“Tom” is a friend who recently got excited about investing in cryptocurrencies.
He’s an intelligent guy who has done business deals worth over a billion dollars for his work, so when he pitched his investing ideas to me, I heard him out.
As Tom enthusiastically explained the crypto-trading strategies he learned from a subscription-based newsletter, I could only scratch my head in bewilderment.
His logic was flawed, and I told him so. However, he ignored my warnings, withdrew most of his retirement savings and used them to trade cryptocurrencies.
Things did not go well for Tom. First, he lost one-third of his money to taxes and penalties by pulling money out of his IRA prematurely. Then the crypto market crashed, dropping his portfolio by an additional 50 percent.
However, the true folly of Tom’s financial misadventure is that he used a new Chinese company to hold his “digital wallet,” which is necessary to trade cryptos. When he tried to withdraw the money he had left, his digital wallet magically disappeared.
This company stole everything, and Tom could do nothing about it.
Tom’s story highlights several issues. The foremost is to always use a fiduciary when investing; a fiduciary is a financial professional who is legally required to act in your best interests.
Unless you are a seasoned pro, the financial landscape has too many landmines that you can hit when investing independently.
However, the elephant in the room is that cryptocurrencies have no intrinsic value.
While proponents of cryptocurrency will argue that government-backed currencies are similar, with no tangible assets underlying them, these folks miss a crucial lesson in economics. A currency is valuable only if someone else accepts it in exchange for the goods and services you need.
Government-backed currencies have one core strength. The governments issuing them will always accept them as a legitimate form of payment, and so will anyone doing business with that government.
Since most global corporations use the U.S. dollar in some form, and every American citizen and company pays their taxes using dollars, the dollar isn’t going away.
On the other hand, cryptocurrencies are not guaranteed as a currency that anyone will accept.
Since making a cryptocurrency is increasingly easy, the likelihood of any cryptocurrency achieving permanent, widespread acceptance seems unlikely. Only when a prosperous nation adopts a cryptocurrency as a legal means of exchange with the government will it become an actual currency.
However, when a cryptocurrency becomes an acceptable form of payment everywhere you go, it will stop being an investment and have a stable value.
No one discusses trading pesos, euros or yen at dinner parties because they aren’t investments. Their values are as stable as possible so commerce can flow smoothly.
Hyperinflation or hyperdeflation produces economic instability, and cryptos routinely suffer from both. As an example, if I order a thousand Teslas for one Bitcoin each, and the price of Bitcoin doubles between order and delivery, I must sell my Teslas for half a Bitcoin. Business can’t function that way.
The real question for cryptocurrencies is this: Are they investments or currencies?
If they are investments, they have no underlying value and should be avoided. If they are currencies, they need a stable value that is controlled by a regulatory agency like the Federal Reserve to avoid the risk of hyperinflation or deflation. Should one crypto coin ever go mainstream, it can no longer have huge price swings, so it will cease to be a speculative investment.
Cryptocurrency is in a cycle of bubbles where investors buy something with no inherent value and hope a bigger fool will come along later and pay them more for it. That said, I think blockchain technology is remarkable and offers great potential.
Rather than watching the price of cryptos, look at who is profiting the most from the crypto craze. It is likely to be the money changers in the temple of finance and not you.
As for Tom, he lost millions, but he’s still in decent financial shape. Most of us, though, are not able to lose millions and walk away unscathed.
Don’t fall for the tomfoolery that is cryptocurrency.
Doug Lynam is a partner at LongView Asset Management in Santa Fe and a former monk. He is the author of From Monk to Money Manager: A Former Monk’s Financial Guide to Becoming A Little Bit Wealthy — And Why That’s Okay. Contact him at douglas@longviewasset.com.