The cryptocurrency crash, speculative investing, and bubbles

Near the end of 2017, on December 16th, bitcoin topped out at just over $19,000 USD per coin. Just last week, the price per bitcoin was around $7,000 USD. Why did it happen? If you search for an answer online, you’ll get a wide range of explanations. Including “the Lunar New Year is approaching and a lot of people in Asia want to sell,” to “Some of the online exchanges can’t handle trade volumes,” and “This is the end of cryptocurrencies.”

The truth is, this is the nature of speculative investing. You really just don’t know. No one does because speculative investing, in essence, is based on human emotion: fear and greed. The only reason that a speculator would invest in “X” is that hopefully they can turn around and sell it to the next person for more than what they themselves paid.

At the end of 2017, the hype around bitcoin and all cryptocurrencies was so high that even people who have very little knowledge of what cryptocurrencies are wanted to buy in. This is one indicator that something drastic is about to happen; when people who are otherwise completely uninvolved in investments are happily talking about trading bitcoin, the market hype is starting to reach a critical point.

The difference between speculative investing and value investing is important. When you think about making investments, ask yourself some simple questions, no matter what type of investment it is. This will also help you determine if the current environment could be a bubble.

1. Does the investment vehicle itself have any actual value? For example, if you wanted to buy bitcoin, do you know what bitcoins are actually used for, and does the price you’re paying reflect the usefulness of it? Imagine buying a share of a large corporation, say Disney. Disney shares regularly pays out dividends, so you actually know roughly how much money you’ll make per share of Disney stock. You also know that Disney is one of the largest media conglomerates in the entire world, making tens of billions in revenue every year. For each investment you’re interested in, ask yourself what actual value it holds.

2. What caused the price to rise? This is important to know because this will be a huge red flag in determining if something is in a bubble. If the price is only rising because people are telling each other about it, it creates a feedback loop which drives the price further. Do you see a problem with this? The price will go up for the same reason it comes down. Using bitcoin as an example, if the value is only increasing due to human emotion, that means the collapse will happen from the exact same phenomenon. Compare this to investing in an existing company whose stock price is rising because they’re making good revenue every year.

3. Who are the people that are buying these investments? Is it Warren Buffet? Or is it your friend’s uncle who happens to play with stocks on the weekends? Generally speaking, high profile money managers will be more likely to put their managed money into investments which hold actual value. There’s a reason why Warren Buffet has continuously delivered good results year after year.

When it comes to investing, there are a lot of opportunities, and at the same time a lot of risks. The best strategy is different for everyone, but for many, a diversified investment portfolio including many vehicle types held over a longer term will be the safer, more realistic route to take.