Cryptocurrencies are amid a speculation frenzy as every man and his dog hopes to get rich from them without any consideration of what a blockchain is. Given the very evident symptoms of a spectacular bubble, how can educated investors claim that buying cryptos is a rational decision?
What’s the Deal?
Proponents argue that one should think of them as a currency rather than an investment asset. They have a point; fiat currency is also not backed by anything and only has value because of people’s faith in it. So why can’t cryptos be the same? There are already people and businesses in existence that accept it. And in many ways cryptos are superior to fiat currency: they are decentralised, have a limited supply (typically) and are impossible to counterfeit. Whilst it would be unprecedented, there is no hard and fast reason why a private currency cannot become the mainstream means of exchange.
If cryptocurrencies’ future as currency is bright, there is arguably a strong case for investment. Demand rising faster than supply will cause them to appreciate. Consider this: the UK, US and Eurozone money supply is £28trn in total. So if people decide to hold just half of their wealth in bitcoin (for instance) as opposed to pounds, dollars and euros, the value of bitcoin in circulation will increase from its current market capitalisation of £234bn to £14trn – a rise of 5,900%!
Don’t Buy Bitcoin Just Yet
Just because cryptos may become an accepted means of exchange, does not mean that they are good investments now. One must consider whether they are currently overvalued; is one bitcoin really worth $15,000? Or is this a price valuing the hopes of future mainstream adoption? The obvious danger is that if the future outlook for cryptos becomes less optimistic, their prices will be hit accordingly.
Another concern is that investors have lost sight of cryptocurrencies’ underlying value as a means of exchange, and are fuelling prices through speculation and greed. Again, this is obvious but it seems like many need to be reminded of what a bubble is (perhaps due to them being too young to remember the dotcom bubble). Furthermore, this ever-increasing influx of speculative investors, and the increased volatility that ensues, actively undermined cryptos’ credibility as currency. Virtually no one (apart from criminals) actually uses bitcoin for purchases.
And lastly, even if cryptocurrencies prove to revolutionise payments, how does one know which will come out on top. There are already hundreds of cryptos, including 29 that have a market capitalisation of over $1bn. And with no limit on the creation of new ones, there will be stiff competition, especially from banks and other financial institutions which will likely find it easier to gain widespread acceptance. One should remember that during the dot-com boom, hundreds start-
ups appreciated rapidly. And whilst internet did end up changing the world, the vast majority of these companies ended up worthless.
Cryptocurrencies are in the dangerous state of irrational exuberance, so one must be cautious if they decide to join in. A skyrocketing price can only be justified if it is accompanied by an appropriate level of real-world use and development.
So Should One Invest?
Cryptocurrencies are in their early days, making it impossible to know what to expect. For the prudent investor, it seems wise to avoid them for now. With all the many variants and the many more that are to come, the odds of picking a winner are slim. Being patient enough to observe the evolving landscape of cryptos and the regulation surrounding them will allow individuals to make better judgements on which digital currencies will be successful and hugely limits the potential for loss.
After all, cryptocurrencies could turn out to be as worthless as tulips.
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