“Tom” is a friend who recently got excited about investing in cryptocurrencies.
He’s a smart guy who’s closed deals worth over a billion dollars for his work, so when he pitched his investment ideas to me, I listened.
As Tom excitedly explained the crypto trading strategies he had learned in a subscription newsletter, I could only scratch my head in bewilderment.
His logic was flawed, and I told him so. However, he ignored my warnings, withdrew most of his retirement savings and used them to trade cryptocurrencies.
Things didn’t go well for Tom. First, he lost a third of his money to taxes and penalties by prematurely withdrawing money from his IRA. Then the crypto market crashed causing his portfolio to drop another 50%.
However, the real craziness of Tom’s financial misadventure is that he used a new Chinese company to hold his “digital wallet”, which is needed to trade cryptos. When he tried to withdraw his remaining money, his digital wallet magically disappeared.
This company stole everything, and there was nothing Tom could do about it.
Tom’s story highlights several issues. The most important thing is to always use a trustee when investing; a fiduciary is a financial professional who is legally bound to act in your best interests.
Unless you are a seasoned professional, there are too many landmines in the financial landscape that you can encounter when investing independently.
However, the elephant in the room is that cryptocurrencies have no intrinsic value.
While cryptocurrency proponents will argue that government-backed currencies are similar, with no underlying tangible assets, these folks are missing a crucial lesson in economics. A currency only has value if someone else accepts it in exchange for the goods and services you need.
Government-backed currencies have fundamental strength. The governments that issue them will always accept them as a legitimate form of payment, as will anyone doing business with that government.
Since most global businesses use the US dollar in one form or another, and every American citizen and business pays their taxes in dollars, the dollar is not going away.
On the other hand, cryptocurrencies are not guaranteed as a currency that everyone will accept.
Since the creation of a cryptocurrency is increasingly easy, the likelihood of a cryptocurrency gaining permanent and widespread acceptance seems unlikely. It is only when a prosperous nation adopts a cryptocurrency as a legal means of exchange with the government that it will become a true currency.
However, when a cryptocurrency becomes an acceptable form of payment everywhere you go, it will cease to be an investment and have stable value.
No one discusses trading pesos, euros or yen over dinner because they are not investments. Their values are as stable as possible so that the trade can go smoothly.
Hyperinflation or hyperdeflation produces economic instability, and cryptos regularly suffer from both. For example, if I order a thousand Teslas for one Bitcoin each, and the price of Bitcoin doubles between order and delivery, I must sell my Teslas for half a Bitcoin. Business can’t work that way.
The real question for cryptocurrencies is: are they investments or currencies?
If they are investments, they have no underlying value and should be avoided. If it is currencies, they need a stable value controlled by a regulatory body like the Federal Reserve to avoid the risk of hyperinflation or deflation. If ever a cryptocurrency goes mainstream, it can no longer have huge price swings, so it will cease to be a speculative investment.
Cryptocurrency is in a bubble cycle where investors buy something with no intrinsic value and hope that a bigger fool will come later and pay them more. That said, I think blockchain technology is remarkable and has great potential.
Rather than looking at the price of cryptos, look at who is profiting the most from the crypto hype. Chances are it’s the money changers in the temple of finance and not you.
As for Tom, he’s lost millions, but he’s still in decent financial shape. Most of us, however, are not capable of losing millions and getting away with it.
Don’t fall into the cryptocurrency trap.
Doug Lynam is a partner at LongView Asset Management in Santa Fe and a former monk. He is the author of From monk to money manager: A former monk’s financial guide to getting a little rich – and why it’s okay. Contact him at [email protected]