Cryptocurrencies are not an investment, but they can still make you a lot of money
Unless you’ve been living under a rock, chances are someone, somewhere has mentioned the word “investment” around you at least a couple of times. In fact, you may have even gotten the advice that you should be investing part of your income for the future.
I’d like to know what, if anything, you actually know and understand about investments before we even talk about cryptocurrencies.
Investopedia defines an investment as “[…] an asset or item acquired with the goal of generating income or appreciation. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or will later be sold at a higher price for a profit.”
I would like to simplify that. A lot.
To paint a simple picture, an investment is essentially a sacrifice. You give up something you can afford to sacrifice today in exchange for something that will be worth more to you in the future.
If we look at it that way then, a good investment is something that:
- You can afford to live without right now
- You have very good reason to believe will increase in value in the future
- You can sell, trade, or use in the future to gain more benefits that you would by doing so today
Now I’m not familiar with investments and financial instruments outside of the western banking system and the crypto currency market, so I will focus specifically on those, but that doesn’t mean that the following list of examples is complete and all-inclusive.
The most common type of investment people know about is some kind of pension or retirement fund, often managed by a large corporation or some part of your local government that aims to grow with the economy in order to provide investors with money after they quit their jobs.
Another example would be high interest rate savings accounts, which our banks are happy to offer us with generally something between 0.05 and 3 % interest. Ratehub is a great tool for comparing such accounts in Canada. Basically you give the bank your money, and they promise to give it back later, with a bit of extra cash on top for your trouble.
Depending on where you live, real estate can be an investment since according to basic market economics, when the amount of homes available grows more slowly than the number of people looking for a home, prices will increase. This is especially true if you’re lucky enough to live in one of the bigger cities such as San Francisco, Los Angeles, New York, or north of the border in Vancouver, Toronto, Montreal. While real estate is a tried and trusted investment, there are events that can wipe that out, such as the 2008 crash, which left many people out in the cold rain.
Of course, there are other things that you may have heard of, such as savings bonds, mutual funds, etc. but the idea behind the “why” for those instruments (that’s what finance people call them) is essentially the same from the perspective of a normal person looking to save some of their money.
There are also investments that no one really calls investments, such as getting an education or learning a skill that will make you more easily employable or will help you to put a roof over your head and food on your table more easily than you would had you skipped the learning processes, but those aren’t the main focus of this article, despite my believing that they are incredibly valuable.
What about cryptocurrencies?
I personally cannot consider cryptocurrencies as investments. They might quack like a duck, walk like a duck and smell like a duck if you only look at the last 10 years, but the truth is, 10 years is all we have to go by. Yes, the price has increased over time (and also decreased from its peak value) and with a brief glance, the cryptocurrency market looks much like a stock market, but the reality is that there are no indicators of where the price will go in 10, 20, 30, 40 years. In fact, when bitcoin hit 20,000 USD in December 2017, the majority of “Crypto Investors” saw it as a great sign that they were right about it being a solid investment and were completely oblivious to the coming price drop which saw Bitcoin go under the 6,000 USD mark only six months later in June 2018.
Over the last few years, many people have bought cryptocurrencies at some certain prices and have sold them a few months or years later for significantly higher prices, and while that may look like an investment because “they gave up something today in exchange for something more valuable in the future”, the truth is Cryptocurrencies currently behave much more like collectible items than investments.
Yes, there are people who want to buy them, and people who have them and are more than willing to sell them, and that creates a market, but we’re a few items short of going from a decent marketplace to actual investment instruments.
There was a time where people bought baseball cards, collected them and sold them to other hobbyists and during that time, a lot of people managed to turn a profit, but does that make collecting baseball cards a solid investment strategy to guarantee a comfortable retirement?
In truth, cryptocurrencies currently have value in much the same way baseball cards had value: there are a large number of people who are willing to trade them at different prices and that creates a market.
There are many groups of people who work very hard to create software that operates the cryptocurrency market and makes it look and feel much like stock markets and other more traditional venues where investment instruments lurk, but that similarity is almost all skin-deep.
