Every good investment portfolio needs to be diversified. Stocks are risky but offer potentially lucrative returns. Bonds are stable but offer paltry returns in comparison. And of course, real estate has always been a reliable real-world asset to round things out.
But some people seek alternative investments as a way to hedge their portfolios further, either to take a few extra risks in uncharted territory, or to balance their portfolios by exposing themselves to a fundamentally different sector of the economy.
Cryptocurrencies have been suggested to be a new (and popular) form of alternative investment. But are cryptocurrencies a good option for ambitious investors?
The Problem With Cryptocurrency as an Investment
First, it’s important to note that there’s a fundamental problem with treating cryptocurrency as an investment. Cryptocurrency is meant to be used as a currency. It’s not meant to be something to buy and hold; it’s meant to be something that’s exchanged on a regular basis. In fact, it derives its value from its ability to be exchanged for goods and services.
If you’re buying and holding cryptocurrency for the future, you’re actively preventing the currency from being exchanged. If everyone did this, the currency would hold no value whatsoever.
That’s not to say you can’t buy and hold any cryptocurrency; instead, it’s meant to help you redefine how you see it. Too many news outlets are referring to Bitcoin and similar coins as investments, which is misleading, and it detracts from the main purpose of cryptocurrency.
The Strengths of Cryptocurrency
We won’t dig into the many benefits of cryptocurrency in this article, but suffice it to say, cryptocurrency is appealing because it holds several important advantages over traditional forms of currency. Ignoring those universal perks, there are some advantages to adding cryptocurrency to your investment portfolio:
- Potential upside. At the end of 2017, Bitcoin exploded in price, resulting in a massive surge in interest in cryptocurrency. Investors and speculators have seen this burst of good luck as a sign of things to come, and have been hopeful for a similar price explosion ever since. If such an explosion does unfold, however unlikely, it could turn even a modest investment into a fortune.
- Independence. Cryptocurrencies seem to operate according to their own intrinsic environments. They aren’t subject to follow the whims of the stock market, real estate market, or any other common market force. This insulates them and could make them a good complement to your portfolio.
- Security. A major advantage of cryptocurrency is its potential for anonymity and security. With the central ledger and cryptographic sequencing, all your transactions are practically guaranteed to be impenetrable and immutable.
The Dangers of Cryptocurrency
That said, there are some dangers associated with cryptocurrency as well:
- Many currencies with hard-to-discern distinctions. There are dozens of major cryptocurrencies in circulation and hundreds of distinct currencies. What are the differences? This isn’t like evaluating two different types of mattresses, with distinct materials and subjective “feels.” Each currency is designed with a different foundation and is maintained in a different way. One of the goals of crypto is to come up with an international, universal standard; so how can you tell which currency, specifically, is going to achieve this? Most of these coins will die out, so your decision is very important.
- Uncertainty and volatility. Cryptocurrency is fundamentally new, so we don’t have much historical data to help us understand how it might grow or evolve in the future. Accordingly, crypto prices have been incredibly volatile. For some people, that volatility is a benefit (it’s the necessary flipside of huge potential gains). However, it’s not for everybody.
- Technical complexity and liquidity. Buying and holding cryptocurrency isn’t quite as straightforward as holding stocks, unless you’re using a third-party wallet, which may have problems of its own. That technical complexity limits the number of people buying and selling the currency, meaning your investment isn’t nearly as liquid as the other holdings in your portfolio.
- Security. We mentioned security as an advantage of cryptocurrency, so what is it doing here? Well, while cryptocurrency transactions are generally considered safe and no one can access your wallet without your password, there are a great deal of cryptocurrency schemes out there—including high-level Ponzi schemes and scams meant to swindle you out of your digital currency. Even seasoned investors are not exempt from these, and they could easily ruin your investment prospects.
So should you be treated cryptocurrency as an alternative investment for your portfolio? If you truly believe in the future of cryptocurrency, you should be buying it and using it on a regular basis—not just hoarding it. However, if you fully understand both the risks and potential advantages of the investment, it may be worth adding as a position in your
overall portfolio.
overall portfolio.