Over the last seven years, cryptocurrencies such as bitcoin and Ethereum have moved from being the pastime of tech enthusiasts to an intriguing prospect for investment. Given the hype surrounding the crypto space, many investors are starting ask, “is this real?”, “are we missing out or should we still wait?” In this article, we will explore the possibility of cryptocurrencies as investment avenues.
Trading cryptocurrencies versus investing in them
The rapid rise and fall of cryptocurrencies (CCs) has attracted a lot of speculators to trade in them. It is routine for even the established CCs to gain or lose 50 percent in a day. For the newer CCs, the moves can be as high as 5000 percent upwards or 90 percent southwards. This has attracted a lot of trading enthusiasts. Does it makes sense to buy and hold cryptocurrencies for a 3-5 year horizon?
Just as one thinks of equity stocks as long-term investments – although there are day-traders in stock markets too – we can ask ourselves: are cryptocurrencies worth evaluating as an asset class for buy-and-hold type of investment?
The basis for Cryptocurrencies
Launched by an anonymous expert in 2009 in the wake of the global financial crisis, the first cryptocurrency – bitcoin – was meant to be a peer-to-peer payment mechanism that did not require a third party such as a bank to facilitate a transaction. This was achieved through ‘decentralization’ and ‘immutability’ – the former based on peer-to-peer network similar to torrent and the latter on cryptographic hashing common in encryption. These features quickly made bitcoin a lot more interesting than just being a payment mechanism. The few who knew the working of these systems quickly latched on to the idea that bitcoin is also scarce by design. Instead of a currency, it became a better candidate for being ‘digital gold’. The idea emerged that the value of bitcoin will hold good even if monetary easing by governments leads to hyperinflation – something conventionally expected of gold.
Ironically, this hope of stable value itself led to massive speculation in bitcoin trading. Also, other cryptocurrencies were launched – Ethereum being the most prominent of them. The price of bitcoin has reached nearly Rs 40,00,000 now from nearly nil in 2010. That attracted further interest in recent years and also prompted many more to launch their own alt-coins.
Is there value?
Like any exciting new idea, cryptocurrency markets have a lot of froth. However, increasingly, serious investors are starting to see some value in them. It is anyone’s guess as to what the value of a given cryptocurrency such as bitcoin should be. However, the collective of major cryptocurrencies holds the promise of something else that is probably worth a serious consideration. That is the idea underlying cryptocurrencies – blockchain – itself a subset of the wider idea of ‘distributed ledger technology.’
This is the “utility” aspect of the cryptocurrency domain. As the idea of blockchain and DLT gains traction, many use-cases will emerge to build on the existing infrastructure of the crypto-world. Think of this as an ‘internet of value’. Just as hardware and software became an integral aspect of the world-wide-web, it is possible that the cryptocurrencies and their associated systems will form the foundational layer of a lot of very useful decentralized applications in the future. For example, we can imagine instant settlement in capital markets, easier peer-to-peer lending, supply chain improvements and so on – all built on blockchain and DLT.
From this standpoint, there is potentially a lot of value in the medium term in the right sort of cryptocurrencies. Which ones are these? An ideal candidate that qualifies for the utility aspect of the crypto-world will have the following characteristics.
-It is widely accepted amongst crypto-developers (and not just crypto-traders).
-It offers versatility and offers a lot more than just peer-to-peer payments and speculation.
-It has a large number of developers working on refining and improving it.
At present, only a few cryptocurrencies come close to satisfying these criteria – Ethereum being in the lead, followed by Bitcoin, Cardano, Polkadot and Chainlink. These are aimed at tapping the vast potential of the blockchain technology, besides just aiming at being an alternative to gold (which is covered by Bitcoin in the list).
This list is neither complete nor definitive. It is meant to be a guideline about how to bet on the medium-term non-speculative benefits of blockchain technology. There may be others in future that get added to the list or the current ones that may fall off.
What about Dogecoin?
No discussion of cryptocurrencies in 2021 can be complete without the mention of Dogecoin. The short answer here is this – it is a purely speculative cryptocurrency with no inherent value by design (it was created as a joke!). It has gained prominence, thanks to some fairly questionable push given by Elon Musk – probably as an ego kick. It is as worthless as something can be. Think of Dogecoin as the penny stock of cryptocurrency world. You can make 500 percent one day or lose 99 percent on another. “Stay away” is a concise advice any sensible observer would give.
This applies to its newer incarnations in the form of similar “meme-coins”. It may also apply to a lesser extent to several non-fungible tokens. Most of these are clearly products of hype – trying to cash in on anything crypto. This is not all that different from the case of a manufacturing company in 2001 that just added .com to its name and suddenly jumped in value by 10 times!
One may wonder that Bitcoin itself has been at the receiving end of Elon Musk’s erratic tweeting. However, Musk’s own company Tesla holds $ 1.5 bn worth Bitcoin and nothing of Dogecoin. His tweets about Bitcoin are not jokes (unlike Dogecoin) and allude to important considerations like the energy consumption of Bitcoin. To put it differently, Bitcoin will survive Elon Musk’s tweeting vagaries – even if it is affected a lot by it. Dogecoin may or may not survive loss of interest by Musk – as he finds a new meme to sway his followers. One parallel here is the story of Gamestop stock vs Tesla stock – Elon Musk’s tweets have caused volatility in both – however, Gamestop went from $10 to $400 to $50 while Tesla moved within a narrower range of $200 to $800 to $600 in similar period.
Regulations
In 2018, RBI banned any buying and selling of cryptocurrencies in India. Later on, the Supreme Court overturned the ban. As of now, the government is contemplating a bill on cryptocurrencies that may provide clarity, one way or the other. If all cryptocurrencies are banned for Indians, this chapter closes for the time being – and it would be an unfortunate case of throwing out the baby with the bathwater. If instead, they are allowed but regulated and taxed, things will remain interesting. We are likely to know either way before the end of the year. If you have not bought any cryptocurrencies yet, you may want to wait and watch.
What should you do?
If regulations clarify things soon and allow Indians to invest in cryptocurrencies, investors can definitely evaluate Cryptocurrencies as an addition to their overall investment portfolio. The recommendation is still to buy and hold for a few years rather than trade daily. Also, it is better to buy a basket of a few utility-like cryptocurrencies, rather than chase the latest meme-coin or non-fungible token.
The place for Cryptocurrencies in an overall asset allocation is clearly amongst the so-called alternative assets which at present include everything other than equities (stocks and mutual funds) and debt (bonds, FDs and mutual funds). In addition to current alternate assets such as gold ETFs, InvITs, REITs and RE Funds, an investor can explore some allocation to cryptocurrencies as well – not exceeding 3 percent of the total portfolio to start with.
Like equity stocks, the holding period here too should be 3-5 years, with periodic rebalancing. While we wait for regulatory clarity, now might be good time to research on the underlying technology of blockchain and the whole idea of ‘internet of value’!