The Intelligent Crypto Investor
Does the advice of Benjamin Graham hold true in the age of highly volatile cryptocurrencies?
- The Basics of Investing
- Speculating Cryptocurrencies
- How to Invest in Crypto
- Trading Strategies
- Asset Allocation
The Basics of Investing
Early on in The Intelligent Investor, Graham teaches us an important lesson: the difference between investing and speculating. Investors take into account the fundamentals of an asset (for example a stock), and take into account earnings, market, team, competition, and projected growth. Thus culminates a valuation and a thesis. One might conclude a stock is undervalued and buy the stock. Conversely one might conclude the stock is undervalued relative to its true value, and short (sell) the stock.
In comparison to an investor, a speculator looks at the price of an asset, and determines if it will increase or decrease. Good speculators, and they do exist, will use a combination of fundamentals and technical analysis. Speculators today do not look like those of Grahams’ day. Today, most speculation volume is done on computers and traded according to rules set algorithmically.
The driving force behind the insanely high growth of cryptocurrencies is due to speculation. Not speculation by hedge funds or the team at Ethereum, they know what they are doing and can decently determine the value of a crypto. The problem is speculation by you and I.
If you do not even know what the currency is, you should not “invest” in it. Too many people are seeing the cryptocurrency class increasing rapidly and determine they want a piece. This drives the price up beyond its true value, causing institutional investors to become even richer and sell their assets at a premium. When a large volume of these sell offs occurs it causes the price of the currency to suddenly drop.
This in turn causes panic amongst lay people who see their “investments” rapidly decreasing in value, and decide to get out. This even larger sell off causes the price of the asset to drop even further. Finally, the crypto being near its true valuation, or undervalued, receives capital from investors, causing the price to increase, and the cycle begins again.
So how should I invest in cryptocurrency?
For starters it is important to note that cryptocurrencies and ICOs lack clear regulation, which will not last long. But while the space is unregulated, this means shady companies can publish a fancy looking website (extra points for magic words like blockchain, A.I., VR, even better if it uses all three), then raise an ICO, take your money, give you a meaningless token and leave you with nothing. Your investment in the crypto asset should not be based on faith that the issuer will behave ethically, your investment should instead be based on due diligence on the team, the platform, the market cap, and most importantly the regulations and enforcement surrounding governance of the asset.
If a company is asking for an insanely high amount of money, do not invest. It does not matter if the company is able to raise millions of dollars if it can not properly justify why it needs that money. A company with too much money is just as bad as a company with too little. The most responsible crypto assets issuing ICOs limit how much money they can receive, and they do not limit the money because they are generous people, they limit it because they want to succeed as a startup and maintain proper valuation and reasonable use of services.
When it comes to investing in the big four: Bitcoin, Ethereum, Litecoin, and Ripple, keep in mind nuances between the currencies. Bitcoin behaves like gold. Ethereum on the other hand behaves more like energy commodities where valuation is based on utility (as a platform for applications to be built on top of). Ripple is a business to business focused application that allows banks to settle international transactions and currency conversions at a discount to the normal fees. Buying Ripple is believing the company will perform well in the future, but the token has nothing to do with the banks and will not affect the platform’s ability to function. Litecoin is an open source p2p (peer to peer) payment platform most similar to Bitcoin, but with a few important differences, namely differences in its proof of work algorithm that make it harder to mine, while also having the capacity for 4 times the volume of Bitcoin.
Buy and Hold: If you think the value of the asset will increase in the long term (a few years) this is the best strategy for you.
Short Sell: If you think the value of the asset will decrease in the short-medium term this is the best strategy for you.
Margin Trading: Trading cryptocurrencies on a margin is risky (and partially banned in NY). It allows you to amplify your normal gains by borrowing currency, at the risk of amplifying your normal losses. This strategy is best for experienced investors and should be executed only when there is a high probability that the price of the asset will move as expected. If there is a sudden fluctuation in price (ie. exchange hacked, fake news, etc.) your margin could be forcefully liquidated and you will lose your position plus pay interest.
Offering Loans: Some exchanges allow you to provide the capital that margin traders would borrow, as a reward you would earn part of the interest paid. While not as risky as margin trading since exchanges usually assure payment, the risks with offering loans is that the value of the underlying currency in terms of USD decreases, so while you may have more Bitcoins after the loan matures, you may have less USD if the value of each Bitcoin decreases in that time. The other risk is that if the value of the currency, say Bitcoin, decreased rapidly during the period of the loan, you would have no way of withdrawing the capital until the period finishes. Although cryptocurrency loans are usually short periods (2 days), cryptocurrencies fluctuate wildly within even hours, so a period of just 2 days holds notable risks.
Overall, I believe cryptocurrencies should be treated much like investing in emerging economies/sectors, they have the potential for major returns, but come at the cost of greater risk. For this reason, I would recommend against having more than 10% of your portfolio in cryptocurrencies. The rest of your portfolio should consist of a mix of cash, real estate, stocks, bonds, and other investments based on your risk appetite.
For the 10% (if you are a crypto-bull) that is crypto, I would recommend holding a diversified portfolio, composed 75% of protocol currencies (Bitcoin, Ethereum, Ripple, Litecoin, etc.), and 25% with application tokens (examples include Golem, BAT, Gnosis, Augur, etc.). As with all investments perform due diligence and do not blindly put money into any asset. Within the 75% of protocol currencies, adjust the specific allocation based on your risk-reward preferences, Bitcoin being potentially safer returns in the long run, while Ethereum being potentially larger returns (at a higher risk) in the long run. I would also recommend using a variety of buying, shorting, and offering loans, to diversify strategies within the portfolio.
*While it is possible to algorithmically trade and loan cryptocurrencies, this is also risky, as not all websites are legitimate, some take large percentages of your earnings, and others require a high degree of programming ability.
The Long Game
In the next year the value of these cryptocurrencies will fluctuate wildly, the driving factors behind the prices are speculative in nature. If you buy crypto, do it for the long game, and consider if this currency/app will exist in 5 years, 10 years, or 20 years. If the answer is no, think twice before putting your money into the hottest token. The internet bubble of the 2000s lost investors trillions of dollars, but it also produced some of the most valuable companies of today (Amazon IPO 1997). Expect the next generation of the internet to be no different. Most companies will fail in 20 years, think which few will not, and invest in those.
* The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.