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What are cryptocurrencies really worth?

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This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.

What is it that gives the likes of Bitcoin, Ethereum and other cryptocurrencies value? Many investors have been intrigued by the potential returns here. In December 2020, Bitcoin reached $24,000 and then skyrocketed to over $60,000 in March 2021 – nearly tripling some investors’ money. Clearly, many people see value in these cryptocurrencies, but what are they really worth and what role should they play in your portfolio?

In this article, our financial planning team at Castlegate here in Grantham, Lincolnshire offers some reflections on these key questions. We hope you find this content helpful. If you want to discuss your own financial plan with us, please get in touch to arrange a no-obligation financial consultation, at our expense:

01476 855 585

Bitcoin & commodities: a comparison

It is often said that cryptocurrencies have no “intrinsic value” because – similar to commodities like gold – they do not produce anything. Warren Buffett, the world-renowned investor, once put it like this: “[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.” A company, on the other hand, can make goods (or produce services) which build wealth – potentially making it an attractive investment.

Cryptocurrencies like Bitcoin may not be physically dug out of the ground, like gold. Yet there is a comparison regarding productivity. Bitcoin is increasingly accepted as a means of payment – with PayPal now accepting it since late 2020, and with El Salvador recently accepting it as legal tender. However, it does not offer a dividend, a balance sheet or a cashflow statement for investors to analyse – to help determine if it is a good investment with strong fundamentals. It is merely a store of value, and a highly volatile one, at that.

Why the state matters

What makes a digitally-based cryptocurrency different from the British pound or US dollar? The physical notes and coins, for one thing. Yet there is also the fact that the state backs these “fiat” currencies (e.g. via the Financial Services Compensation Scheme). Bitcoin and its counterparts, however, have no central authority guaranteeing it; only market forces driving its value. This is part of the reason why cryptocurrencies are so volatile, sometimes moving up (or down) by 40% or more in a given day. You can go to sleep and be very confident that £1,000 in your bank account will still be worth the same when you wake up tomorrow. If you hold the same in Bitcoin or Ethereum, for instance, then you may discover that half of the value is gone by morning.

Critics can argue, of course, that fiat money has no intrinsic value either since it is no longer backed by a physical commodity (e.g. gold), and governments can always print more money – reducing the value of each coin and note. Bitcoin, however, has a set number of “coins” (21m) which means they are not vulnerable to inflation. However, it remains true that the volatility of cryptocurrencies makes them difficult to use as currency stores. After all, do you really want your life savings subject to a tweet from Elon Musk or other celebrities?

What place for crypto?

Can cryptocurrency fit within your portfolio alongside your other investments? In general, we might say that if you have a spare £50 or so, it cannot hurt to take a punt. However, putting large sums into Bitcoin, Ethereum and other cryptocurrencies could lead you to lose a third, a half or more of your net worth.

It is easy to look at graphs of Bitcoin’s exponential rise in the past and think: “Look what I have missed! I need to join this before it’s too late!” However, past performance is no guarantee of future results. Just because it rose in the past does not mean this will continue. Beware of the two common investor pitfalls: recency bias and herd mentality (fear of missing out).

Consider, also, that cryptocurrencies are still very new and are still finding their place in the world. Many countries are suspicious of them, putting their future in doubt. India, for instance, proposes banning Bitcoin in law, and since March 2021 China has been cracking down on crypto miners (leading them to seek friendlier jurisdiction). Even in the USA, the Senate has been discussing tightening crypto regulations due to Bitcoin’s role in crime and tax evasion. Ultimately, governments have the power to ban cryptocurrencies if they want to.

When it comes to building wealth, other investments are much safer and offer promising levels of return – such as equities (stocks & shares). Whilst these still pose risks to investors, these can be mitigated by adopting a long-term strategy and by diversifying appropriately across lots of companies, markets, industries/sectors and even asset classes. A financial adviser can be immensely helpful here, guiding you through good investment practice and identifying strengths and weaknesses in your portfolio so you can make improvements.

Conclusion & invitation

If you are interested in discussing your own financial plan or protection strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:

01476 855 585