As early retirees, the question we’ve started getting more than any other, from people who are pros at investing to folks who want to start from scratch is, “Should I buy bitcoin? You guys own bitcoin, right?”
Bitcoin and other cryptocurrencies have been getting a lot more news lately as valuations have skyrocketed and plummeted, and people who don’t normally pay attention to niche tech things are digging into concepts like what a blockchain is. (We also suspect that some of our colleagues think we were able to pull off this whole early retirement thing by striking it big with bitcoin
We don’t buy bitcoin or any cryptocurrency. And, frankly, if you care about your own financial security, we don’t think you should either.
Quick refresher on bitcoin and cryptocurrency
If you need a primer on bitcoin or cryptocurrencies generally, here are some good ones:
• New York Times
• New York Magazine
• Telegraph UK
• Ars Technica
Fundamentally, crypto is peer-to-peer virtual currency with no middleman like a government or bank standing in the way. It’s virtual because there are no actual coins, and it only exists digitally, which requires records. All transactions are anonymous, and are intended to be secure and private, so there’s no record that says “Jane Smith has 10 bitcoins.” Instead, Jane has one or more 64-digit (or 256 bit) keys that are her proof that she owns however much bitcoin she owns. (That anonymity enables illegal transactions to be conducted with it, but I honestly don’t care about that. Crime will find a way.)
For bitcoin or any cryptocurrency to exist without a central processor, you need a decentralized and democratized network of computers to keep those essential records, so that every bitcoin owner knows what he or she owns and can prove it. That record ledger is called the blockchain, and this short video is a good basic explainer. If you want the geek version of the explanation that goes a lot deeper into cryptography, read this one. But think of the blockchain as the secure data ledger for the currency, which lives in many different computers around the world. Every transaction that has ever happened with bitcoin is logged in the bitcoin blockchain.
Enabling the exchange of bitcoins and all cryptos are cryptocurrency exchanges or digital currency exchanges. These are the intended-to-be-secure businesses that facilitate the transferring of digital currency from one account for another for a fee.
What to do in your 50s to build wealth for your retirement
Bitcoins are created through “mining,” and there is a diminishing and finite number that will ever be created, which is intended to boost their value and create scarcity. For that reason, early investors paid peanuts for multiple Bitcoins, while today a buyer might buy a fraction of one for thousands of dollars. (No point putting today’s value in here because it will be irrelevant in an hour.)
The New York Magazine piece nicely sums up what Bitcoin (or any cryptocurrency) was intended to be, and what it has become:
“[A] theoretically untraceable and unhackable version of PayPal, more or less. But so many people got so excited about buying into the system that a market developed around buying and selling it — with bitcoin becoming less important as a currency than as a commodity, like gold. You can still buy things in bitcoin (like you can with gold, sort of), but many more people are now using it as an investment vehicle.”
It’s the fact that bitcoin and other cryptos are now used first as an investment vehicle, and only marginal as a repository of value, that we’re opposed to buying them.
Here’s a lot more detail on why we’re anti-crypto:
It’s clearly a bubble right now
You could take it from Robert Schiller, who wrote:
“Dabbling in bitcoin lies somewhere between gambling and investing. after all, true investing requires a rational appraisal of an asset’s value and that is simply not possible at present with bitcoin… It is not just that very few people really comprehend the technology behind bitcoin. It is that no one can attach objective probabilities to the various possible outcomes of the current bitcoin enthusiasm. [Note: “current enthusiasm” = bubble.] … Bitcoin is an example of ambiguity, and the efficient market theory does not capture what is going on in the market for this cryptocurrency… Researchers showed in 2006, for example, that when making decisions involving ambiguity, people do not use the parts of the brain required for calculations of probabilities and expected values… This is fascinating from a psychological perspective. But it isn’t grounded in solid economics.”
Or from George Soros, who said:
“Bitcoin is not a currency because a currency is supposed to be a stable store of value and the currency that can fluctuate 25% in a day can’t be used for instance to pay wages because wages drop by 25% in a day. It’s a speculation. Based on a misunderstanding.”
Or you could look at some data yourself. This volatility chart, comparing B$ to the S&P 500
and to gold, says a lot:
Citi Private Bank, the folks who did the chart above, found that:
“Bitcoin’s correlation to the S&P 500 was virtually zero, while its correlation with gold was 0.054, meaning gold and bitcoin only trade in sync about 5% of the time—a relationship so negligible as to be insignificant.”
