Got crypto fever? Monday's big surge in the value of Bitcoin (BTC 0.39%) and other cryptocurrencies certainly may have stoked your interest.
Before you take the plunge, however, be sure you're doing so with a complete understanding of what's actually driving the digital money movement. Not everything is as it seems on the surface.
To that end, here's a rundown of the two top reasons to invest in a cryptocurrency like Bitcoin, and four reasons to steer clear of them altogether.
Two reasons to buy
1. Money will eventually be digital: Let's face it -- paper money is on the way out. Coins, too. Cash transactions only accounted for about one-fourth of consumer purchases pre-COVID-19, according to the Federal Reserve Bank of San Francisco, and the pandemic accelerated an already-existing downtrend in cash payments.
It remains to be seen which digital approach to facilitating commerce will win out, but it's difficult to deny that people are increasingly seeing physical money as a nuisance that's crowding their wallets and purses.
2. Central banks may not be as efficient as democratized, free-market efforts: Let's face another reality -- while their intentions may be good, faith in the ability of central banks like the Federal Reserve to regulate economies is waning. The fact that 2008's subprime mortgage meltdown spurred a massive global recession validates the idea that they've lost control.
That's not to suggest a completely unchecked paradigm like the use of Bitcoin or Ethereum (ETH 0.42%) would make the economy less volatile. Indeed, it's likely to make things more volatile on a day-to-day basis. Perhaps central banks' meddling is actually causing more of the extreme economic swings, however, than a more democratized, free-market approach to currency valuations would.
Four philosophical problems
Sounds good, right? Before wading into crypto waters, though, think about four key stumbling blocks that just might bring crypto mania to an end.
1. There's no actual scarcity: Yes, the total number of Bitcoins that can ever be mined is capped at 21 billion. As of the latest look, a little less than 19 million have been mined. Once they're all out, that's it. A market-based or auction-based system will then determine the value of the crypto.
Bitcoin isn't the only cryptocurrency, though. There's also the aforementioned Ethereum, Dogecoin (DOGE -0.32%), and oodles of others, with more seemingly arriving every week. It's problematic simply because the potential number of cryptos is infinite, and they can -- and will -- compete with one another for usage and for value. While anyone can exchange one fiat currency for another, at least the central banks behind them are collectively limiting the world's total amount of currency in circulation.
2. It's volatile, which makes it a poor currency: It's a largely ignored aspect of the cryptocurrency story to date, but the reason most people want it now is the exact same reason cryptos make for a lousy currency -- buyers are stepping up because they feel the value of cryptos will be moving higher in the foreseeable future. But the last thing any employee, employer, tax collector, lender, or borrower wants is an ever-changing value of the currency used to do business or pay employees. It's supposed to be stable and predictable, which for all of their problems, fiat currencies typically are (at least on a day-to-day basis).
3. It may not be as digitally secure as suggested: One of the key selling features of cryptocurrencies is that the underlying blockchain technologies used to make them work also made them super-secure. But maybe they don't. The FBI was able to digitally recover most of the Bitcoin-based ransom hackers demanded in exchange for returning control of Colonial Pipeline's pipeline management computers.
Granted, the FBI has tremendous resources, and the hackers in question broke the law. Nevertheless, that it could be done at all calls into question just how safe anyone's crypto holdings really are.
4. It's unregulated: Finally, while the whole point of any crypto is to operate outside of regulatory environments, sometimes it's in consumers' best interest to operate within the confines of a regulated environment. Aside from legal protections linked to doing so, despite their shortcomings most central banks still do a reasonably good job of throttling economies. A transition to a consumer-controlled environment would not only prove volatile, but such a sweeping change could prove downright devastating. That's one of the many reasons why governments are entertaining more control measures of digital currencies, which of course ultimately works against crypto values.
Should you invest in crypto?
Are you suddenly less convinced cryptocurrencies are a must-have holding? That's not the goal, to be clear. While it's true that there's an inherent risk in ownership, there's also no denying there's upside potential in these trades.
But do recognize that nearly all of the gains any crypto has dished out since its inception have been rooted in speculation rather than a calculated assessment of its underlying value. That's fine, but speculation sets the stage for major sell-offs from which prices may never fully recover.