I’ve never owned any Bitcoin or any other cryptocurrency.
When most people say they’re “investing” in Bitcoin, they’re really speculating.
According to Benjamin Graham, Warren Buffett’s mentor, investing requires (1) safety of principal and (2) an adequate return.
Speculation on the other hand is buying something hoping that someone comes a long and pays even more for it than you did. This is also sometimes referred as the “greater fool” theory of wealth accumulation.
When Bitcoin increased from $10,000 to over $50,000 in seven months, people thought future returns were guaranteed to be more than adequate (requirement #2).
However, because I believe there is little underlying value in cryptocurrencies – there’s no cash flow or business asset represented by one’s ownership – you have no safety of principal (requirement #1).
Contrast this to buying stock in a good, but unfavored business. Let’s say the company produces $10 billion a year in profit, has grown its profit by at least ten percent every year for the past ten years, and has $5 billion in assets that can be liquidated if necessary. For whatever reason, investors today think the business is bad and therefore its stock lags the general market, especially popular technology stocks.
If you buy stock in this business, you have some downside protection. First, there are real earnings you are entitled to as an owner of its stock. Second, there are real assets that can be liquidated to provide cash to debt holders and shareholders.
One of Graham’s core investing ideas is to regard the ownership of shares in a public company the same way you would whole ownership of a private company. If you owned 100% of a company, would you care if its public market value swung up or down 20% throughout the year? Likely not. What would you care about? The stability of the underlying business’s performance – is it producing good sales and profits? This is the value of owning an asset, whether it’s a small business or stock in a large business, that has intrinsic value – you can ignore the current public value if you want.
On the other hand, there’s little in the way of Bitcoin losing 90% of its value and never recovering to its previous high. A new cryptocurrency might overtake Bitcoin’s popularity, government regulation might affect Bitcoin’s value permanently, or speculators might lose interest (like has already happened with some meme stocks that shot up in value over the past two years).
Some people have – and still will – get rich speculating in inflated assets. This pattern has repeated itself for hundreds of years. (If you’re interested and not well aware of the story, read about the tulip mania speculation from the 1630’s.)
Any time prices appreciate to unreasonable values, risk is higher though most people think risk is lower at the higher price. If the price of a company or speculative asset appreciates 100% or 1,000% without an equivalent increase in the underlying asset’s performance, it’s a time to be cautious.
Like Buffett has said, in investing and business, it doesn’t make sense to risk what you have and need for what you don’t have and don’t need. Putting money in speculative assets hoping the price goes up another 1,000% while risking your financial livelihood is a bad idea.
When in doubt, use the rule of thumb from The Psychology of Money, will you still sleep well at night if you put money in this asset?