Should We Borrow To Buy Bitcoin?
How traditional investment advice applies to the new cryptocurrency economy
This article is a collaboration between Fraud Stamp and CryptoQuestion. You can follow CryptoQuestion on Twitter @cryptoimpartial and Instagram @cryptoimpartial or visit their website at www.CryptoQuestion.tech
On Christmas day bitcoin (BTC) reached another all time high. Unlike the stock market the cryptocurrency market never sleeps. However in many ways cryptocurrencies, or more specifically bitcoin, possesses similar qualities to stocks.
A few weeks ago the latest hot topic on the social media platforms was whether it was wise to borrow against your home and invest in bitcoin. That discussion had started after a well known podcaster admitted he had taken out a loan failing to tell the lender what he intended to use the money for. The discussion moved away from the ethics of his actions and towards whether it was an acceptable risk to borrow money to invest in bitcoin. The reaction was mixed.
That discussion is the crux of this article. Should we be throwing caution to the wind and ploughing our spare money into bitcoin? When you read about companies like MicroStrategy investing the bulk of their surplus cash into bitcoin (over $1bn including borrowings of $650m) and that Elon Musk is contemplating doing the same at Tesla you have to ask yourself a very important question: Am I missing something?
It has been said that every event is a repeat of the same or similar situation from the past. These past events generally establish certain rules which should be followed based on past experience. In the case of the phenomenon which is bitcoin by throwing caution to the wind and disregarding these investment rules we are declaring that bitcoin is unique, that the world has never seen anything like it before.
What are these investment rules which have been learnt over many years through the school of hard knocks? Here are the eight most important ones which are particularly relevant to bitcoin.
- Don’t invest money you’ll need right away. Always have an emergency fund. Following on from this basic rule, don’t invest what you cannot afford to lose. By ensuring you never invest all your money into one investment if the worst case scenario comes to fruition you are still able to remain in the game. There are many horror stories of people investing all their available savings into a single stock which they think is the next big thing, a commodity, junk bonds, an alternative investment (from ostriches to tulip bulbs) or an attractive looking property play. Some work out, most don’t hence the rule!
- Don’t invest in anything you don’t understand. This is Warren Buffett’s golden rule and has stood him in good stead throughout his long and successful investment career. Do you really understand how bitcoin works? Do you understand the factors that influence its price? Are you investing because everyone else is? Or have you sat down and worked out independently of anyone else why bitcoin is a solid long term investment?
- Leave your investments alone. Another one of Mr Buffett’s golden rules. Don’t be one of those people who checks the price of your investment ten times a day. The best practice is to buy an investment and hold it. That policy has worked exceptionally well for Warren and his investors over the years.
- Diversify your portfolio. Often described as the golden rule of investing. This rule doesn’t just mean investing in a large number of stocks to spread your risk, it also means having different kinds of investments (stocks, bonds, gold, property and bitcoin) that will perform differently over time reducing overall risk. This is where bitcoin fits in, as a constituent of a well diversified portfolio.
- Do not invest in single stocks. This rule doesn’t just cover stocks, it covers any type of investment. If you are presented with something that your advisor says is the best investment opportunity he has seen in his long illustrious career and recommends you invest your entire savings into it I think a fair response would be a stiff punch to the nose. It is always advisable to spread your risk among a basket of investments which react differently to market conditions.
- Understand your risk tolerance. Are you a risk taker or risk averse? Are you a pensioner who needs a financial loss like a hole in the head? Are you young with money to burn? Do you panic when one of your investments loses 20% in value in one day? Do you sleep like a baby despite market turmoil? These are all factors which you must consider when investing in any asset. If you don’t handle stress well and panic when bitcoin dives by 50% in a day then this investment isn’t one for you. Likewise if you are a pensioner who is in need of a regular income investing any of your pension in bitcoin is not advisable.
