Why are cryptocurrencies not considered proper investments?

Question

I plan to invest a portion of my savings in cryptocurrencies that I understand on a technical level (e.g. Bitcoin and Ethereum). However, otherwise prudent financial advice articles on the internet invariably claim that my decision is unwise. Cryptocurrencies are not commonly seen as a proper investment; they are seen as "risky", "speculative", or even "gambling". I don't understand why cryptocurrency is not considered a proper investment in the same class as real estate, stocks, bonds, and foreign currency. The Bitcoin-USD price volatility probably contributed to the "speculation" and "gambling" labels, but stock market volatility doesn't stop stocks from being considered investment-grade! To reduce risk from individual cryptocurrencies, I could simply hold a large basket of cryptocurrencies instead of just one or two (similar to diversified index funds for stocks).

• Why are cryptocurrencies not considered proper investments?
• Can I make my cryptocurrency holdings "investment-grade" by holding a basket of cryptocurrencies instead of just one or two?

Answer 1

Stocks, bonds, and real estate all have the advantage that they are investments in underlying assets that are expected to become more valuable over time. Economies grow over time which means that, broadly, companies become more valuable over time and, broadly, land becomes more valuable over time. Sure, there is volatility. And there will be winners and losers-- some stocks become much more valuable over time, some stagnate, and some fall to 0. But a broad basket of stock, bond, or real estate investments will be expected to grow in value over time based on their fundamentals.

Currencies (crypto and otherwise) don't have that advantage. There is no fundamental reason to expect that a broad basket of currencies are going to appreciate over time based on their fundamentals. Currency investments are generally 0 sum-- if I make money based on the euro appreciating against the dollar, someone else loses that amount of money based on the dollar falling against the euro. If you add in trading costs, they are generally negative expected value. In fact, if you look at the disclosures for any currency trading "opportunity", you'll see that the overwhelming majority lose money. It may be worth having some foreign currency in your portfolio as a hedge if you have income and expenses in multiple currencies-- someone that works in the US but owns an investment property that requires a mortgage payment and property taxes in euros may reasonably want to hold some euros just to make sure they're not hurt by swings in the currency market much the same way that large international companies hedge their currency risks. But most advisors aren't going to recommend that you hold a diversified portfolio of currencies as a long-term investment.

Cryptocurrencies have additional problems because they don't really work (at least yet) as a currency. Practically nobody is using bitcoins, for example, to buy goods and services in the real world. Transaction costs are high, real businesses don't want to get stuck holding a bunch of currency whose value may fall 20% overnight, etc. Almost no one is looking at etherium as a stable store of value. The vast majority of cryptocurrency transactions today are speculators that are betting that one cryptocurrency or another will grow or shrink in value over the relatively short term. And most of that speculation is happening in either unregulated or poorly regulated exchanges that have the unfortunate habit of failing and taking investor's money with them.

If a rational adult wants to take a small percentage of their portfolio and speculate in pork belly futures or Indian rupees or bitcoin, most people aren't going to object too strenuously. Sure, it's likely that you'll lose money speculating. But for some people that sort of speculation is fun and there is the potential that you'll make money on it. But it's much closer to taking your money to a casino than it is to prudent long-term investing.

Answer 2

Imagine a doomsday scenario and consider: what is stopping the value of the investment from going to zero? You mentioned four investments:

• Real estate: if everyone suddenly decided your house is worthless and won't buy it even for $0, you can still live in it, rent it out, or sell the land.
• Stocks: let's say you own Microsoft stock. If everyone suddenly decided MSFT stock is worthless and its price drops to $0, you can take over Microsoft, become the owner, bank all the profits the company makes (it made $44 billion of profits last year), and become an instant billionaire. This is why a profitable company's stock price cannot go to zero.
• Bonds: let's say you own US government bonds. If everyone suddenly decided the bonds are worthless and its price drops to $0, you can pick up all the bonds, and when the US government eventually pays its debts, you pocket the value of bond plus interest.
• Foreign currency: let's assume you live in the US and the Canadian dollar is the foreign currency. If everyone suddenly decided Canadian dollars are worthless, you could buy the CAD, go to Canada (where they will inevitably retain value), buy computers/cars/whatever, bring them back to the US, sell them, and make money. As long as the Canadian economy is functioning, they will be producing goods that can only be bought with CAD.

In other words, all four of these investments have solid fundamentals to back them up. Their value cannot go to zero, because even if everyone else decides they are worthless, you still stand to profit.

Now try filling in the blanks for what happens if everyone suddenly decided bitcoin is worth $0. OK, you can amass all the bitcoins in the world, but what can you do with it? Sure, right now you could buy things with those bitcoins, but only because the vendors selling things are accepting bitcoin. If everyone collectively decided bitcoins were worthless, they wouldn't accept it anymore.

Note the crucial difference between bitcoins and Canadian dollars - CADs are backed by the Canadian government & economy, bitcoins are backed by nothing.

Answer 3

Do you consider tulip onions to be a proper investment?

