For economists, Bitcoin and other cryptocurrencies are an interesting experiment, but they are not yet ready to be adopted by banks and financial institutions as a way of doing business. The extreme volatility of Bitcoin (see chart below) and other cryptocurrencies make them an extremely poor store of value (one of the main functions of money) though they might be an adequate medium of exchange. Further, if you look at the history of Bitcoin, you will see that there have been a number of scandals and thefts. Bitcoin’s defenders say these problems are just the “growing pains” of a whole new type of currency and system. To this I say, that is fine, but let me know when it is grown up and adopted by (and guaranteed by) major financial institutions in the United States. My advice is to stay away from these cryptocurrencies for now.
The graph below certainly looks enticing. If you had bought one Bitcoin on January 8, 2015, at a price of $288.99, you would have had your investment grow to $19,650 dollars by December 16, 2017, a return of 67 times your original investment, 3,350% per year for each of the two years you held it. But how could you have known that? At the same time, if you had bought one share of Amazon stock on January 1, 2015, at $320, you would have had your investment grow to $3,225 on August 6, 2020, a return of 10 times your original investment, an equivalent to 200% annual return on your investment for each of the five years you held it. The fundamental difference here is that Amazon makes something. It provides goods and services to customers, it has a cash flow, and it has revenue and net income on which you can calculate Return on Investment (the universal way we value companies and the price of their stocks). Buying Bitcoin is almost like buying collectibles, like an A-Rod rookie baseball card or a pair of original Air Jordans. Will these collectibles increase in value? Maybe yes or maybe no. Do you remember the Beanie Baby collecting craze? Did those increase in value?
Figure 4.5. Bitcoin Stock Price by Fred Rowland is used under a CC BY-NC 4.0 License. Source: Cointelegraph data (11/22/2020)
Figure 4.6. Amazon Stock Price by Fred Rowland is used under a CC BY-NC 4.0 License. Source: Yahoo Finance data (11/30/2020)
“Risk follows reward” is an immutable law of Wall Street; if you are seeking higher than average returns, you must go after riskier investments. You might have been lucky enough to invest in Bitcoin in 2015, but you might have bought it in 2017, at the height of its speculative run. You also could have bought shares in an S&P mutual fund at the Vanguard Mutual Fund Company, and your return from January 2, 2015 to August 6, 2020, would have been + 63% over fve and a half years for an annual return of 11.5%, with much less risk than Bitcoin (and the start-up, Amazon).
Figure 4.7. S&P 500 by Fred Rowland is used under a CC BY-NC 4.0 License. Source: Yahoo Finance data (12/3/2020).