This post is not about whether or not you should buy Bitcoin or other cryptocurrencies. It’s about what points you should consider before making your buy and sell decisions. I hope that at the end of reading this post, you can decide for yourself whether or not and how to play in this market.
Over the last year, we have seen the price of Bitcoin jump from $7k in Dec 2019 to $30k+ by January 2021, multiples of its low of $4.5k in Mar 2020. In the last two months of 2020, the currency more than tripled from $11k in Oct 2020. This increase is presumably because of:
- Increased liquidity in the system from central banks printing money over the last few years, only accelerating during the pandemic. The result of this is that almost all asset classes have gone up during this period, except real estate and a few others that were directly impacted by the pandemic.
- Institutional and high net worth individuals “diversifying” their portfolio, not wanting to miss out on the gains in this asset class.
- Algo trading that exaggerates the price movements based on the price trends. This is similar to what happens in the stock markets.
I have been investing in several asset classes for over 20 years back and I have made several mistakes during this period. Based on my experiences, here are the things you should consider before deciding to buy or sell in the crypto market.
1. Never do anything in life purely based on FOMO
FOMO means ‘fear of missing out’ and it makes us behave irrationally. It makes one do crazy things from personal relationship decisions to renting/buying real estate at inflated prices.
When you are viewing a flat to buy or rent, an agent or owner will also tell you that many people are interested in this property, and if you don’t put a deposit down, you might lose this property. If this made you rent the property immediately without other considerations, you have been a victim of FOMO. Irrational decisions could prove very costly especially when it comes to your hard-earned money.
“FOMO refers to the apprehension that one is either not in-the-know or missing out on information, events, experiences, or decisions that could make their life better. Those affected by it may not know exactly what they are missing but may still worry that others are having a much better time or doing something better than they are, without them. FOMO could result from not knowing about a conversation, missing a TV show, not attending a wedding or party, or hearing that others have discovered a new restaurant.” Read more about FOMO on Wikipedia.
You might have read or heard about a few people who become millionaires after investing $100 or of someone who makes “easy cash” by trading in cryptos. If you decide to buy cryptos based on these stories because otherwise you’d feel left out, you have been hit by FOMO.
2. You’re not “investing”, you are speculating
There is no harm in gambling or speculating. As an entrepreneur, we do that all the time – I gave up my steady well-paying job at Skype/Microsoft to build my own company and make nowhere close to the cash I used to make in a full-time corporate job. My net worth is locked in the shares of my company, and I’m ready to take that risk. It’s all calculated risk.
You could be buying any security as an investor, trader or a speculator. Let’s understand the difference between these three with respect to cryptos with some basic definitions.
Investors are those that look for hidden value, regardless of timeframe. They may be interested in the technology and are willing to hold (or hodl) the asset over the long term. They tend not to take small profits and also tend not to sell frequently.
Traders are more interested in day-to-day price action. They look to make a lot of small profits frequently. They may base their buy and sell decisions off of technical signals on charts.
Speculators are interested in making cash quickly and rely heavily on news, announcements, and gut feelings. Speculators tend to buy into a trend and attempt to sell at the top. They generally don’t care about the asset, but they do want to see quick growth. The proliferation of easy access to exchanges, spare time from the pandemic, and national stimulus measures for the pandemic have all increased the number of speculators.
Speculating is not bad in itself. You can make good money when speculating – if you’re right. You can also lose your shirt – or your government stimulus. If you do not know much about the space, do not speculate with money you cannot afford to lose.
If you believe you’re an investor or trader, understand these securities in detail and build your strategies. At CityFALCON, we provide all the tools and information you need to make such decisions. Below is an example where you can see what news is affecting the price. A simple scroll through the charts can give you a ton of insights to make your decisions.
3. Not many talk about people losing money and ‘dead coins’
The news focuses on people making money because they are the most interesting stories. Every once in a while, they may cover someone who lost large amounts – though these are covered in the context of tragedy. For instance, the Softbank CEO lost $130m or 65% of his investment in Bitcoin, and sadder stories of retail traders losing big.
There are plenty of people who lost money in the crypto markets (and other markets), and they quietly continue to live their lives with much lower wealth than before. And for every successful coin or token, there are multiple dead ones that gained no traction. Their projects died or are languishing, and only true believers continue to hold these assets. If you don’t mind having your capital tied up for years in a low-probability investment, you can keep on holding. But be aware that dead coins litter the landscape and only a few have actually gone to the moon.
You can find info about ‘dead coins’ with a quick search, and if there is no activity on their socials, forums, or messenger service chatrooms, the coin is probably dead.
4. Portfolio diversification and risk management
In an environment flush with liquidity, asset managers and investors are constantly looking for new asset classes. You may be surprised at the sorts of things they invest in – expensive art, vintage coins, stamps, etc. With interest rates at almost zero, people are looking for more ways to make money, and crypto as an asset class may be very exciting.
What is important to note is that unlike some small retail investors who might have 20-30-50% of their net worth locked into crypto, fund managers and HNIs would invest a very small portion of their assets in a volatile asset class like this. So when you hear about some fund putting a few million dollars into Bitcoin, it may be less than 1 to 5% of their portfolio. Similarly, if you want to invest or speculate in crypto, and let’s say your net worth is $100K, you should ideally not have more than $5k in crypto. Of course, this depends on your risk tolerance.
