Bitcoin and Cryptocurrencies: Bonanza or Con Game?
Over the past couple of years, I have had clients and friends ask me about Cryptocurrencies and whether they should invest in them. I always ask them “why”?
The most common response is they have concerns about the long term viability of the dollar and whether or not it will have any value in the not to distant future.
The second most common is FOMO, fear of missing out on big profits!
Should You Invest in Bitcoin and Cryptocurrencies?
You may have noticed that these cryptocurrencies have sold off a lot recently and you may be thinking this is a good time to buy.
Given this growing interest, I want to provide some information and suggestions regarding Bitcoin, Ethereum and their other cryptocurrency relatives of which there are over 18,000 as of March 2022.
Talk about explosive growth, by the end of 2021, the market was adding about 1,000 new cryptocurrencies each month!
There is little to no regulatory oversight in this arena, so I want to share some of the basics that you should understand if you are going to invest.
What He Didn’t Understand and You Should
A month or so back, I got a call from someone who was referred to me by an existing client. He started by saying he was interested in planning for retirement.
He then went on to brag that he was one of the smart folks who was putting all of his money in Bitcoin as most people don’t understand how to make money there.
He even bragged that he was making a risk-free return of over 19%!!! I’ve been around a long time and have never seen “risk free” returns that high, even in 1980 when money savings accounts were paying 18%.
So, I looked it up and he was “loaning” his bitcoin through and exchange and being paid 19% on the loan.
Since the loan was anonymous, he can’t be sure who he is lending to and the exchange has no assets to back up or secure that he will get his crypto currency back, much less the interest! I guess his definition of “risk-free” is different than mine.
As an update, several of the depositories that were paying this kind of interest, are currently in big trouble. Last Monday a group called the Celsius Network, which takes deposits of cryptocurrencies and lends them to speculators who want to leverage their speculations in cryptos told their depositors that they would be “pausing all withdrawals, swaps and transfers between accounts because of extreme market volatility”.
I wonder if the gentleman I mentioned above is still being paid his 19% if he was using that platform.
What are Cryptocurrencies?
They are digital or virtual currency, that is secured by cryptography, which makes counterfeiting nearly impossible according to Investopedia.
Most are based on “blockchain” technology in which all transactions are decentralized and therefore not controlled by governments (one of the main attractions for many folks).
It uses something called a “distributed ledger” in which many computers record each transaction, which makes it less likely to have a failure at a single point (like a transaction that won’t go through your checking account due to a “network failure”).
So how do you obtain tokens? There are 2 main ways:
- You can buy them on an exchange. These are “units” that are already identified and in existence. Think of it like going to a foreign country and then you go to a currency exchange to buy the local currency. The exchange rate fluctuates, and you hope the exchange rate moves in your favor once you buy. You will need to have a secure internet connection and a method of payment.
- You can “mine” for new tokens. Mining is essentially done by very powerful computers solving complex math problems that are essentially guesses of a random 64-digit hexadecimal number called a hash. This allows the blockchain to handle more transactions and the miner that solves the math problem first is rewarded with tokens, and the process begins again.
The more folks that are mining, the harder it becomes to “win” new tokens, because the likelihood of winning is based on the percentage of the overall computing power of the network’s total that the miner controls. Also, over time the reward to the miner goes down by half every 4 years. The computers being used currently can be very expensive to purchase and even more expensive to run as they use a huge amount of electricity.
This is because they run trillions of possible guesses so folks who earn the most tokens are the people with the most computing power.
Miners participate in the blockchain by verifying transactions that are recorded in the chain. This is called “Proof of work” and is a service that participants may be paid for.
The mining protocols and computing power required can vary by which cryptocurrency you are mining. For example, it is generally much more expensive to purchase the computers used to mine Bitcoin than what is required to mine Ethereum.
Did You Get All Of That?
What I just wrote is really an oversimplified version of what is involved in mining these cryptocurrencies.
Considering there are thousands being created each year, can they all be valuable? So far it seems the answer is probably not. Some currencies are being created for specialty transactions and others are for general use.
Still others are being created to profit the creators taking advantage of the speculative fervor surrounding cryptocurrencies.
Arguably tokens like Bitcoin only exist for speculation and hold no value.
The complexity of dealing with them creates a perception of being valuable, but at the core, Bitcoin’s value is really based on the amount of electricity that is consumed in mining and recording transactions.
People should understand this before participating. In future posts we can examine some of the specific risks and protocols that I fear are not fully understood by many participants.
There are also environmental issues that are becoming apparent as more and more people participate in this arena.
If You Like Risk that is Unregulated, Crypto Might Be for You
Since this is a highly unregulated arena, there is an attraction to hustlers and hucksters.
Like Glen Frey once said, “the lure of easy money, it’s got a very strong appeal”. Reading about the big profits being made by some has attracted a lot of attention as an alternative to more mainstream investments.
This is why I want to share some of this information so that if you are looking to participate, I want you to make sure you understand what you are getting into and encourage you to do your own research.
That way you are less likely to get scammed or taken advantage of.
Just remember the old saying, “Caveat Emptor”!
Roger holds the coveted and well-earned designations of Chartered Financial Consultant (ChFC®) and Retirement Income Certified Professional (RIPC®) from the American College. He is also a licensed insurance agent for life and health insurance and a Certified Paralegal for Estate Planning.