Even as the stock market continues to soar, investors are looking for the next great thing that will turn them into the millionaire next door.
Many believe bitcoin is that thing. They like the thrill of a new payment system taking hold. So despite cautions from regulators and investment advisers, people are rushing in hoping to make a fortune. And therein lies my problem with bitcoin and its virtual cousins: Quick money often leads to disappointment.
Already this year, bitcoin has seen heart-stopping drops, prompting more consumer warnings from regulators. The Commodity Futures Trading Commission — which has oversight of such virtual currencies as bitcoin, ethereum and litecoin — has created an online resource at cftc.gov/bitcoin for those who dare to invest. Be sure to read: “Understand the Risks of Virtual Currency Trading.”
Also, the American Enterprise Institute is hosting a panel discussion on bitcoin from 5 p.m. to 6:30 p.m. Feb. 12. You can watch it live online at aei.org. The main question the panelists will address is: Are bitcoin and its competitors sustainable currencies, or is this just another investing fad that will eventually crash spectacularly?
Bert Ely, principal of Ely & Company Inc., a consulting firm in Alexandria, Virginia, will be on the panel. Ely is a prolific pontificator on financial issues, and his latest mission is to caution investors about chasing bitcoin returns. I’ve been reaching out to financial experts to ask them what people are asking me about investing in bitcoin, and here are Ely’s answers.
Q: Why is bitcoin bad for the average investor?
Ely: Bitcoin, and all other cryptocurrencies, except possibly some of the Initial Coin Offerings (ICOs), are not real investments comparable to a home, real estate, stocks, bonds, mutual funds, or other assets that produce income or are tangible assets that can experience genuine price appreciation.
In a sense, cryptocurrencies are a mirage, a game of sorts, that will end badly for most investors, especially if they have borrowed money to gamble on cryptocurrency price appreciation.
Q: Why shouldn’t some people, with money they can afford to lose, chase bitcoin returns?
Ely: People who like to gamble with money they can afford to lose should view investing in, or actively buying and selling bitcoin and other cryptocurrencies, as akin to gambling at a casino, betting on the horses at the race track, or buying lottery tickets.
Q: Some have compared bitcoin to a Ponzi scheme in which money from new investors is used to pay off earlier investors. How is investing in bitcoin like a Ponzi scheme?
Ely: I argue that bitcoin and other cryptocurrencies, except possibly some ICOs, are akin to Ponzi schemes because those who create the cryptocurrencies (bitcoin miners, Ripple, etc.) will have profited greatly, at the expense of those who are holding cryptocurrencies when these schemes collapse.
Based on the market value of all cryptocurrencies, the wealth transfer from cryptocurrency losers to winners will be enormous when the bubble finally bursts, far exceeding what folks who invested with Bernie Madoff lost.
Given the amount of turnover (short-term buying and selling) in cryptocurrencies, I suspect already realized losses are many billions of dollars. Losses will be especially painful for those folks who have borrowed on their credit cards or against the equity in their homes to gamble on cryptocurrency price appreciation.
Q: What do you tell folks who fear they will miss out on what could be a big win? In every bubble there are winners, right?
Ely: In hindsight, those who invested early in bitcoin and other cryptocurrencies, and already have cashed out, are the winners. While some who jump into the cryptocurrency game today may get lucky and actually make a profit, if they then sell at the right time, most will lose — the cryptocurrency train has left the station.
Q: What lessons can investors learn from the recent drop in bitcoin?
Ely: The recent drop in the price of most cryptocurrencies, and not just bitcoin, illustrates how volatile the price of all cryptocurrencies is and the reality that this price volatility has no rational basis. That is the case because there is no there there with cryptocurrencies. They have no intrinsic value, nor do they generate any income for cash flow for those who “invest” in them.
I’m with Ely. Because for me — not to get all biblical on you — there’s a Proverbs verse that warns that wealth gained hastily will dwindle. Rather than chase quick riches, aim to increase your wealth — little by little — with prudent investing strategies. Slow and steady isn’t as sexy as investing in bitcoin, but it’s also not as risky.