There are two kind of investors. One is keeping a decent distance from cryptocurrencies like Bitcoin and believes it is for 100 percent a bubble. The other already bought it and awaits to become rich. To be frank I have no crypto investments and it will remain like that.
Nevertheless a huge mass of retail investors are already into this game and lot are thinking to get in. I believe many of them are first time investors thus it is important to expose some of the basics of investing and also highlight Bitcoin-specific attributes to it.
General investment strategies
On a really high level there are two major groups of investors. The “long runners” are the “sprinters”. The reason behind getting into positions is completely different, but the goal is the same. Earning a positive return, hopefully beating the market.
- Buy and hold: this strategy has a proven track record on a long-run. Key to success is finding value in a given asset and than being patient. Most of the bluechips like Apple are a good example. In 2013 Apple shares saw a huge, over 40 percent price drop within couple of months. Since that valley, the price tripled, and all patient value investors are back into positive returns.
- Speculation: speculation is an opportunistic approach, and it is all about catching the right moment. Trading on rumors, finding seriously undervalued assets, anticipating important announcements, is all part of the quick process. In a typical day, a speculator might go long the WTI crude oil futures and in the afternoon exchange it with a Japanese yen short position.
How to invest into Bitcoin
First of all not investing into something is also a viable decision. Economics 101 tells there is an opportunity cost for every decision we make. For example I can decide not to buy Bitcoin but invest $15.000 into US T-notes and earn a small but fix regular return in form of coupon payments. There is not only a serious value risk in Bitcoin but also an additional executional or delivery risk.
- Exchange: the first trading venue for Bitcoin had a very bad ending – Mt Gox bankruptcy – but since at least a dozen of exchanges emerged. As the digital currency market is still very lightly regulated these providers need to meet very basic requirements like attaining a money transmission license. There is no client funds protection scheme, no strict capital requirement towards these providers.The main difference is still in the platform features. More advanced trading tools are offered by Kraken – stop loss, trailing orders, margin – while Coinbase attracts a wider base of clients by offering a wallet for storing and spending Bitcoin. The trading features are more basic as there is a 3-5 day delivery between the paper money bank account and the Coinbase digital money account.
- Online Brokers: there is a clear advantage of trading cryptocurrencies via reputable online brokers. It is regulation. Providing investment service is strictly regulated, and involves the necessity to pull client funds under a protective umbrella up to a certain amount. Many brokers hold banking license, like Swissquote, or public company form with listing on major exchanges like LSE or NYSE.The disadvantage? You are able to invest in form of CFDs, meaning you trade only an underlying contract and thus can benefit only from the price differentials.
- Futures – CBOE: trading directly on a futures market is not an option for retail investors but it is possible via brokers offering future contracts, like Tradestation or Interactive Brokers. Bitcoin futures are cash settled upon maturity dates, and can be traded both direction. Due to exchange regulations there are limit movements, upon which trading is halted or suspended.Third party risk is the smallest in this form of Bitcoin investing but futures are not cheap regarding fees and minimal contract sizes.
Bitcoin is constantly being paralleled with the Tulip mania, dotcom and the subprime bubble burst. The demand for Bitcoin is several times higher than the supply, thus if economics has any credibility, the only direction is a corrective fall in the future. While no one can predict when such a move can happen, at least there are some additional pitfalls to watch for.
- Volatility: as the price of Bitcoin penetrated the four and five digit figures in dollar terms, volatility has somewhat decreased in percentage terms but in nominal value quite the opposite is happening. Volatility can be grasped easily on a daily Japanese candlestick chart where the wiggles mark the daily highs and lows. The range is generally around 20 percent, occasionally even higher. If you can’t handle emotionally or financially such a rollercoaster, don’t trade Bitcoin!
- IPO like price chart: technical analysis is a strong pillar for professional traders. However as Bitcoin has still a relatively short history and a chart that looks like a successful IPO, there are no orientational points, support and resistance levels in it. Trading is pretty blindfolded.
- Lack of institutional buyers: institutional buyers like mutual funds and wealth management firms bring stability as they appear on the buy side, their holdings are disclosed just as their investment policy. Until institutional flow will stay away from Bitcoin, it will remain a wildcard.
- Third party risk: Lehman Brothers, MF Global, AIG. Rings a bell? All these financial institutions went bust during the subprime crisis in 2008. Since improvements and restrictions by Dodd-Frank act were implemented, but these don’t apply to mostly unregulated Bitcoin exchanges and other offshore crypto brokers. Even if you are risking only a small amount make a background check on your digital currency provider.
- Bubble threat: Bitcoin is a bubble firstly because demand and supply is in massive imbalance, and secondly because of the speed how it attracts attention. Despite this, there is an opportunity to get in and out with a profit trading Bitcoin, but the failure is coded in the human nature in form of greed. Many retail investors are only thinking about the entry, and have no exit strategy at all.
How to profit from the Bitcoin craze
- Stay on the sideline: many experienced professionals highlight it daily, that the price dynamics of Bitcoin recall typical bubble patterns. In the past with very few exceptions (2008 subprime prediction by Nouriel Roubini) nobody could foresee the exact timing of the burst.
- Portfolio investing: a safer way is to split the funds available for investing and put Bitcoin into a basket of other, more safer instruments, like equities or bonds. If your Bitcoin holding is only 20 percent and the rest is fixed income, than the maximum loss is actually less than 20 percent in case of Bitcoin price dropping to zero (also an improbable scenario).
- Active trading: it is very important to realize profit and limit greed. As Bitcoin is climbing higher and higher so it gets more dangerous to stay in position. The problem is that most retail investors get trapped by pure psychology. Once they locked in a decent return they want more of it. Very few can remain disciplined and decide to get off the Bitcoin express.
With a market cap getting close to $300 billion Bitcoin already surpassed mega corporations like Bank of America and is threatening Google which is quite a big nonsense compared actually how smalls is Bitcoin’s share of the global payments segment and that it’s value is limited due to the amount that can be extracted by miners.
With some luck – early purchase of Bitcoin – and big amount of discipline – having some doubt about cosmic price targets – it is possible to gain on Bitcoin and for sure there are a couple of ordinary people that already bought a house and a car as early investors. However the crypto landscape will change with futures trading – short bets coming in from professional players – and regulatory boards passing restrictive laws that will lead to huge price drops, sweeping out a mass of retail long positions. As a consequence many Bitcoin dealers, exchanges will go bust being unable to pay out even tiny remaining funds to their clients.
What if the professionals are wrong and Bitcoin will go in a straight and even line to $100.000? Just don’t get mad, very few people will hold their positions for so long, and besides the odds of this scenario are similar to hitting the jackpot on the national lottery.