“In Love” with Bitcoin? Invest With Your Head, Not Your Heart

Wall Street Journal columnist Brett Arends has a bone to pick with investors buying bitcoin: They don’t know what they’re doing. In a recent op-ed piece on MarketWatch, Arends takes “ordinary Americans playing the high-risk game [of bitcoin investing]” to task for having “absolutely no idea what they’re doing.”

The journalist cited a survey conducted in early November by Pollfish on behalf of LendEDU, wherein 564 Americans with active virtual currency investments were questioned about bitcoin as an investment opportunity and as a currency.

LendEDU researchers asked:

  • How much the individuals were investing
  • How long a horizon they had on their investment
  • If the investors had considered capital gains taxes

The poll indicated that only about one in five investors think of bitcoin like they would other currency investments: “a long-term store of value like gold or silver.” About two in every five said that bitcoin is “world-changing technology,” and fewer than one in every 25 said that they were buying bitcoin to use for transactions or purchases.

On average, respondents had invested just under $3,000, and more than half plan to hold that investment less than three years. Interestingly, more than half of respondents also said that they were not concerned about the technological security of their investments, despite Arends’ reminder that “hundreds of millions of dollars of the tokens have already been stolen by online hackers.”

What Bitcoin Investors (Might Be) Thinking

Arends is rather blunt in how he takes bitcoin investors to task, saying they are investing in virtual currencies for reasons that “are [not] financial reasons for making an investment.”

Indeed, investors do tend to cite distinctly non-financial rationales for their bitcoin investments, including:

  • The technology is “world-changing”
  • A friend or family member encouraged them to do so, and
  • Bitcoin might eventually become a long-term store of value

That final reason is the most problematic claim of them all as far as Arends is concerned: “It is nothing short of preposterous to claim [bitcoin as a long-term store of value] at this stage. It has only existed for a few years, and it is one of the most volatile financial assets in the world.”

So what are investors thinking?  Or are they, as Arends suggests, not thinking when they are buying bitcoin?

A deeper dive into the LendEDU survey results indicates that investors are thinking very hard about the potential and excitement associated with bitcoin and maybe not quite enough about the boring, logistical aspects of investing in the currency.

Here’s what I mean:

  • The average Bitcoin investor plans to sell out of their Bitcoin holdings when the price reaches nearly $200,000. (Current price: about $8,000)
  • More than a third place no priority on complying with tax rules to which Bitcoin investments are subject!

Essentially, it appears that bitcoin investors are getting carried away, and we all know where things usually go when investors get carried away, and it’s usually not pretty.

But if you start thinking with your head and your wallet instead of your heart and your emotions – and if you start thinking about how to structure the purchase and sale of this asset Bitcoin in a tax-efficient and legally safe way – you could still enjoy the emotional benefits of being involved in a “world-changing technology” and the financial benefits of getting out while the getting is good.

Is The Day Of Reckoning Drawing Near?

Just yesterday, TechCrunch analyst Fitz Tepper posted the following bold statement: “At this point, it looks like $10K before the end of the year is possible.” Of course, like any good analyst, he followed that up with a big caveat: “Of course, it’s just as likely for the price to plummet, as many say we are due for a correction.”

I suggest that both of these statements are equally likely to come to fruition before the end of 2017.

In college, I worked in a research lab where a mentor gave me two great pieces of advice:

  • “A good scientist never commits 100 percent”; and
  • “If you’re completely sure you’re right about something in this lab, you need to assume you’re wrong.”

This advice is as relevant for investing in general and Bitcoin in particular as it is in a laboratory.  I think bitcoin investors know in their hearts as well as their minds already, but that few are going to be able to force themselves to accept, that the end is near…

…Unless it’s not.

Do I mean bitcoin will go away? Absolutely not.

Do I mean bitcoin is a bad investment? Absolutely not.

In fact, it might be a better investment now (or in the near future), if you make that investment in an educated manner, than it was when it cost much less but was a much greater mystery.

The real question is this:  Does Bitcoin represent a legitimate value at whatever price you purchase it?  If it doesn’t, then you’re a speculator rather than an investor.  There’s nothing wrong with being a speculator… but speculation is a profession, not an investment strategy.

A New Factor:  Big Money Wall Street

Pending regulatory approval, the Chicago Mercantile Exchange will begin trading futures contracts on Bitcoin in early December.

This could prove to be a game changer, as the ability to trade Bitcoin using a medium well understood in the financial community – futures contracts – means that “big money” will have an easy way to get into the action.

That could be both positive and negative.  For evidence, look no further than the U.S. stock market.  Anytime large futures trades on the S&P 500 (or other indexes) are executed, the broader market reacts immediately, because it’s always assumed that “big money is smart money”.

True or not, the market volatility created through the presence of a futures market will likely be infinitely higher for Bitcoin than for other better-established financial markets, like the S&P 500, for one simple reason:  Compared to the market value of the S&P 500 (well over $20 trillion), Bitcoin is a mere fly in the ointment (under $150 billion).

You can count on this: When Wall Street-sized money is thrown at a market as relatively tiny as Bitcoin, huge volatility is sure to result.  And it won’t all be to the upside.

A Real Estate “Bubble” Parallel

Think about the Miami, Florida, luxury condo market for a moment. That market is softening, and a number of investors and developers are probably going to get dragged down into the quagmire because they jumped into a hot market that was hot for reasons they never understood.

In the case of Miami condos, foreign investors bought for far different reasons than American investors buy, and hedge funds and investment firms made decisions on a scale that few individual investors can even fathom.

Bitcoin investing is already a mystery, and when you add in astronomically big players with their own sets of unique resources and motives that have no relation whatsoever to your own, you had better understand how their actions affect your investments and the timing of your purchases and sales.

So What’s Next?

According to that LendEDU survey, investors say that they are not selling their bitcoin investments at this time, even though bitcoin values are at all-time highs and a number of analysts are predicting that mid-November’s sell-off will not be the last time the currency’s values tank, at least temporarily.

According to CoinDesk, bitcoin rallied 11 percent in just half a day on November 13 after a big weekend sell-off, taking it back to a value of just over $6,500 per bitcoin. The sell-off seemed to be in response to a cancelled “fork” of the currency. Bitcoin’s record high at that time was just shy of $7,900.  This morning, Bitcoin is trading a bit over $8,200.

With numbers like that, it’s not surprising that most of the investors LendEDU surveyed said that they would not be selling off their entire bitcoin investments any time soon, but it is telling that most appear to be planning on cashing out in less than three years.  To me, this indicates more that investors are, at the end of the day, trying to think rationally about an irrational asset.

If you want to swim with the cryptocurrency sharks – and who would blame you – it will be imperative to be prepared, take precautions, and carefully watch the progress and evolution of the market with an objective, emotionless eye.