Investing in cryptocurrency is not like investing in stocks and bonds. It's kind of like investing in startups — but, different. In truth, there's nothing really like it.
With stocks, investors are buying a fraction of the ownership of a company. They buy shares of stock if they believe the company's value will — within a reasonable period — be worth more than they paid for it. And, they can rely on established metrics like a stock’s price-to-earnings (PE) ratio for a sanity check. Thereby, the value of the stock is the same thing as the value of the company it represents.
Cryptocurrency doesn't work the same way. First, there are no sanity check tools. Second, the investors are buying digital currency with fiat money. Think about that, for a second. The unit of measure for expressing the value of a digital coin is, currently, the fiat money used to purchase it.
Isn't the plan for cryptocurrency to replace fiat money? After all, I can buy a Tesla with cryptocurrency. But, I can't pay my phone bill with IBM stock.
Long-term vs. Short-term Investments
On one hand, long-term crypto investors are betting we will, very soon, be able to pay all of our bills with cryptocurrency. On the other hand, the short-term investors are betting the cryptocurrency will be worth more than the fiat currency used to purchase the digital coins. But, where is the value in cryptocurrency coming from? The answer is simple: Supply and demand.
However, unlike the U.S. Dollar, the supply for Bitcoin and Ether — and most digital coins — is locked. Which means, their value can only be affected by demand. Whereas, the value of the U.S. Dollar is affected by both, and usually drops every time more money is printed.
Case in point: there was a time when you could buy a bottle of CocaCola for five cents. Why does it cost over a dollar, now? Did the supply go down or the demand go up? No. The value of money went down because more was printed.
So, where is the demand for cryptocurrency coming from?
Long-term crypto investors are holding onto their cryptocurrency because they believe it will go mainstream. In which case, they see demand for the digital currency being driven by trust in it over fiat money because of its technology. But, this goes against traditional advice regarding holding onto cash.
Short-term investors are speculating there will be more people who believe it will go mainstream than those who don't. In which case, they are betting the demand will increase as more long-term investors buy into the cryptocurrency craze. The short-term investors are not necessarily betting it will go mainstream; they are simply betting the number of people who believe it will go mainstream will increase.
It is these short-term strategies that feed the skeptics with arguments focused on speculative excess and Ponzi schemes. After all, how can crypto live up to the hype if it feels like a roller-coaster ride without safety constraints?
What the skeptics are not seeing, however, is that this is a young industry, where most of the projects are barely five years old. If the long-term investors are right, the digital coins will be treated as currency and will serve other specialized functions. But, for now, they are actually start-up equity for this emerging technology.
So, how does this change anything? It changes how we see crypto investing.
Traditional startups have no liquidity at the start. If crypto were a traditional start-up business, smart investors would invest for the long-term. They would not want to flip their shares a month after they invested in it because it wouldn't have time to create value. But, crypto isn't a traditional startup. It has liquidity and the short-term investors are taking advantage of this by buying digital coins on the speculation that it will go up in value. In other words: someone will want it more than they do.
Short-term investors are focused on demand. It is demand that is causing the price to go up and down. And, it is the short-term investors who are creating this artificial demand. However, when the real demand hits a certain point, cryptocurrency will become the baseline that everything else is measured against. In other words, it won't be the value of cryptocurrency going up that makes it appear expensive; it will be the value of the fiat money going down. This is the point in which it goes mainstream. Long-term investors are focused on the technology as being the driver to crypto becoming mainstream.
Long-term vs. Short-term Risks
The short-term risks are highly volatile and tend to follow the stock market trend — except, more exaggerated. If you are a short-term investor buying while the stock market is falling, you risk losing it all. On the other hand, you might see hefty profits if the market is on an upward trend.
But, what makes short-term investing in cryptocurrency very risky is that you have no tools to help you decide when to hold them and when to fold them. You might have better odds playing craps in the casino.
The long-term risks tend to lessen as more people accept it as currency. For this reason, skeptics call it a Ponzi scheme. From the perspective of the short-term investor -- buying and selling on the winds of the stock market -- then, it would appear to be something like a Ponzi scheme. Each trade is simply trading money with the hopes that someone will want my currency more than their currency.
However, for the long term investor who believes cryptocurrency going mainstream is inevitable, the risk is reversed. Those who invest later have less risk than those who invested earlier — but, the potential of making big profits favors those who invested earlier. Thus, bigger risk, bigger return. The risk, however, is that their investment is tied up until crypto goes mainstream. On the other hand, crypto might be inevitable, but it doesn't mean their currency will be the chosen one.
But, first, why would anyone prefer virtual money over physical money?
