Is cryptocurrency really an investment? | Guest column
You have undoubtedly heard of the new form of currency known as digital currency or “crypto”.
It’s a fascinating new development in the financial world and it has gained enormous attention on Wall Street as people try to capitalize on it. To define it, a “crypto” or digital currency (DC), is a form of “currency” represented by digital data, or a data file, which can be used for the payment of goods and services online. Some of the more popular cryptos include Bitcoin and Ethereum, but there are around 4,500 private cryptocurrencies now identified.
There are a lot of big players on Wall Street looking to capitalize on the current digital currency craze. They do this in several ways, for example “mining” and acquiring DCs (or “tokens”); trading in shares of companies that claim to operate, use or own CDs; or trade DC futures contracts. We have received many questions from customers about CDs and “invest” in them. This begs the question: are DCs like bitcoin really an investment?
To answer this question, let’s first define an “investment”. In my opinion, an investment involves the process of analyzing and placing money in a vehicle or instrument that is believed to have a high probability of generating a gain, or a positive return on capital (ROC), based on on a definable and predictable source of return such as income (i.e. rent or dividends) or price appreciation based on future profits. In other words, to be an “investment” there must be a “fundamental” basis for the investment of funds. The “instrument” could be things that should generate a positive ROC, such as a bank CD, a high quality stock or bond, real estate, a mutual fund, etc.
So let’s move on to cryptocurrency. Is it an “investment?”
Based on the above definition of an investment, we believe it is not. Crypto does not have definable “cash flows” such as earnings or dividends. Its price is extremely volatile, which makes it a bad store of value. The key to trading or owning crypto is its perceived scarcity value. Many players in the crypto space believe that a DC like bitcoin will only increase in value because of their limited quantity (21 million produced) and the growing number and value of transactions using DCs. Although this may be the case, it should be understood that the CD is only the medium of transactions; it does not provide the characteristics of an investment.
Crypto trading then is really more of a form of speculation, in my opinion, which is all about guessing the future price of something based on non-fundamental factors, such as emotion or fear of missing out. As we do with all of our clients’ investments, we believe that the best approach to achieving positive ROC is to invest in diversified holdings of quality stocks and bonds that provide a rational basis of ownership based on fundamentals. solid financials.
Robert Toomey, CFA / CFP, is vice president of research for SR Schill & Associates on Mercer Island.