You may have heard people talking about the technological potential of the distributed ledger technology (or blockchain) that cryptocurrencies are built on, how it could replace banks, capital markets, reduce costs for running financial services and maybe eliminate financial institutions altogether.
Don’t get me wrong, as technologist, I honestly believe that the potential is there and the technology is on the right track to reach the capability to do these incredible things, but from the perspective of my experience, I can tell you that the cryptocurrencies that you can buy and sell today are not there yet. Some are very impressive and have amazing potential technologically speaking, but whether or not they continue to increase in value and ever live up to the legends we technology people tell depends on much more than the quality of the technology or the idea.
Because there are a very wide variety of factors that have to be considered to figure out whether or not a cryptocurrency will make it into the future or be replaced by a competing one, and whether or not they will ever see the lauded mass market use, it’s practically impossible for anyone to tell you where a specific coin or token’s price will be in a few years.
Optimists usually side with “well, more than it;s worth today” and pessimists side with “it’s a bubble and it’s going to crash to 0”.
My perspective on the matter? It doesn’t matter.
I hope I’ve painted a clear and convincing picture so far of why you shouldn’t look at cryptocurrencies as long-term investments the same way you look at your 401k or RRSP accounts and that you’re beginning to gain some perspective on why it doesn’t make sense for everyone to rely on cryptos as investments for their future.
In fact, while the stats are rare, I believe that the vast majority of people who have bought into cryptos so far have only made money during specific periods of time where the market was good, and outside of those periods generally stagnate or lose money. There’s a supporting theory on this topic called the Pareto Principle, written by Vilfredo Pareto, a 19th century economist and civil engineer, but that’s way too much info for the purpose of this article which is already getting long.
“But wait, you said it doesn’t matter whether or not cryptos are investments and that we can still make money! How?!”
Well, I did say both of those things and I believe them entirely without a doubt. The reality is that in any marketplace, whenever you have anything bought and sold at different prices, you have what’s commonly called “trading” and whenever you have trading, there’s an opportunity to make money and an opportunity to lose money.
In effect, what I’m saying is that it’s entirely possible to develop the skill to buy cryptocurrencies at good prices and sell them back on the market at a profit later.
Technically speaking, this practice can be called “day trading”, a term you may have heard before, which lets the skilled and savvy traders profit from the volatility of the market.
To give an example, say at 10 AM, IVO coins are trading at a dollar, then at noon, they are trading at two dollars, and then at 2 PM back to a dollar, it’s easy to see that the price has moved up and down a dollar. Well that movement is called volatility (even though volatility can include much more complicated notions, you really don’t need to know them for this to make sense) and it’s what lets some people reliably turn a profit even though no one really knows where cryptocurrencies will be in a decade.
Following my example above, if I was willing to buy 100 IVO coins at 10 AM and was clever enough to sell them at noon for a dollar more than I paid for them, I would have made myself a hundred dollars of profit to keep. If, however I had missed the opportunity to sell at noon and had to settle for selling at 2 PM, then I would have made nothing and could consider that I’ve wasted my time.
You will probably see a lot of people talking about trading like this and using catch phrases such as “buy low sell high”, but the reality is that while it sounds simple, it takes a fair bit of skill, a lot of intuition, a high capacity to tolerate risk, a lot of patience and dedication to learn how to do it properly.
Over the years, many books and articles have been published, detailing how to make money off of trading and many traders have done very well for themselves.
I’d like to remind you, however, that it’s not as simple as picking up a “trading cookbook” from your local bookstore (which of course still exists and hasn’t gone out of business because of Amazon), following a recipe, and putting money in your pocket.
If you want to make money off of cryptocurrencies reliably instead of trying your luck by buying and holding this or that token you heard about on a forum or from a friend, you will have to learn a lot about economics, finance, statistics and trading. There is no way around it and there are no silver bullets.
I sincerely hope that this article has shed some light on what investments are and why you should only get into cryptocurrencies with caution and a determination to learn, if at all. Best of luck to everyone!