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7 Reasons You Should Definitely Not Invest In Crypto - From a Guy Who Co-Founded A Crypto Fund
by Tim Johnston
I have spoken to over a thousand investors since launching in November 2017. Despite meeting a number of savvy investors, many of whom have invested in the Fund, the overwhelming response to crypto has been one of caution and scepticism. By now, I’ve heard just about every response to why you should not invest in crypto. While some reasons for not investing in crypto are sound, others highlight common failings in investor psychology.
Let’s dive in and explore the 7 reasons why you should definitely not invest in crypto.
1. I Don’t Understand It
This is clearly the best reason not to invest in crypto.
Investors need to understand what they’re investing in, whether it be crypto, derivatives or exotic fish. A basic understanding is essential. Warren Buffett has said repeatedly, “don’t invest in something you don’t understand.”
Without an understanding, investors will not have conviction in their investments, will not be prepared for the investment journey and will likely make a poor sell decision.
There are two options for an investor that doesn’t understand an investment opportunity.
The first is to move on. If you don’t understand crypto, if it’s too complex or you simply don’t have the inclination to learn, the wise decision is to move on. Investors cannot be faulted for knowing their limitations.
Many investors don’t realise there is a second option: homework. Read, listen, watch, discuss and learn about the investment opportunity. Warren Buffett avoided investing in many of today’s most successful tech companies because he didn’t understand them. Perhaps he would have been even more successful if he made the effort to understand Internet companies? Applying this lesson to crypto, today’s investors might be more successful if they do the homework to understand crypto. For those interested in learning, our resources pageis a wonderful place to start.
Crypto is volatile. Apollo Capital recently analysed the average returns of crypto Fundsand the results are fascinating. In a series of returns from June 2013 to April 2018, monthly returns varied from over -30% to over 400%. These returns are not for the faint hearted.
Investors need to know themselves. This sounds like a cliche, but it is true, especially when it comes to investing in crypto. Some investors can stomach volatility, some cannot. If the thought of the value of your crypto portfolio dropping by 20% in a given month makes you weak at the knees, crypto is not for you.
Volatility is relative to position sizing. The volatility of a given investment is relative to how much is invested. If an investor invests their life savings in crypto, the volatility would be extremely difficult to manage. The thought of losing 20% of your life savings in one month is frightening. However, a position of 2%, 5% or 10% of an investor’s portfolio in crypto might mean the volatility is less daunting.
Let’s take an example of investing 2% of a portfolio in crypto. If crypto goes down by 50%, the investor will lose 1% of their portfolio. While not desirable, most sophisticated investors can handle such a loss. Many investors don’t realise the potential upside from a 2% position. In a recent study by Apollo Capital, a 2% allocation to crypto from Jan 2016 to Apr 2018 accounted for 50% of the portfolio’s return.
It is also important for investors to distinguish between the volatility of an investment and the volatility of a portfolio. Including a volatile investment, such as crypto, in a portfolio does not necessarily increase the overall volatility of the portfolio. It all depends how that investment is correlated to the other assets in the portfolio. Crypto assets have shown not to correlate to traditional asset classes. Put simply, even though crypto is volatile, including it in a diversified portfolio doesn’t make the portfolio more volatile. Investors can have the benefit of the return potential of crypto, while keeping the volatility of their overall portfolio constant.
3. Crypto Has No Use
Here, I will go no further than to quote Marc Andreessen’s New York Times’ article “Why Bitcoin Matters”:
Critics of Bitcoin point to limited usage by ordinary consumers and merchants, but that same criticism was leveled against PCs and the Internet at the same stage. Every day, more and more consumers and merchants are buying, using and selling Bitcoin, all around the world. The overall numbers are still small, but they are growing quickly. And ease of use for all participants is rapidly increasing as Bitcoin tools and technologies are improved. Remember, it used to be technically challenging to even get on the Internet. Now it’s not.
Crypto is not perfect. Nothing at this early stage of its development is faultless. We constantly remind investors of two crucial facts. The first is crypto is a technological breakthrough. The second is many of the world’s smartest computer scientists and technologists are working in crypto. And now after the ICO boom, some of the smartest minds in tech are working on delivering on the promise of this technology.
4. Illegal Uses
One of crypto’s first popular use cases was for nefarious purposes. Silk Road was an online marketplace where users could buy and sell illegal goods, including illicit drugs and firearms. Users generally paid for goods with Bitcoin, thinking it was untraceable and anonymous. Many bad actors have moved on from Bitcoin, realising that it is in fact traceable.
The question becomes whether these cryptos are used solely for illegal activities, or whether this is just one use-case. For example, the Internet is used for illegal activities, including piracy, identity theft and terrorists communications. Should we call for a ban of the Internet because it is used for Illegal activities? Yes the Internet is used widely for illegal activities, but this is a tiny percentage of the overall use of the Internet. Applying this to crypto, what percentage of the use case of crypto needs to be for illegal activities before it is worth banning? 10%? 50%? 100%? This is a tough question and different people will have different answers.
