As humans, we're always looking for signals, particularly from markets. Are stocks likely to decline or rise? Will interest rates drop? What about the value of the dollar?
When it comes to cryptocurrencies, the same questions nag at us: Bitcoin, for example, just hit an all-time high. What does it mean, if anything? Since there are more than 800 cryptocurrencies out there, we need some guidance.
One interpretation is that Bitcoin prices reflect general anxiety and uncertainty over the U.S. and global economic situations. While corporate earnings and stock prices remain strong, are Bitcoin investors seeing something the rest of us aren't?
There are plenty of reasons to go slow on cryptocurrencies, as there are myriad concerns on how the currency trades. According to a recent piece by Bloomberg:
"Even as investors are lured by their price gains and volatility, the biggest institutions are reluctant to get in, raising further concerns about liquidity.
On June 21, ether crashed to 10 cents from $317.81 in trading on Coinbase. The cause was a single $12.5 million trade -- one of the biggest ever -- that triggered further selling. It all happened in just 45 milliseconds, after which computer algorithms started buying, driving prices back up to $300 within 10 seconds. Some digital coin exchanges have collapsed or customer funds have disappeared. All of which is scaring away the very investors the exchanges need to succeed."
Here are five questions to ask when investing in cryptocurrencies:
-- What is the price based on? Do you understand the code behind pricing the currency? Few do. That's always been a stumbling block for me. I think the investing public needs much more background on how the currencies are valued and the blockchain technology behind them.
-- What benchmarks can it be compared to? With stock prices, we have lots of benchmarks such as the Dow 30 and S&P 500 Index going back decades. That shows us relative levels. Bitcoin only has a short history, so we have few tools to show comparative values.
-- Why do you want to invest in Bitcoin? While I can see the innovative logic in wanting to get away from traditional paper currencies, keep in mind that while actively traded, there's almost no regulation of cryptocurrencies. That may change soon, but that's on the horizon at the moment.
They could be manipulated in many ways. And they may or may not be a good way to save for retirement. Since regulation is on the way, that's one of the reasons I would wait before I invest.
-- Cryptocurrencies may not be a hedge. Traditionally, precious metals like gold have been a hedge against inflation and the decline of the dollar.
When the cost of living goes up, so does the price of gold. But with inflation low and the dollar relatively strong, Bitcoin may not be an effective hedge. It may be more of an anxiety index.
-- Do you know the downside of Bitcoin? Like any other traded entity, it goes up and down in price -- a lot. A few years ago, it lost more than 90% of its value. If you want stability, this is not the kind of thing you want in your portfolio.
The bottom line is that if you want to invest in a cryptocurrency, don't load up on it. It should comprise no more than 10% of you total portfolio. While it will take some time to understand how it performs over time, it's best to be cautious.