- Buy when everyone is fearful. This rule is the signal of a cold hearted professional investor. When the crowd is selling in panic the professional with nerves of steel is snapping up unwanted stock or in this case bitcoin believing the market has overreacted. A shrewd investor goes against the crowd not with it. When the Uber driver tells you he has purchased bitcoin, that is when you want to take profits and wait for the same driver to tell you he has sold, then buy.
- Don’t deviate from the process. Follow your investment rules religiously. The first time you deviate from your rules that is the start of the end. It is like an alcoholic taking his first drink after being on the wagon for twelve months! If you decide to hold 5% of your portfolio in bitcoin stick to that and rebalance your portfolio.
Does Bitcoin Deserve Special Treatment?
Some of the most enthusiastic among us may say these rules do not apply to bitcoin. Bitcoin is unique. To that we respond with the wise words of Sir John Templeton the successful value investor who once said “The four most costly words in the annals of investing are ‘this time is different.’”
With any investment it is not all one way traffic. There are also many risks attached to bitcoin which tend to be brushed under the carpet when market exuberance takes over. When the market turns it becomes quickly obvious that we should have realized that there were glaring downsides to our once faultless investment. What are the glaring downsides to bitcoin? Here are a few.
- Despite the often cited argument that the maximum supply of bitcoin is restricted to 21m coins we often forget that each coin can be divided into 100,000 Satoshi’s.
- BTC is already a mainstream investment or store of value however it is barely utilized as a medium of exchange because of its volatility and the snails speed in which Bitcoin processes transactions (BTC blockchain processes 7 transactions per second compared to 24,000 for VISA).
- There is no intrinsic value behind bitcoin.
- There is no generally accepted valuation model to determine bitcoin’s value. A few valuation models that do exist suggest an intrinsic value of under $5,000 based on the opportunity cost of using an alternative to bitcoin and the financial savings made as a result of using bitcoin. These models have their faults and do not take into account other non financial factors.
- Regulation. A few countries have banned bitcoin such as China and India (China prohibits exchanges from dealing legal tender for virtual currency). What would happen if the US instituted a ban?
Counter Arguments in Favor of Bitcoin
For each risk there is a strong counter argument especially as the bitcoin frenzy remains in full flow.
A few convincing ones for the value of bitcoin to continue its rise include:
- Based on 100,000 Satoshis for each BTC, a value of $1 per Satoshi (and $100,000 per BTC) would produce a market cap of $1.8 trillion (it is $500bn now), compare that to golds market cap of roughly $10 trillion that is a strong argument for BTC to continue its rise for some time to come.
- Whilst bitcoin’s blockchain is fundamentally slow there are networks which work on top of the blockchain that will speed up the processing of transactions so it is competitive with centralized systems. This will increase future adoption and therefore the price.
- Bitcoin will become a mainstay of every investor’s portfolio.
A Sensible Conclusion
It all comes down to risk tolerance. As we saw earlier a persons risk tolerance depends on a number of factors. This article is not by any means saying don’t invest in bitcoin. We are advocates of bitcoin and can see the price continuing to rise. A price of $100,000 isn’t a mere pipe dream any more, it is a real possibility. However like with most investments in the past and present things don’t always turn out the way we expected. As they say, there is many a slip between cup and lip. This slip could be the US imposing a ban on bitcoin, unlikely but possible. A competitor to bitcoin could emerge which quickly overtakes bitcoin. This is a more likely scenario in the medium term with Facebook’s virtual currency being a main contender.
Nothing is risk free. There was the tulip bulb mania back in the 1600s and the dot com bubble in the late 1990s. It is always best to urge on the side of caution. Borrowing against your home is the act of a maverick investor or someone who has let greed go to his head. It rarely turns out well. The sensible investor would do better to add bitcoin to his portfolio and limit it to below 10% (5% feels about right). The overriding fear in all of us is the fear of missing out — they even have an acronym for it (FOMO). The fear of losing your home or your car should always override this. That is why the golden rule in the case of bitcoin is only invest what you can afford to lose. If you can’t afford to lose it don’t invest it — simple.
No Financial Advice
This article does not constitute financial advice in any way. The article should be treated as supplementary information to add to your knowledge base.
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