This is not a rhetorical question. Rather it is a question, which answer has to be informed by history:
The first historical record of an economic investment bubble popping leading to a crisis is the "tulip crisis" of the Netherlands. In its time, investors (called florists) bought tulip onions and speculated that the tulip would have a novel plant disease that would lead to funny patterns on the tulip's blossom.

Since the blossomed tulip would be much more valuable than the onion, this investment promised huge profit. Soon other people started to buy tulip onions. Soon the demand overwhelmed the offer. Soon the prices skyrocketed. Soon not tulip onions were traded but a derivative that promised tulip onions. The highest bid recorded was a house in one of the best locations in a major city for a derivative that promised three (!) tulip onions.

When time came to cash in, nobody actually wanted the tulips, because everyone only wanted the profits from investing into tulips. The value of the investment turned out to be zero. Most of the derivatives were fake anyway. All money was lost for everyone, who was still invested into tulips.

Back to the non-rhetorical question: What is the difference between cryptocurrencies and tulip onions as an investment?

You could basically replace most cryptocurrencies by mailing cash. That is irreversible and anonymous as well. You might not be able to prove that you mailed the cash. However people who need irreversible and anonymous money transfers typically can't go to court over the cash mailed. Likewise you can't take an anonymous party to court over not receiving a service after paying in BitCoin.
Cryptocurrencies may be more secure and more practical than mailing cash. However very few people actually use Bitcoin as a means to transfer money.
As a money transaction service for most people, PayPal is

• faster - within one minute instead of one hour (~10 minutes per block, 6 blocks for relative safety)
• safer - reversible in case of fraud, no losing access to your wallet (in case of handling your own wallet), no losing your wallet in a hack, no going bankrupt of an uninsured service provider (PayPal is a bank and thus subject to stability mechanism) due to a hack (hacks of service providers already happened). And all of this isn't even addressing that the initial paper already described an attack that would be counted as feasible in actual cryptography: To break BitCoin, you only need half of the computational power of the network for one hour, actual cryptography experts usually consider all of the computational power of all computers currently available until the heat death of the solar system as safe.
  The attack already "happened" by accident leading to a split in the block chain from which a spin-off cryptocurrency was founded.
• cheaper - free for private persons, low percents for businesses instead of two digit dollar amounts for a single transaction to get sufficient priority.

This comparison may seem useless, because of existing use cases for cryptocurrencies. However the question is, if BitCoin (or a basket of cryptocurrencies) is a proper investment and not if there are any use cases. I'm refuting that any use case for Bitcoin addresses a problem for so many potential users, as to stabilize or even continually increase the value of Bitcoin, which could make it a proper investment.
I'm not affiliated to PayPal other than being a customer.

Last time I checked, ordering a pizza for BitCoins cost the equivalent of $60 for the pizza plus $12 for the transaction. Sure the pizza delivery service accepts $60 for a pizza. It might even accept $60 in tulip onions for a pizza.

No cryptocurrency enthusiast has ever been able to explain the difference between the cryptocurrency and tulip onions. Usually you get strange looks and some technobabble that the value can't sink, because of how some more technobabble will decrease future mining rewards. The problem is that a decrease in future mining rewards only marks the point in time at which mining does not pay off any more. If mining doesn't pay off, the network will die. People will try to cash in their "investment" and the bubble will pop.
You might say, that the "basket of cryptocurrencies" is a derivative. Don't fool yourself. If the bubble pops for BitCoin, it will for all other cryptocurrencies that don't offer a substantial benefit over established services like PayPal.

As a rule of thumb, any investment (not just cryptocurrencies) needs to pass the tulip onion test of "What's the difference?".

Answer 4

If you own a house, then that house is creating economic value by providing people a place to live, and you will be receiving money in exchange for providing that value. Stocks and bonds are more complicated, but ultimately, their increase in value (generally) comes from companies creating economic value, and having an external revenue stream because of that.

Currencies, both foreign and cypto, don't work that way. There is some value they provide by facilitating transactions, and they can bring in wealth through seigniorage, but for the most part, there is no external source of value. Whatever money old owners get for them is from new buyers.

Answer 5

People don't see cryptocurrencies as proper investments because they are new. This is not entirely unreasonable. Proper investments like stocks, bonds, commodities, gold and real-estate have 100+ year track records, and their fundamentals are well understood. In contrast cryptocurrencies are less than 15 years old. You can't look at the long term track record of a cryptocurrency and make reasonable guesses about future performance.

Another reason is that other investment classes have coherent folk-wisdom stories that explain why they increase in value. For stocks see the other answers about growth in the economy. The reality for stocks is a lot more complex. Try explaining China's massive economic growth and lacklustre stock market performance. Cryptocurrencies don't have a simple accepted folk story. You can see evidence of this in the other answers, one states that cryptocurrencies increase in value because they are inflationary (not true for all cryptocurrencies). Another states that they're not good currencies because no-one would spend them because they go up in value (I spend cryptocurrencies and think they will go up in value). Another states that there is no underlying value... The cryptocurrency folk-story is: confusing, poorly understood and not accepted by the investment public. People don't "understand" it, and therefore don't trust it.

