Editor’s note: This article was first published in March 2014; the prices it quotes and its description of bitcoin as unregulated, with a very bleak future, reflect that moment, and “the main exchange closed” refers to the Mt. Gox collapse of February 2014. Bitcoin has since traded far above those levels.
A very common conversation whenever people talk about investing in bitcoin is whether it would pay to buy in the event of another sharp fall in this “digital currency”.
We have all seen bitcoin trade above 1,200 dollars, fall to around $300 and then climb back to $700. It is hard not to think of bitcoin, or compare it to stock market movements, where if the price dropped to $100 it would look like a real bargain.
After all, one stock market belief is that whatever goes down comes back up, and whatever goes up comes down at some point. And the fact is that this move could work out well, but it could also end horribly.
If we want to gamble or speculate, anything goes, be it buying tulips, bitcoin or daisies. But if we analyse bitcoin rationally, as investors, these would be the reasons to stay away from a kind of investment that professional investors of the stature of Warren Buffett have regarded as the new tulip mania.
In every innovative investment you usually find the same pattern: first the visionaries invest, when the price is rock-bottom. Then comes the herd, investing on the strength of how big this kind of investment is going to be now that its price has soared. Then come the people Buffett described as the idiots, who are the ones who invest only to watch the price of that asset collapse.
The problem with bitcoin is that, since it has no intrinsic value, the person buying at 500 dollars could be one of those idiots just as much as the person buying at 5 dollars. After all… can anyone say what a bitcoin is really worth, what its value is? The value of bitcoin is $0, and its price fluctuates on the speculative hope that someone will be willing to pay more than the price you originally paid.
Let’s analyse this kind of investment rationally, assuming we are talking about an asset X.
The asset in question:
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Was created anonymously: nobody knows who its creator is, but everyone knows the creator pocketed 400 million dollars before walking away from it.
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Is not regulated by any body or institution.
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Its main trading platform has closed, and everything suggests users will not get their money back.
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Its trading platforms can be hacked and the asset stolen, with nobody held responsible. In other words, your investment can be stolen and nothing happens. A platform can also shut down and you cannot make a claim, because in reality nothing of value has been stolen from you.
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Is too innovative an investment: it has existed for only a few years and nobody knows whether it has a future, although for now that future looks very bleak.
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Could be declared illegal by governments at any moment, wiping out the entire investment.
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Is the asset used for money laundering, arms purchases and all kinds of illicit activities.
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Has enormous volatility that responds to no economic patterns or macro benchmarks.
See also: IBEX rebound: when will it happen?
Would you invest in this kind of asset? Analysed this way, it is not the kind of investment anyone dreams of. And so this investment is high-risk at 400 dollars just as much as at 50 dollars.
There is a very basic principle of investing: do not invest in something whose value you do not know, or whose reasonable price you cannot work out. At a price of 1 dollar per bitcoin, would it be cheap or expensive? Nobody knows, and there is no way to find out, so from a rational point of view the investment would be ruled out entirely.
Further reading
- 6 life lessons I learned while day trading millions of dollars
- 5 poker tips applied to stock market investing
- What liquid and illiquid assets are
Featured image: Gage Skidmore, CC BY-SA 3.0, via Wikimedia Commons.
