Cryptocurrency is gaining broader adoption among investors these days. Fintech companies are making it easier to get started buying and using crypto; companies like Tesla have experimented with accepting bitcoin (BTC 2.30%) as payment; and El Salvador's government has even made it legal tender in the country.
After a pullback in prices across the cryptocurrency market in the past two months, some investors may be eyeing the declines as an opportunity to buy in. Here are three reasons you should invest in crypto, and one reason you shouldn't.
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Why you should invest
1. You think decentralized finance is the future
2020 saw a lot of decentralized finance, or DeFi, projects enter the market, but the idea of using DeFi applications for transactions is still very niche. However, the ability to exchange currency and send money quickly and inexpensively holds a lot of promise for a global economy, and that's why DeFi could play a significant role in our financial systems in the future.
DeFi is an industry that uses blockchain technology to replace centralized financial institutions like banks and exchanges with decentralized versions. The benefit is greater access, faster transactions, and in some cases, lower transaction costs.
There are hundreds of ongoing projects with entrepreneurs creating new organizations every day. Luckily, you don't have to pick the winners and losers in this emerging space. You can, instead, invest in the platform they all use.
There are only a handful of blockchains that support the smart contracts needed to develop and operate a decentralized application. Ethereum is, by far, the most popular, but it has a growing list of rivals, including Binance Smart Chain and Polkadot.
Ethereum has a couple of important competitive advantages that could make Ether (ETH 2.16%) a simple and lucrative way to invest in the future of DeFi.
First of all, it benefits from the first-mover advantage and network effect. DeFi apps work better when they have broad adoption, which Ethereum already enjoys. As a result, it's easier to get a project off the ground on the Ethereum blockchain than its newer rivals.
Second, Ethereum is truly decentralized. Its biggest competitor, Binance Smart Chain, has gained adoption by offering lower transaction fees while Ethereum's transaction fees have climbed to become extremely expensive.
But Binance achieves those low fees by using a proof-of-authority (PoA) system for validating transactions. Under the system, Binance chooses who gets to run the network and has full authority to give them the boot. That's not truly decentralized.
Ethereum, by comparison, uses a proof-of-work system, which gives anyone with compute power relatively equal opportunity to mine the next block and earn the transaction fees. Ethereum is looking to help mitigate its high transaction fees by moving to a proof-of-stake system.
2. Increased adoption from institutional investors
One factor that made the recent rally in bitcoin different from previous climbs in the cryptocurrency's price is the broad adoption among institutional investors. More and more financial institutions are creating a position in bitcoin as part of their portfolio.
Not only do institutional investors create a big buyer in the market, they also effectively remove a supply of bitcoin from trading. Bitcoin has a fixed lifetime supply (21 million coins), and miners mint just 6.25 new bitcoin every 10 minutes or so after the last halving event about a year ago. Earlier this year, institutions were buying up supply more quickly than it was created, resulting in a surge in price for coins still in circulation.
Furthermore, there's a big push toward bitcoin ETFs that can make it easier for retail investors to gain exposure to the cryptocurrency in a regular brokerage account. That could result in even more demand for bitcoin among institutions.
3. It's a good form of diversification for stock investors
If the majority of your portfolio is composed of stocks, bitcoin and other cryptocurrencies can offer a good form of diversification. The price correlation between cryptocurrencies and the U.S. stock market is close to zero. That means the crypto market is unaffected by the stock market, and vice versa.
As a result, you could improve your diversification by allocating a portion of your portfolio to cryptocurrency. That said, cryptocurrency will increase the volatility of your portfolio too. If you can't handle the wild price swings, be sure to allocate just a small percentage of your holdings to the asset class.
Why you shouldn't invest in crypto
1. You're trying to get rich quick
You can grow your wealth extremely quickly if you pick the right crypto asset. Tons of Dogecoin (DOGE +1.07%) millionaires popped up overnight earlier this year with the sudden spike in its price.
But let's be clear: Buying Dogecoin earlier this year wasn't really an investment -- it was speculation, gambling. The value of Dogecoin goes down just as easily as it goes up, and those Dogecoin millionaires could've just as easily gone broke.
The goal of investing in cryptocurrency is to make a profit, but it's highly unlikely you'll see the value of your portfolio increase by 100 times in just a few months. If you buy a currency or token with an investment thesis, and you're right, you should see the value increase over time similarly to buying a stock in a company with a strong outlook.
Investing in this space doesn't have to be like playing the lottery. There are good reasons to buy cryptocurrency, but trying to get rich quick isn't one of them.