As for your desire to include crypto in your investment portfolio. I think that it is an alternative investment, like whiskey, cars or art. Therefore it should be less than 5% of your net worth. If you like crypto and understand the underlying tech then go for it. You might lose your entire investment, or you might become unimaginably wealthy. Have fun.

Answer 6

Fiat currencies can be volatile although they are backed up by a government's central bank which has gold and other kinds of reserves.

Cryptocurrencies are not backed up by any banks, so when they crash they can crash to 20% or less, and no government will try to save their value.

Shares and companies all represent physical goods and estates in the real world, whereas cryptocurrencies are not tied any physical goods, they don't represent any commodities or physical elements, which adds to their volatility risk, compared to i.e. rented real estate investment.

Answer 7

Cryptocurrencies are like gold: Not worth anything on its own (but see below), increasing the global quantity costs time and money. That's the reason why cryptocurrency "mining" is considered analogous to gold mining.
From this perspective, buying cryptocurrency should be considered the same as buying gold, which most people do not consider an investment either (but there are many contexts where people still say "invest" though it's actually just savings, or speculation if you hope/expect the price to go up).

Now the analogy to gold isn't 100% accurate: Gold has economic value outside its function as a means of payment: Some technical processes need it, and people have been buying it for its beauty.
Cryptocurrencies have no such value. It isn't known (yet) whether this difference is significant or not.

For the current situation, cryptocurrencies are fundamentally speculative.
Short-term, cryptocurrency price is extremely volatile.
Mid-term, most coins tend to go up, but some went down, usually when connected to some scandal around it, or if some state started restricting them.
Long-term, any cryptocurrency can drop to near-zero, namely if some technically superior coin comes along. E.g. BTC's mining process is pretty expensive (to prevent people from flooding the network with conflicting blockchain updates); people have been working on other, cheaper ways to achieve the same end, with no tangible results yet, but if somebody finds something that works, all current-generation coins will become impractical overnight, with an associated loss of value. It's a low-probability, high-loss scenario, which means you're highly speculative long-term.

Now some regulators have decided it's an investment, others have decided it's a currency, and there's a third camp that says it's a financial paper like stock options and the like.
As others have remarked, that's because the whole thing is so new that we don't have the experience to say what kind of thing it is.
And this insecurity in itself makes cryptocurrencies more speculative, too.

Answer 8

Investments generate a return on the capital invested that’s not dependent on appreciation in their capital value. Stocks, bonds and real estate all do that. Foreign currency doesn’t do it directly, but it does when held in an interest-paying account. Bitcoin does not generate a return, and that’s why it’s a speculation rather than an investment If you could find an interest-paying Bitcoin account, that would make it an investment, but it would still be a highly speculative one.

Answer 9

In some countries value held in cryptocurrencies is legally considered to be an investment. For example, where I live there is no capital gains tax on investments, so if I earn large sums of money speculating with cryptocurrencies then I earn this tax free. But if I gamble on some website and win the same amount of money, then I have to pay a tax over my earnings.

Cryptocurrencies do have a practical use as a means to transfer money. While PayPal is cheaper to use and has other benefits, as pointed out in the answer by NoAnswer, the sanctions imposed by the US on Iran makes it impossible for many Iranians to get paid using PayPal or any of the other conventional means. For example, Iranians are banned on many online platforms where they used to earn money in exchange for work, like writing software. The solution to this problem is to use a middleman who receives the work from the Iranian, submits it and gets paid. The middleman then transfers the payment minus a commission to the Iranian using Bitcoin.

The use of such middlemen is legal in most countries, even if it is used on US platforms, as the sanctions imposed by the US on Iran are considered to be illegal in most countries. So, this is a legally allowed use of Bitcoin which has economic value by exploiting the US sanctions and Iran's workforce.

The enormous volatility of cryptocurrencies attracts people who are into online gambling. This fact has been used an an argument against using cryptocurrencies as investments. However, there fact that there exists a large market for online gambling, means that the average value of the popular cryptocurrencies like Bitcoin is unlikely to collapse to zero. Investing in Bitcoin when the price drops sharply therefore does make sense.

But unless investing in cryptocurrencies is going to be more rewarding than investing in other assets, it's not going to be seen as a proper investment. So, are there a good reasons to choose to invest part of your portfolio in cryptocurrencies?

The enormous volatility due to the limited practical uses attracting mainly gamblers, makes it useful to invest a fraction of your portfolio in the popular cryptocurrencies like Bitcoin and Etherium. The optimal profile of a portfolio is such that a fraction is invested in extremely risky assets that have a large growth potential, but can just as well collapse in value.

For example, if your portfolio is worth $1 million, then investing a few thousand dollars in Bitcoin is a good choice. Should Bitcoin go down sharply in value, you would only lose a few tenths of a percent of the value of your portfolio. But while the value held in Bitcoins can only go down by a fixed amount, it can go up by an unlimited amount, the large volatility makes such upward fluctuations more likely to happen compared to more traditional assets.