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What the cryptocurrency sell-off can teach us about investing

In May, the Guardian reported that a senior manager at Goldman Sachs in London had quit after making millions of pounds investing in Dogecoin. The cryptocurrency – a satirical reference to Bitcoin – was founded as a joke in 2013, existing in relative obscurity before rising in value by 6,000% this year. 

There is an entirely natural feeling of missing out when the price of a crypto asset soars. “Back in 2018, you could buy one Bitcoin for under £3,000. Now, they’re worth over £26,000”, you hear, as you imagine what your early retirement might have felt like. It’s true that, with some fortunate timing and a knack for foresight, some have made enormous amounts trading crypto. 

The problem is that this is simply not the experience for many trading in volatile assets. For every winner, there are just as many losers; in fact, the severity of crypto’s price swings means that there is a very real risk of losing big. Here, we’ll consider the highs and lows of crypto trading and why it’s incompatible with a long term, sustainable approach to investing. 

May sparks cryptocurrency freefall

About half way through May, 2021 saw its first major sell-off of cryptocurrencies, with Bitcoin, Ethereum, Dogecoin and others falling sharply. These kinds of drops are not uncommon, but May’s corrections were the most severe in the history of the major cryptocurrencies – Bitcoin and Ethereum, particularly. 

May’s broad crypto crash wiped out about $1 trillion in market value, down from $2.5 trillion just a week prior (that’s less than the capitalisation of the two largest companies in the S&P 500). The scale of the volatility has been attributed to a few different factors – the amateur and professional investors attracted to crypto because of recent growth may have been skittish, or happy to sell once the perceived upswing had reached its peak. 

Further volatility was stoked by China’s commitment to cryptocurrency regulation – Beijing had sent out a clear message that it was not planning on relaxing its approach to crypto trading any time soon. Meanwhile environmental concerns led Elon Musk to renege on his (and Tesla’s) support for cryptocurrencies, causing further drops in the market.

Volatility is unavoidable 

The large-scale sell-off doesn’t fundamentally tell us much about the future performance of cryptocurrency. Given their (short) history, it’s not impossible to imagine that the price of Bitcoin or Dogecoin could soar again, thanks in part to the kind of impenetrable alchemy that saw the latter spike seemingly out of nowhere in 2021. 

The problem for those speculating when the next spike might be is that it is just as easy to buy at a relative peak as it is to strike gold by buying low. This is the case for any risky assets, but few are comparable to cryptocurrencies when it comes to the upheaval we see on trading platforms seemingly every month. Unfortunately, cryptocurrency is in a position where one news story that reflects negatively on the future of the asset can have profoundly detrimental impacts on the market. 

Volatility is a part of investing, whether it’s in cryptocurrency or government bonds. Without it, investors wouldn’t make any money. The issue with the crypto market is its relative nascence – Ethereum creator Vitalik Buterin himself said that he sees the current situation in the markets as a bubble, before noting that it can be “notoriously difficult to predict” when that bubble might burst. 

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But if volatily is unvoidable, so are the taxes you will have to pay on the gains obtained investing in cryptocurrency, which is another important aspect to consider.

Not all cryptos are created equal

There is more risk inherent in some crypto assets than others. The high prices and famously volatile history of Bitcoin, for example, make investing heavily into it a risky move. The likes of Dogecoin, too, are seemingly too limited in scope to be considered long-term investments and there are question marks over how long higher valuations can continue. 

There are some blockchain technologies, like Ethereum, that are already being used in real-world applications like NFTs. The sophistication of Ethereum’s smart contracts means that developers can quite easily create decentralised applications powered by blockchain technology – Ethereum, as a result, has a loyal group of followers that see it as the future of the industry. 

This is all to say that, ultimately, it’s too early to tell when it comes to blockchain as a sustainable investment. The technology is developing at pace and we will continue to see real-world applications developed. The effects that these will have on valuations remains to be seen and it’s even more difficult to predict exactly which crypto assets will lead the way or even exist in the long term. 

Diversification is more important than ever

For those that are interested in investing in crypto assets, the important thing is to diversify. Trading crypto over the short term seems risky, but they could be held as a potentially lucrative component of a wider investment portfolio. During periods of high volatility in the markets, fortunes can be made (but also lost). There is nothing new in there – market bubbles have always been a potentially lucrative opportunity for someone.

Cryptocurrencies apply the same logic: people feel more comfortable engaging in speculative trading with them because there’s a bias that makes them feel that somehow it is easy to make a profit from them. On the contrary, crypto is an unregulated market, much more exposed to speculative actions and manipulations, while it appears to be at the mercy of the fickle sentiment expressed in the press or on Twitter by Elon Musk. 

As a result, successfully trading in crypto is complex and requires nerves of steel, particularly in off periods. In fact, when people talk about the crypto rally and how easy it is to make money, they often forget to mention that over the past two years a trader could have done better, taking considerably less risk, by investing in stocks. As per any trading activity, crypto requires perseverance (will daily crypto traders be willing to keep screening the market in three months time, when lockdown is finished?), skills and luck: it’s an activity we wouldn’t suggest people invest even a minor part of their savings into.

For medium and long-term investors, then, it’s about having a diversified portfolio to offset any potential losses from crypto  Blockchain is probably here to stay, but we can’t predict if Bitcoin, Ethereum or other coins will as well, and we are not sure at all that their price will keep growing more than the one of other asset classes (like equity).

 Of course, we don’t rule out investments into cryptocurrency in the future. Bitcoin and Ethereum are, after all, just assets and should be analysed as such. The current level of volatility will likely calm down as blockchain technology embeds itself into society as many expect that it will, while the inputs of people like Elon Musk can only cause chaos for so long. For now, though, the volatility associated with cryptocurrency places these assets outside of our acceptable range.

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