditional financial institutions, giving individuals more control over their money and reducing dependency on banks.
My Thoughts: While decentralization may appeal to libertarian-minded individuals, it carries notable drawbacks. The cryptocurrency market’s lack of regulation and oversight makes it susceptible to fraud, scams, and market manipulation. Exchange hacks and fraudulent schemes have led to significant investor losses. Furthermore, the irreversible nature of cryptocurrency transactions means lost or stolen funds can often not be recovered. Since the dawn of civilization, sovereign currency has been a cornerstone of national stability. It is highly unlikely that today’s major powers will relinquish control over their currencies—perhaps a borderline third-world country might, but certainly not the superpowers.
Pro-Crypto Argument 3: Technological Innovation
Argument: Proponents highlight the innovative technology behind cryptocurrencies, such as blockchain, which promises to revolutionize various industries by offering more secure and transparent transactions.
My Thoughts: While blockchain technology holds potential beyond cryptocurrencies, it remains in its infancy and faces significant challenges. Based on my research it seems that issues such as scalability, security, and regulatory compliance must be resolved before widespread adoption can occur. Moreover, the success of blockchain technology doesn’t guarantee that cryptocurrencies will succeed as investments. Many blockchain projects fail to meet their promises, and the speculative nature of investing in them adds another layer of risk. Despite the enthusiasm many express when justifying their crypto purchases with blockchain or its derivatives, I doubt these are the true reasons behind their buying crypto.
Notable Skeptics and Their Views
Charlie Munger’s Critique: The late Charlie Munger, former vice chairman of Berkshire Hathaway, was one of the most vocal critics of cryptocurrency. Munger famously referred to Bitcoin as “rat poison,” highlighting his disdain for its speculative nature. He also used some humorous words that rhyme with “crypto,” which I won’t repeat here in this article. He argued that cryptocurrencies lack intrinsic value, unlike stocks or bonds, which are backed by real earnings or tangible assets. Munger compared the cryptocurrency craze to the 17th-century tulip mania, stressing the irrational exuberance and speculative fervor that can lead to financial ruin.
Other Notable Critics: Warren Buffett has famously referred to Bitcoin as “probably rat poison squared.”
He predicts a grim future for cryptocurrencies, highlighting their lack of intrinsic value and speculative nature. Buffett asserts that “Bitcoin has no unique value at all. It doesn’t produce anything. You can stare at it all day and no little Bitcoins come out or anything like that. It’s a delusion, basically.”
Cryptocurrency vs. Gambling
Volatility and Speculation: One of the most striking similarities between cryptocurrency and gambling is the extreme volatility. Cryptocurrency prices can swing wildly within hours or even minutes, driven by speculative trading, market sentiment, and media hype. This volatility makes cryptocurrencies attractive to those seeking quick profits but also exposes investors to significant losses. Unlike traditional investments, where value is derived from underlying assets or earnings, cryptocurrency values are primarily driven by speculation and market dynamics.
Lack of Fundamental Value: Traditional investments, such as stocks, bonds, and real estate, are backed by tangible assets or earnings. For example, when you buy a stock, you own a share of a company that produces goods or services, generates revenue, and pays dividends. In contrast, cryptocurrencies lack intrinsic value. They are not backed by physical assets, earnings, or cash flow. This absence of fundamental value makes cryptocurrencies highly speculative and akin to gambling, where the outcome is uncertain and driven by chance rather than underlying value.
Frequently Asked Questions from Millennials and Tech Enthusiasts
Frequent Inquiries: As a financial advisor, I am often asked about cryptocurrencies by friends and clients, especially those from the technology age like millennials. These inquiries typically revolve around the potential for high returns, the technological innovation behind cryptocurrencies, and the perceived opportunities for diversification. While I appreciate the curiosity and enthusiasm, I caution against viewing cryptocurrencies as a viable long-term investment strategy.
Tech Enthusiasm vs. Financial Prudence: Millennials and tech-savvy individuals are naturally drawn to the innovative aspects of cryptocurrencies, such as blockchain technology and decentralized finance (DeFi). However, technological enthusiasm should not overshadow financial prudence. Investing should be based on sound principles, such as diversification, risk management, and long-term value. Cryptocurrencies, with their speculative nature and lack of fundamental value, do not align with these principles.
The Fundamental Principles of Successful Investing
Long-Term Value: Successful investing is built on the foundation of long-term value. Traditional investments, such as stocks and bonds, have a proven track record of generating returns over time. These investments are backed by tangible assets, earnings, and cash flow, providing a solid basis for value creation. In contrast, cryptocurrencies lack these fundamental attributes, making them speculative and unreliable as long-term investments.
Diversification and Risk Management: Diversification is a key principle of successful investing, aimed at reducing risk by spreading investments across various asset classes. Traditional investment portfolios typically include a mix of stocks, bonds, real estate, and other assets to achieve diversification. Cryptocurrencies, due to their high volatility and speculative nature, should not be a significant part of a diversified portfolio. Instead, they should be viewed, if at all, as a small, speculative allocation within a broader investment strategy.
The Risks and Downsides of Cryptocurrency
Regulatory Risks: The regulatory landscape for cryptocurrencies is uncertain and evolving. Governments around the world are grappling with how to regulate digital assets, and potential regulatory changes could have significant impacts on the market. For example, stricter regulations could limit the use and trading of cryptocurrencies, leading to decreased liquidity and value. Investors should be aware of the regulatory risks and the potential for sudden changes that could affect their investments.
Security Concerns: Security is a major concern in the cryptocurrency space. The decentralized nature of cryptocurrencies makes them vulnerable to hacking, fraud, and theft. High-profile cases of exchange hacks and fraudulent schemes have resulted in substantial losses for investors. Additionally, the irreversible nature of cryptocurrency transactions means that lost or stolen funds cannot be recovered. Ensuring the security of digital assets requires advanced knowledge and precautions, which many investors may lack.
Conclusion
In conclusion, while the allure of cryptocurrency is undeniable, it is important to approach it with caution and skepticism. The speculative nature, lack of fundamental value, and numerous risks associated with cryptocurrencies make them unsuitable for long-term investment strategies. As a financial advisor, I prioritize sound investment principles that have proven successful over time, such as diversification, risk management, and long-term value creation. I encourage my clients to focus on traditional investments that offer stability and reliability, rather than chasing the speculative gains of the cryptocurrency market.
I invite you to share your thoughts and experiences with cryptocurrency. Have you invested in digital assets? What has your experience been? I am here to provide personalized financial advice that aligns with your goals and helps you navigate the complexities of the investment landscape. Contact me to discuss your investment strategy and ensure it is built on solid, proven principles.
