Five Reasons Which Make Cryptocurrency a Bad Investment

The incredible rise in the price of cryptocurrencies in the past few months has caught the interest of almost every investor in the entire world. Even the most traditional investors have been introduced to the concept of cryptocurrencies. However, not all investors want to invest in it. For instance, Warren Buffet has famously stated that he or is his company will not invest in cryptocurrencies using any mechanism. Buffet clarified that he would not short them or take any position in them. This is because he believes that cryptocurrencies will ultimately come to a bad end.

Many orthodox investors share the same opinion with Warren Buffet. In the previous article, we studied the disadvantages of using cryptocurrency from an end user’s point of view. In this article, we will have a closer look at why orthodox investors believe that investing in cryptocurrencies is a bad idea.

1. Cryptocurrencies do not Generate Cash Flow

Traditional investors consider a cash outflow to be an investment if it generated future cash inflows without the need to sell the asset. For instance, if a person buys a home, they can generate cash flow in the form of rent without having to sell the underlying asset.

Similarly, if an investor buys equity shares in the business, those shares generate cash flow in the form of dividends. However, when it comes to cryptocurrencies, there is no cash flow which is generated.

The only gain that the investor hopes to make is if they find someone who is willing to pay a higher price for the currency on the market. This makes cryptocurrency investors vulnerable to the whims of the marketplace.

The lack of periodic cash flows makes cryptocurrencies inherently speculative. Most people who hold these currencies are speculators hoping to make a quick buck.

Hence, according to orthodox investors, buying into cryptocurrencies is like buying into the greater fool theory! The only possible way to make money is to convince someone to buy the same asset at a greater price.

2. Cryptocurrencies are not Backed by Tangible Assets

Most orthodox investors believe that cryptocurrencies do not make good investments. However, a large portion of them also believes that cryptocurrencies do not make good currencies either. This is because, in order for currencies to be effective, they should have some underlying value.

Traditional currencies such as gold and silver had value because they were considered to be precious metals and emerged as currencies in almost all parts of the world. On the other hand, fiat currencies derive their value from the power of the government.

It is illegal to not accept these currencies in the country where they are issued. However, there is no tangible asset or government decree which assures the value of cryptocurrencies.

3. Cryptocurrencies are Prone to Hoarding

Another reason why cryptocurrencies are not considered to be good examples of currency is that they are prone to hoarding.

The job of a currency is to stay in circulation. Currencies enable the transaction of other goods and services. They are just the medium of exchange and do not represent value. However, when it comes to cryptocurrencies, investors want to hoard large amounts of them. This is because they believe that these currencies will increase in value over a period of time.

If an investor believes that their currency will triple in value in a couple of years, they are unlikely to spend it. Hence, it would be wrong to state that cryptocurrencies are the currency of the future. The way they are currently used hints at the fact that they are being used as speculative financial instruments.

4. Cryptocurrencies are not Stable

All currencies fluctuate in value. This is because the amount of money in circulation keeps om increasing or decreasing in comparison to the assets in the economy. On average, the United States dollar loses about 2% of its value each year because of inflation. This is normal for currencies.

However, cryptocurrencies take this instability to a whole new level. It is common for cryptocurrencies to lose 30% of their value within a single weekend.

In the past couple of years, cryptocurrencies have been extremely volatile. They have tripled in value only to come back tumbling down and then rising once again. Also, the drop in value gets triggered by seemingly meaningless events.

For instance, when Elon Musk tweeted negative views about cryptocurrencies, a lot of these currencies lost 30% to 40% of their valuation. This level of instability is extreme and hence cryptocurrencies cannot be considered to be a viable store of value.

5. Cryptocurrencies are not Predictable

Lastly, movements in the price of cryptocurrencies do not follow any fixed pattern. For instance, stocks seem to have a direct relation with GDP growth whereas bonds have an inverse relationship with interest rate growth. However, when it comes to cryptocurrencies the movements seem completely random. There is no significant correlation to any factor. Hence, cryptocurrency investors cannot keep track of the fundamentals because they do not know what these fundamentals are!

The above factors are significant and make cryptocurrencies unconventional at best and outright speculative at worst. It is for this reason that orthodox financial planners advise their clients to stay away from cryptocurrencies altogether. However, if the clients still want to invest, they are advised to use only a small percentage of their overall portfolio towards cryptocurrencies.

Authorship/Referencing - About the Author(s)

The article is Written and Reviewed by Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.