The important point here is to diversify across asset classes. The crypto market has a tendency to follow Bitcoin’s fortunes, so diversifying across the crypto space is not a fully-diversified strategy. The way BTC goes is the way the market usually goes. Putting 50% of your assets into cryptos heavily weights your allocation towards a very volatile asset class. Be judicious with your strategy.
5. Relative low market capitalisation increases the volatility in prices
Market capitalisation is important, and so is traded volume. Generally they go hand-in-hand, but not always. Be wary of low market cap, and especially low volume, investments. They are difficult to buy and difficult to liquidate. If your investment is sizable, you might even move the market, which can become problematic.
Even if you aren’t moving the market, though, once you get in – if you can find enough available coins to buy – you might not be able to get out. And since the liquidity is low, you may end up selling at a much steeper discount than you had expected. Low liquidity means high volatility, and you should only trade or invest in low market cap assets if you are comfortable with that volatility and potential to get trapped in a market with no buyers.
Comparison of market capitalisation of different asset classes and stocks:
|Market Capitalisation as on 4 Jan
|New York Stock Exchange
The entire crypto market is the size of some large individual companies. Crypto as an asset class is a very small component of the markets, and hence as more money is trying to buy in, the price will go up fast. Some believe that this is the reason cryptos might be much bigger than it is today.
Moreover, liquidity may not increase much over the long term, either. A founding principle of many cryptocurrencies is in its limited supply. Just like physical assets like Gold and Silver, there are only so many Bitcoins and Ethers and other coins that can be mined, ever. For Bitcoin this is just 21 million coins. No more can ever be created (excepting a Bitcoin fork).
This enforced scarcity means the total float is limited, too, much of which is already locked up by just a few blockchain addresses. There is speculation the keys to some may have been lost, meaning those coins will never re-enter circulation. Either way, the actual float of coins is currently below 21 million, making the asset attractive for long-term investment.
Below is an easy table for you to track major cryptos, their price movement and more in a convenient way.
6. Lack of buyer protection and government regulations makes crypto a risky play
Cryptos are new, and while governments are scrambling to enact legislation and regulations, the Covid pandemic took most of their time for most of 2020. Moreover, governments are slow and traditional institutions are not much better. On the other hand, less reputable exchanges are quick, and they’re happy to set up the technology you need for an exchange.
Of course, that comes at a price. There may be very high fees and penalties for withdrawals. The spreads between buying and selling may be wide, meaning the exchange takes profit on every transaction. Wide spreads are especially odious for traders who want to take many small profits.
Due to the lack of regulation, most governments won’t insure deposits in crypto exchanges, and crypto exchanges are extremely high value targets for hackers. This leads to problems with buyer protection and unscrupulous dealing.
If you trade or invest in crypto, at the very least use a platform that provides some protections. Traditional banks may have crypto accounts, and some of the world’s largest exchanges at least have their reputations – and the budgets to hire strong tech teams. That said, don’t forget that a founding driver for cryptocurrency technology was to remain beyond government control. This makes it attractive for scammers, because there is no way to reverse the transactions and no government has global jurisdiction.
One famous, and influential, example is the SEC’s case against Ripple for allegedly offering $1.3 billion in XRP coins. The SEC claims this was an unregistered securities sale to retail investors. In late 2017 during the initial cryptocurrency craze, several national regulators raced to regulate the space, sometimes at the detriment of the investors.
7. Almost all asset classes are inflated due to excess liquidity
There is a lot of talk about all-time highs in most asset classes. Yes, the economy has grown over the past decade, and the lows of pandemic-induced fear in March provided amazing investment opportunities. However, don’t forget that the ECB and the Fed, the world’s two most influential central banks, have been printing money over this past decade, too. Coronavirus accelerated that trend.
All of that new money must go somewhere, and with unattractive savings rates, it has made it into every asset class, including equities, real estate, and cryptos. Essentially, the markets are inflated. Not in the sense of a speculative bubble – though maybe that too – but inflated because of, well, inflation. There is so much money sloshing around due to excessive printing of Euros and USD that markets started to absorb the money, driving prices up.
Is the tech-heavy NASDAQ up because of its constituents’ record-breaking profits? Yes. But don’t forget all those dollars the US is printing are also contributing. All those USD and EUR have to go somewhere, and investors like returns.
The S&P 500, not quite so tech-heavy, has followed a similar trajectory this year – and indeed over the past decade.
The price of gold was already on an upward trend from 2018. Money printing and fear caused the surge, and cryptos’ potential to augment gold as an investment has certainly helped the asset class rise.
There is no “easy money”. Unless you bought 100 bitcoin back at $1 a piece and lost your key until now, you have probably been influenced by several of the points above. Due diligence is vital, especially if you’re just starting out in crypto now.
If you speculate, only do so with a small portion of your money. Diversify, don’t succumb to emotion-driven FOMO trading, and keep in mind the downsides, like low liquidity, low market cap of the entire space, and the forgotten stories of lost fortunes.
Start your due diligence with a watchlist of popular cryptocurrencies, then join us for a webinar next week to discuss cryptos and more: