Compared to stocks, few "investments" have been able to touch the returns of cryptocurrencies like bitcoin and ethereum over the trailing year. Whereas investors have cheered well above-average returns for the stock market, bitcoin has advanced by more than 300% since last August, and ethereum has moved higher by more than 2,600% just since 2017 began.
Blockchain goes big
The catalysts for cryptocurrencies have been aplenty. A falling U.S. dollar, which is at more than a two-year low relative to the euro, has sent investors scurrying for ways to protect their wealth. Traditionally, gold has filled this void as a store of value when the dollar has been weak, but bitcoin and ethereum have been popular choices of late. A digital currency like bitcoin has protocols built in that only allow for 21 million coins to be mined, making it, in a way, a finite asset like gold.
The underlying blockchain technology backing these cryptocurrencies has also been a major source of optimism. In a nutshell, blockchain is a digital and decentralized ledger that allows for the recording of virtually any transaction, and the belief is that it'll make transactions considerably more secure and efficient. Ethereum's gains are as a result of what's believed to be superior underlying blockchain-based technology. Not surprisingly, more than 150 organizations, including some very prominent companies, have begun using ethereum's blockchain in pilot or small-scale tests.
Even momentum could rightly be cited as a catalyst. After all, bitcoin and ethereum have yielded returns over the past year (or less in ethereum's case) that investors typically only see after holding stocks for years or decades at a time.
Not so fast, digital currency investors
Then again, there have also been a number of red flags raised by digital currencies that should make investors think twice about investing in bitcoin, ethereum, or any of the more than 900 options.
To build off the last catalyst, momentum has created a small army of novice investors who may be chasing past returns from bitcoin and ethereum without truly understanding the underlying technology or what it's trying to accomplish. It may be a crude example, but the number of advertisements focused on luring investors to bitcoin has reached levels that are akin to what this Fool has seen in instances just prior to a bubble bursting (e.g., the housing bubble or dot-com bubble). Does that mean bitcoin is in a bubble? Not necessarily, but the similarities are too apparent to ignore, and the lack of diversification for some investors is certainly troublesome.
Bad press is another concern for cryptocurrencies. For example, bitcoin's decentralized network is designed to protect against a cyberattack, and it would be virtually impossible for an organized group of hackers to gain hold of a majority of coins. However, that hasn't stopped digital currencies from finding themselves in the limelight for money-laundering schemes. Just this past week, the Department of Justice charged a Russian bitcoin exchange operator with 17 counts of laundering up to $4 billion worth of bitcoin since 2011. Alexander Vinnik, who stands accused, is also believed to be behind the hack that pilfered $480 million from Mt. Gox, which at one time handled about 70% of all bitcoin transactions. Bitcoin's price languished for years following the implosion of Mt. Gox, and there's nothing to suggest such a scenario couldn't happen again.
And then, there's always the latest development with bitcoin.
Bitcoin splits into two
On Tuesday, Aug. 1, bitcoin investors woke up to the news that they had feared: Bitcoin was splitting into two currencies, bitcoin and bitcoin cash.
The reason for the split derives from software engineers being unable to come to a needed consensus on which updates bitcoin should implement. In other words, a majority (but not large enough majority) wanted to see bitcoin's underlying technology beefed up to become more attractive to enterprise customers, while a minority of engineers, which was big enough to prevent the required percentage of consensus from being reached, wanted to keep bitcoin as a libertarian's dream currency. The result is a split in the underlying currency, with bitcoin operators going with the Segwit2x system that will move the primary currency out of the current blockchain, and bitcoin cash engineers simply using bigger blockchains within the existing blockchain framework.
The split is concerning for bitcoin cash holders because there aren't very many miners dedicated to mining coins for the brand-new currency. Furthermore, bitcoin cash isn't going to be supported by a number of exchanges, including the highly popular Coinbase. Bitfinex, another very popular digital exchange, will decide whether to list bitcoin cash "based on how the situation evolves," according to CNBC.
Additionally, the split in bitcoin into two separate currencies hampers its ability to gain legitimacy. While there are a number of businesses that do accept bitcoin, its uses are still very limited. Bitcoin has gained notoriety recently by acting as a bridge currency between the marijuana industry and consumers with credit and debit cards, but this may wind up drawing the ire of U.S. regulators and won't exactly establish bitcoin as a legitimate currency.
Despite the recent surge in bitcoin, and other cryptocurrencies for that matter, it seems as if we're introduced to an "Oh, look! Another reason to avoid X" scenario each and every week. I suggest keeping your distance from digital currencies until we see broader platform adoption from big-brand companies. Only then will these rebel currencies have a shot at being worthwhile investments.