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Many investors have been intrigued by cryptocurrencies since their emergence in 2009 (when Bitcoin was created). Since COVID-19 swept the world in 2020, however, they have become even more interesting as investors have sought strong returns outside of the stock markets (which crashed in March 2020) and a “safe haven” outside of fiat currencies like the USD, GBP and Euro as national governments have printed more money to combat the pandemic. Yet are these digitally-based currencies truly a good investment opportunity? If so, how should they be included in a portfolio?
In this guide, our team at Elmfield here in Padiham, Burnley, Lancashire provides a financial planning-based perspective on cryptocurrency investing. We hope this content is useful both to our existing clients and to others. If you’d like to speak to an independent financial adviser then you can reach us via:
T: 01282 772938
What is a cryptocurrency?
Many people synonymise cryptocurrency with Bitcoin. Whilst Bitcoin is the world’s most popular cryptocurrency in 2021 (worth $600bn in June 2021) there are, in fact, over 4,000 currently in existence – with new ones created every day. In simple terms, a cryptocurrency is a currency involving no physical coins or notes; rather, it is digitally-based. It allows people to buy and sell things through an online system, whereby computers (across the world) store information about the transactions going on and verify them through a process called “mining”. These computers, as such, hold the “ledger” – which is public – and do not rely on a central bank or government to operate, using a decentralised control system instead.
Is cryptocurrency an investment?
In its purest form, Bitcoin was not imagined as an “investment” – but as a means of exchange. Yet people have come to treat it as such. Popularly, the likes of Bitcoin are treated in a similar way to “fiat currency” (government-issued money) by forex traders. In other words, you buy a certain amount of the cryptocurrency – using an online platform – and later sell it at a profit to other investors if it later rises in value. Some experts, however, do not regard this activity as “true investing” because the assets are “unproductive” – i.e. unlike companies which create products/services of value to people, producing dividends and capital growth in the process.
However, there are other ways to make money from cryptocurrencies. In particular, many have turned their attention to building computers which “solve” the complex equations involved in verifying a cryptocurrency’s transactions. By mining in this way, the “miners” can be rewarded through payment in the respective cryptocurrency. They can then use these rewards to buy other cryptocurrencies expected to rise in value, or simply convert it into fiat money.
What are the distinctive features?
Cryptocurrencies are notoriously volatile and can fluctuate wildly in value – from extreme highs to extreme lows in a short space of time. Whilst there are no indices measuring crypto price volatility, most agree that cryptocurrency markets are far riskier than established stock markets. In 2016, for instance, the price of bitcoin rose by 125%. The next year it rose another 2,000%, before the price receded significantly. The reasons for this volatility are numerous, complex and very difficult to predict – including:
- The cost of mining. Miners need to buy and maintain expensive computer equipment to process the cryptocurrency’s transactions. If hardware prices go up, therefore, this can depress profits and lead to a devaluation as miners seek better alternatives elsewhere.
- Political events. In recent months, China’s authorities have been clamping down on cryptocurrency mining centres within its borders (e.g. Sichuan province). This caused the Bitcoin price to spiral downwards in June 2021.
- Other cryptocurrencies. New entrants to the crypto market can lead to disruption that results in price fluctuations. Moreover, movements in specific crypto prices – particularly Bitcoin – can impact others’ too.
Should I invest in cryptocurrency?
Given the extreme volatility of cryptocurrencies it would be unwise for most ordinary people to invest significant sums into them. Building up a retirement fund, in particular, should involve investing in assets which allow you to examine their underlying fundamentals (something very difficult, if not impossible, to achieve with a cryptocurrency). The price movements are likely to be too hard to stomach over many years, except perhaps for a rare minority of high-risk-appetite investors. For those keen to invest directly in a specific currency for the experience, it might be fun committing a spare £50 (or other amount you can afford to lose) just to “scratch the itch”.
Yet for those interested in cryptocurrency as a longer-term portion of their portfolio, it may be worth speaking with your financial adviser about “indirect” ways to gain from this interesting innovation in digital finance. For example, rather than directly mining cryptocurrencies yourself, perhaps you could invest in some shares of companies which engage in large-scale mining and which can develop other revenue streams if this aspect of their business does not bear fruit.
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938