Bitcoin just might be the most controversial topic in the investing world. Supporters think the cryptocurrency has the potential to disrupt the financial industry. They also point to bitcoin's staggering returns in recent years. Critics highlight the risks and volatility of bitcoin.
Those same arguments, both for and against, also apply to another investing alternative: biotech stocks. Some investors view biotech stocks as a great vehicle for huge returns from innovative products, while others are afraid of the high levels of risk and volatility. Which of these two promising -- yet potentially perilous -- investment alternatives is the smarter investment pick?
Risks and volatility
To understand the risks and volatility of bitcoin, it's helpful to first learn exactly what bitcoin is and how it works. My colleague Maxx Chatsko wrote a good article summarizing the key things to know about bitcoin. I recommend reading it if you're not familiar with the cryptocurrency.
There are three major risks for investors in buying bitcoin. One is the risk that governments prohibit use of the digital currency. China is the the largest market in the world for bitcoin trading. If Beijing decided to make serious moves against bitcoin, prices would crash.
Another risk is that an alternative cryptocurrency largely supplants bitcoin. The Ethereum network's Ether currently ranks second in total market valuation and has some advantages over bitcoin that could continue to attract more investors.
The third major risk for bitcoin relates to its underlying technology. Companies and exchanges that focus on bitcoin can be vulnerable to cyber attacks. Two such attacks in the past caused bitcoin prices to fall and contributed to a spike in volatility.
Individual biotech stocks also face significant risks and volatility. A key risk for biotech stocks relates to concerns about the safety of their drugs. For example, Intercept Pharmaceuticals (NASDAQ:ICPT) stock plunged recently after the FDA warned about risks of its liver disease drug Ocaliva. In Intercept's case, Ocaliva had already been approved by the FDA. For many biotechs, though, issues related to safety or efficacy occur in clinical testing and prevent products from ever reaching the market.
There's also the ever-present possibility for biotechs that another company introduces a rival product that cuts into market share. Even the threat of this happening can wreak havoc on a biotech stock.
Biotechs even face the potential that their products work too well. As a case in point, Gilead Sciences (NASDAQ:GILD) stock dropped more than 40% between mid-2015 and mid-2017 primarily because of declining sales for its hepatitis C drugs. Those drugs cured so many patients that Gilead's market shrank considerably.
Which is riskier -- bitcoin or biotech? Individual biotech stocks appear to have more risks than bitcoin does. Of course, you can also buy exchange-traded funds (ETFs) that hold many biotech stocks. Biotech ETFs tend to be less volatile than bitcoin and could present lower risks for investors.
When it comes to performance, it's not even close between bitcoin and biotech. The first bitcoin exchange opened in 2010. If you had bought $10 worth of the digital currency then and held on to it, you'd now have a fortune of close to $13.9 million. That's an average annual return of more than 650%. It's hard to find biotech stocks that would have turned $10 into $100 during the same time period.
However, most investors wouldn't have bought bitcoin in its infancy. How does the cryptocurrency stack up against biotech stocks more recently? Here's how the NYSE Bitcoin Index has fared so far in 2017 versus the best-performing biotech ETF, the SPDR S&P Biotech ETF (NYSEMKT:XBI), and one of the hottest biotech stocks on the market -- Puma Biotechnology (NASDAQ:PBYI).
Clearly, bitcoin is outperforming biotech any way you look at it. Those returns came with high volatility, though.
Investors make decisions based on risk-reward profiles. When comparing two investing alternatives, they should determine which option provides the better prospects for return for the amount of risk taken. So far, bitcoin has demonstrated a better risk-reward profile than biotech stocks have. But will that continue? There's no way to be sure.
I certainly don't expect that bitcoin will generate annual returns in the future like it has in the past. On the other hand, the level of risk could decrease as digital currencies become more widely accepted. In my view, putting a small portion of an investment portfolio in bitcoin isn't a bad move. Understand, though, that it would be a purely speculative play.
If you're truly looking for a disruptive investment, though, I'd go with biotech stocks. The advances that many biotech companies are making are incredible. The possibilities for treating serious diseases are more exciting than ever before. And buying a biotech ETF is a great way to invest in the disruptive potential with lower risk and volatility. A century from now, I suspect the changes to the world introduced by biotechs will be much greater than those resulting from bitcoin.
Bitcoin versus biotech? Perhaps the smartest investment choice of all is this: Try a little of both.