Cryptocurrencies are all the rage right now, and none is more popular than bitcoin. Speculators have been driving up its price, predicting it will be the currency of the future, but many others are skeptical.
You can buy bitcoins with traditional currency. And like a traditional currency, bitcoin lets owners buy goods and services online and, increasingly, in the real world. But one of its most popular uses is to speculate on its own price rising. The way some bullish investors talk about bitcoin is reminiscent of the early dot-com days.
That's not the only similarity with the dot-com bubble: The technology underpinning bitcoin and other digital currencies may be the future, but the fact that bitcoin uses that technology doesn't necessarily mean it's a smart investment. There are still serious questions about its staying power, and not-so-sophisticated speculators might be easily fleeced by the more sophisticated.
Here are three reasons you should be hesitant to invest in bitcoin.
1. This great investor says bitcoin is worthless
Legendary investor Warren Buffett famously declared the currency worthless. He told CNBC in 2014: “Stay away from it. It's a mirage, basically. It's a method of transmitting money. It's a very effective way of transmitting money and you can do it anonymously and all that. A check is a way of transmitting money, too. Are checks worth a whole lot of money? Just because they can transmit money? … The idea that it has some huge intrinsic value is just a joke in my view.”
Of course, you shouldn't avoid bitcoin just because Buffett doesn’t like it. And yes, since he said that, bitcoin has gone on a tremendous run. Still, when arguably the world’s best investor says an asset is worthless, you should think long and hard about putting money in it. Buffett was long criticized for not understanding internet stocks and then looked like a genius when many dot-coms bombed in 2000 and never recovered.
2. Bitcoin doesn't produce value over time
Bitcoin's price has run up a lot. How much? A lot a lot. In late November 2017, it traded at more than $9,600 per coin — a gain of nearly 900% this year. For a currency that some say is worthless, it sure costs plenty of coin to buy one.
It's not unusual for the price of an asset — such as a stock — to increase. If a business expands its operations, growing and making more money over time, investors are willing to pay more for shares of its stock.
That’s not how it works with an asset like bitcoin, however. Bitcoin's price goes up only because people want to pay more for it, and speculators are buying only because they hope to sell it to someone else for more. It’s what’s called the “greater fool” theory of investing.
Bitcoin has rocketed the most in absolute terms this year, but its percentage return was even higher during its first year of trading. The currency debuted at 9 cents in July 2010. A year later, it was trading for $13.48 — a gain of nearly 14,900%.
3. Bitcoin pricing is volatile
Bitcoin bulls argue that it’s the currency of the future, but its price is tremendously unstable, making it unsuitable as a currency today. While its price was near $7,900 per coin in early November, it was below $6,000 just days later, a decline of more than 25%. We’ve seen five drops of more than 20% this year alone. Then, by late November, bitcoin had risen again and eclipsed $9,600. That's whiplash.
Consumers need stable prices to make purchase decisions. Imagine if you walked into McDonald’s one day and your meal cost $10. What if the same meal cost $5 the next day, and $20 the day after that? You’d have a hard time figuring out where to eat lunch, and the business would have a hard time making appropriate financial choices.
Consider value-producing assets instead
Unlike bitcoin, well-managed companies produce value over time, and index funds tracking a basket of stocks have a great track record of making money for investors. The fund tracking the Standard & Poor's 500 index has delivered 10% annual returns, and it’s easy to buy. In fact, Warren Buffett himself recommends it to anyone who doesn’t want the hassle of picking individual stocks.