It’s impossible to know how widely crypto is used for illegal activities. Top researchers in the space have stated that any reported figures are, at best, an estimate. There needs to be a clear distinction between something that is designed for illegal activities and something that might be used for illegal activities. If something is designed solely or primarily for illegal activities, it should be shut down. Silk Road is a clear example. However, we know there are many use cases for crypto which is not illegal and indeed, is a force for good. It appears naive to avoid investing in something or using it, simply because it can be used for illegal activities.
5. Another Bitcoin
A common response I have heard from wary investors is will Bitcoin be the Myspace to another crypto’s Facebook? It’s a good question and there are two key responses.
The first is network effect. Network effects have been called the business model of the Internet. Bitcoin has the largest network and the most number of users. At the time of writing, Bitcoin’s market cap and daily traded volume is roughly three times that of Ethereum, the second largest crypto. This is not to say that Bitcoin will be dominant for eternity. Network effects can be competed away. Myspace and Facebook is a well-known example. However, currently, Bitcoin is the dominant crypto and it will be extremely difficult for another “money-like crypto” to compete.
The second response is a portfolio approach. Investing in crypto is best done in a diversified portfolio. There is no reason why an investor cannot invest in both “Myspace” and “Facebook.” We don’t need to be exactly sure of which one will win, we don’t need to put all our eggs in one basket. With a technology this young, the best approach is to invest in a range of crypto projects which show enormous potential.
6. Crypto Has No Intrinsic Value
Another reason not to invest in crypto is because it has no intrinsic value. Crypto does not pay dividends, is not tied to cash flows, has no right to other assets.
This line of thinking requires a broader perspective. Let’s consider fiat currency. A $5 note has no intrinsic value, it’s simply a fancy piece of paper. The piece of paper is worth $5 because we all believe it’s worth $5. Some will argue that it’s backed by the government which issues the currency, but this doesn’t point to any intrinsic value. There have been plenty of cases where this backing has become worthless, like the current crisis in Venezuela.
Another example is gold. Gold has been the worldwide store of value for thousands of years, yet where is its intrinsic value? Gold is valuable because we all believe its valuable. In both cases of fiat currency and gold, neither has any intrinsic value. Yet they are valued because we are told to value them and we collectively believe in their value. We all believe they have value until we stop believing.
We could argue that this applies to any asset class — there is no such thing as intrinsic value. The value of all assets comes from the perception that other investors, often called the market, would be willing to pay for that asset. In some asset classes like equities and real estate, the models used to value the asset are well established and well known by market participants. The value of other assets, like commodities, currencies and crypto, are determined by the forces of supply and demand. Investors point to discounted cash flow models and net present values, but the only model that truly works to value an asset is working out what someone else is willing to pay for it. That’s where value comes from. In crypto, the asset class is young, scarce, not well understood, is a technological breakthrough and we believe the demand for these assets will increase in the future.
7. Wait and See
At the start of the article, I mentioned that some of the reasons for not investing in crypto are examples of failures in investor psychology. The “Wait and See” approach is the most serious of these failings. In most cases, it will only lead to worse investor outcomes.
Let’s analyse the scenarios for the Wait and See investor after crypto prices go up, go down or go sideways
- Crypto Prices Go Up — prices have gone up, therefore crypto is great and I’m now comfortable to invest, albeit at a higher entry point
- Crypto Prices Go Down — the investor gets scared, there must be something wrong with crypto, and decides not to invest
- Crypto Prices Go Sideways — crypto isn’t that impressive, what’s all the fuss about?
One of the biggest lessons from co-founding Apollo Capital is how I have observed countless investors, including sophisticated and professional investors, using price as a proxy for quality. At Apollo Capital, the interest we have received in investing in crypto has been directly correlated to the price of crypto. Prices goes up, everyone wants to invest. Prices go down, no one wants to. We all like to believe we are capable of going against the heard, being the contrarian investor who reaps the uncommon gains, but most of this is self-delusion. I haven’t heard one investor say “I’d like to invest, but I’d like to see prices drop to buy in cheaper.”
The approach we advise is the same as analysing any other asset class: it comes down to fundamentals. While crypto assets don’t have fundamental earnings, business plan or asset backing, the fundamentals in crypto is the technology. Investors need to understand or at least appreciate that crypto is a technological breakthrough, it is early, and that there could be huge demand for these assets in the future. Price action should have no impact on investors’ decision making.
Crypto is not for everyone. In the basket of alternative assets, it is an alternative asset. There are a number of sound reasons why investors should not invest in crypto. Yet, through my own personal journey in crypto, I learnt an important lesson. When I first heard of Bitcoin, I dismissed it almost instantly. It might have been fear of the unknown or because crypto is difficult to understand. It was easier for me to dismiss crypto and move on, than to keep an open mind and learn about it. Now, with the benefit of perfect hindsight, I realise I should have set aside a few hours and learnt about this fascinating new technology. It would not have cost much to invest a small percentage of my portfolio. At worst I would have lost my investment, shrugged it off and moved on. Instead, I was later than I would have liked to what is shaping up to be the biggest investment opportunity of my lifetime. I wonder whether the same applies to investors today who are yet to invest in crypto.
Tim Johnston is the Managing Director of Apollo Capital — Australia’s Premier Crypto Fund. The Apollo Capital Fund is a professionally managed portfolio of crypto assets, offering investors exposure to the fast growing crypto market. For more information, please head to apollocap.io