In the first post of the Cryptocurrencies series, we talked about how cryptocurrencies were working. In the second post, we look at the history of cryptocurrencies. In this post, I am going to discuss what I think is wrong with them.
Personally, I believe that cryptocurrencies are not an investment. When you buy a cryptocurrency, you do not buy any value. You just speculate on the fact that others people will later give higher value than what you paid. This speculation, or even gambling, not investing. Moreover, there are also several problems with investing in a cryptocurrency that you do not have with stocks. Let’s see what they are!
1. Cryptocurrencies have no real value
I am not saying you cannot buy things with cryptocurrencies. Because you can. You can also exchange them for standard currency and do what you want with them. However, as an investment, they have no real value. When you invest in a company by buying stocks, you buy a part of the company. This company has assets and generate earnings. You shares represent a part of these assets and earnings. They may even grant you some dividend.
But when you buy some cryptocurrencies, you do not buy any value. You simply buy a coin with currency that you hope to exchange for more currency later. This is also the opinion of Warren Buffett who said “You’re just hoping the next guy pays more. And you only feel you’ll find the next guy to pay more if he thinks he’s going to find someone that’s going to pay more”. This is not investment, this is speculation! There is nothing wrong with speculation, you just need to be aware of what it is. And you should be aware of the risks.
2. Cryptocurrencies are highly volatile
Bitcoin’s price has been highly volatile since the beginning. And it has been the same for most cryptocurrencies. Just take a look at the chart above. It is very easy to see that daily volatility in the last two years has been much higher on bitcoin than on gold or stocks.
Moreover, the price of a cryptocurrency is not tied to any value like the price of a stock. So they mostly react to news and to investor appeal. There is a very strong herd mentality with them. And this can change very fast. It has not been uncommon to have daily change of more than 10% with cryptocurrencies. On the other hand, this is very rare for stocks.
3. Cryptocurrencies are too anonymous
Cryptocurrencies are highly anonymous. In fact, I believe they are too much anonymous. All transactions are recorded. But the only thing recorded is your public key or your user name. If you know someone’s public key, you can know how much he got. However, normally, you do not know who is behind the public keys. That means you can send money to someone and nobody will know that the money is coming from you if they do not know who is behind your public key.
This is a severe problem in my opinion. It is too easy to use them for criminal activities. While they could do the same with cash, now they can instantly send money from one account to another. And all this in total anonymity. This can also be used for tax evasion. Bill Gates also shared this concern in a recent Reddit Ask-Me-Anything (AMA), by saying “The main feature of cryptocurrencies is their anonymity. I do not think this is a good thing.”.
I think cryptocurrencies need more regulations and security before they can become mainstream.
4. Cryptocurrencies have a bad environmental impact
The mining of cryptocurrencies, which is at their heart, consume a lot of energy. Currently, it is estimated that the bitcoin network by itself consumes about 72 Twh per year. This is more than the energy consumption of a country like Austria!
Some miners use renewable energy for their operations. However, most of them are set in rural areas where energy is cheap. For instance, there are a lot of them in China where the main source of energy is coal-based. Which is extremely environment-unfriendly!
You can do what you do with cryptocurrencies with other currencies. But without the extreme energy consumption. I do not think it makes sense to consume so much energy for a simple currency. Something should be done to reduce their energy consumption in the future. We already have enough environmental concerns in the world without this one!
5. Cryptocurrencies lack protection
There is much less protection when you trade cryptocurrencies than when you trade stocks. To start, there is no protection against insider trading. In stock trading, insiders from a company are prohibited to use internal knowledge of the company to make a profit on the stock market. There is no such thing in cryptocurrencies. If an insider has more information than the others, he can still do what he wants.
Another lack of protection is in guarantee. If you invest 100’000 dollars in cryptocurrencies and keep your coins in the exchange website, nothing is protecting you against the bankruptcy of the exchange. If the exchange closes down, you lose everything. Stocks and cash are insured in most countries (by FDIC and SIPC in the U.S. for instance).
There are also some guarantees for the price you pay for stocks. For instance, they are laws that make sure you do not get a worse price than the best offer there is at that time. But there is no such things for cryptocurrencies. As such, different exchange websites can have large difference in price.
While I am very interested by the technology behind cryptocurrencies, I am not interested in them as an investment. In fact, I believe they are not an investment, they are speculation. When you invest, you invest in some value, generally the value of the company. Or the future value of the company. However, cryptocurrencies have no intrinsic value. If you want to gamble your money, it is fine, you just need to be aware that you are doing it. Do not start gambling a second mortgage on cryptocurrency and start saying it is a safe investment. It is not!
For now, I do not want to invest in cryptocurrencies. I already gambled some money into them in the past. And I consider this one of my biggest investing mistakes. In the past, I believed it was an investment. But now I know that they are not an investment.
What about you ? What do you think about cryptocurrencies ? Are you speculating on them ?