Digital Currency is Inevitable
Interestingly, China is currently experimenting with replacing their fiat money with digital currency — called e-CNY. The U.S. has also been researching how to go to the digital dollar for several years (CDBC). Thus, governments see value in digitizing fiat currency. But, these are not the same thing as cryptocurrencies.
So, why buy cryptocurrency if fiat money will be going digital, anyways?
It's all about trust. How do you feel about the government having direct access to all of your transactions? How would you feel about the government knowing everything you've earned, bought and sold? What kind of control can governments have if they have direct access to our digital wallets?
The fact is, they already know about our debit and credit card transactions. Banks and credit card companies are required to provide this data to the government. Also, the government can freeze our bank accounts at any time via a court order. But, with the currency being digital, there's no place you can hide your money.
Unlike digital fiat money, cryptocurrency is transparent, trustless, and, most importantly, private. It is not run by any one entity, government, agency, company, or person. Crypto is a problem for governments who want to go digital in order to gain more control.
According to a survey from a cryptocurrency exchange service, cryptocurrencies could see mainstream adoption within ten years. The only way this will happen is for consumers to trust crypto over fiat money -- even if that fiat money is digital. Even more complex, consumers need to trust a whole new financial system over the current one.
But, which cryptocurrency will be the one to replace fiat money? Currently, there are thousands of flavors of digital coins using different implementations of the distributed ledger technology.
Mainstream Adoption
Mainstream adoption will be based on three key indicators:
- Trust
- Ease of use
- Business adoption
Trust
Although, security is a number one concern, trust is more than just about keeping your hard-earned cash safe. It is also about keeping your privacy safe. Crypto is designed around trustless protocols; meaning, we trust the system more than we trust the people using the system. Thus, it offers trust without the need to use third-party entities to provide trust.
Ease of Use
In order for it to reach mainstream adoption, it has to be easy to use. Credit and debit cards have already made it easy for us to spend money without have to carry cash on us. In other words, we've already been groomed for digital money. What's in your pocket? Are you carrying cash or plastic?
Business Adoption
Blockchain technology is projected by many analysts to one day have a significant impact on business — if it isn't already happening. It has the potential to improve efficiency and effectiveness, cut costs, and increase revenue. This promise has led many companies to invest time and resources in blockchain pilot projects.
Most likely, the flavor of cryptocurrency to see mainstream adoption will be the one accepted by businesses — more specifically, the retailers. Smart contracts and NFTs can save businesses substantial profits by eliminating services that are inserted in the middle of the sale transactions.
Many of these services are there to protect businesses and consumers from untrustworthy entities. Some are there to make it more convenient for the business or consumer. After all, businesses want to make the sale process as painless as possible for their consumers. But, these services come with a price. And the cryptocurrency technology can help retailers circumvent the need to for many of these services.
However, retail is not the only sector that can benefit from the crypto technology. Businesses are researching the use of blockchain technologies in their supply-chain. Inventory management, tracking, obsolescence, regulatory compliance, and so on. There are too many possibilities to talk about in this article. The point to take from this is that businesses are seriously looking into cryptocurrency to help tap into lost profits or increased savings.
Bottomline: businesses are poised to adopt cryptocurrency.
Challenges for Businesses
Although blockchain technology is expected to have a positive impact on businesses, there are challenges. And, many of these challenges are stopping businesses from fully adopting this technology, today.
As a means of processing transactions, blockchain-based systems are comparatively slow. Its sluggish transaction speed is a concern for businesses that depend on high-performance. Also, a lack of standards and interoperability between various blockchain platforms and legacy solutions is another challenge.
But, there is good news for the long-term investors: progress is being made in addressing these obstacles. Developers are working on increasing transaction speeds, providing interoperability and standards, and making it easier to implement solutions on the blockchain.
Summary
Investing in cryptocurrency requires understanding what it is about and how it will become mainstream. You can take the riskiest route by being a short-term investor, or take the less risky route by being a long-term investor. However, the less-risky route is still very, very risky.
There are many flavors of crypto in the market. So, deciding which one to bet on is tricky.
When there was only one player -- Bitcoin -- then, the decision was easy. What about Ether? It is a powerful contender with a strong technology. And, then, there are crypto implementations, like HBAR, which runs on a DAG-type of ledger and promises higher speeds with a better consensus mechanism.
Fiat money will eventually go digital -- whether it be replaced with crypto or is simply digitizing the existing fiat currency. The financial district is bound to go through some massive changes in the next few years.
So, how do you invest in crypto? That's the million dollar question. In the next few articles, we'll investigate the more popular flavors of crypto -- their advantages and disadvantages -- in search of information that can help us answer that question.
Also, we'll look at NFTs. Investing in NFTs is much more straightforward -- if, again, you understand what you're really investing in.