— Jen Wieczner, writing in Fortune
That itself is not a fatal flaw, but it does tend to suggest that bitcoin is operating independent of larger economic forces. When the stock market crashes, housing prices tend to be impacted. When the dollar fluctuates, imports and exports shift. Economic forces don’t exist in a vacuum, and are all interconnected. So if something is operating almost entirely out of that interconnected system, as the Citi analysis and Schiller quote show? It’s probably a bubble.
And when you see a bubble, run away, quickly. But even if it wasn’t a bubble or super volatile, there are still some important reasons not to buy crypto.
[Update: There are now concerns that the price of bitcoin is being manipulated and propped up by Bitfinex and its dollar-backed cryptocurrency Tether. Which just adds to bubble worries.]
It’s not actually secure — or private
The entire idea behind bitcoin is that you have this secure, private currency that can’t be tracked. Except neither of those is true in reality.
Bitcoins and other cryptocurrencies have proven fairly easy to hack and steal. There was the first big bitcoin exchange hack in 2014, of Mt. Gox, which was then valued at $473 million, and which caused the exchange to shut down, restricting users’ access to their bitcoin wallets even if their particular bitcoins weren’t stolen. (And because bitcoin is only quasi-legal, those users didn’t have same litigation recourse they’d have if a site just decided to restrict access to their money. There’s no FDIC for this stuff.) There was the NiceHash Bitcoin hack, valued at north of $70 million. There was the DAO Ethereum hack, which — unlike other hacks — didn’t hit an exchange or wallet site and instead targeted the “smart contract,” and was valued at $70 million. There was the $72 million Bitfinex hack in 2016, followed by the cyberattack that shut down the same site. There was the $500 million hack of Coincheck, a Japanese wallet site for the NEM cryptocurrency. And those won’t be the last. (And these are not theoretical money numbers. These are real people’s real Bitcoins or other currency units.)
Crypto fanatics will say that those hacks weren’t flaws in bitcoin itself, or any other currency, but rather with servicers who operate a level above the blockchain. They argue that these hacks can be prevented in the future, as though hackers sit still and don’t keep trying to find new ways to steal things. But, fine. Let’s pretend the security is a short-term problem.
Read: How to get a job working with bitcoin
Even if future crypto is totally secure, it still won’t be as private as it’s intended to be. Blockchain surveillance firm Chainalysis, and certainly others, tracks every transaction on the bitcoin blockchain and now even has multiple U.S. government contracts to monitor for illegal transactions. If you want to hear the kind of stuff they can figure out by looking at supposedly anonymous key codes, listen to this recent episode of the Reply All podcast. They believe they’ve found the hacked Mt. Gox Bitcoin fortune, and they can extrapolate from transaction data nearly everything you’d want to know about any bitcoin user.
So let’s say you’re willing to wait out the bubble, and you don’t care about security (why?!) or privacy (fair enough). There’s more.
Read: What we’d do differently if we had kids
It’s easy to lose
Because bitcoin is anonymous, there’s no record anywhere that you own however much bitcoin you have bought. The only proof you have is the digital key you get when you buy it, which is what lets you reference your ledger entry on the blockchain and at some point sell or transfer your value. But turns out that digital key is easy to lose.
A recent study concluded that nearly a quarter of all bitcoins ever mined are lost forever, because people lose their key codes all the time, especially folks who invested in the early days when each coin wasn’t worth that much. And there are the sad sack stories that come along with that, like the guy in Wales who accidentally threw out an old hard drive with his bitcoin keys on it, currently worth maybe more than $100 million, and his local government won’t let him dig through the landfill to find it.
If you lose any other password or account number, there is always a way to look it up or retrieve it. Not so with bitcoin. Even the incredibly sophisticated surveillance firms like Chainalysis can’t help you without a key code, as this Planet Money podcast episode highlights.
Read: Americans are giving bitcoin as a wedding gift
It’s terrible for the environment
I’m personally heavily persuaded by this one. Mining bitcoins is quickly becoming one of the most energy-intensive endeavors on the planet, and it’s only set to worsen. One analysis showed that Bitcoin mining now consumes as much electricity as the country of Denmark, enough to power 3 million homes, but others have questioned the assumptions in that study, and say it’s likely lower. By one estimate:
“It takes about the same amount of energy to produce a 50 euro bill as it does to power a 60-watt lightbulb for roughly half an hour. Producing the same value of bitcoin would require enough energy to power your house for four days.”
Writers have said that bitcoin will consume as much electricity as the entire U.S. by 2020, or even the entire world, costing us our clean energy future, and some say that’s wildly exaggerated (but it still consumes plenty of power). (Ethereum and other cryptos are subject to the same critique.)
Regardless of which extrapolated figure or projection is correct, no one disputes that mining bitcoins and running transactions on the blockchain consumes a lot of electricity. And as the price of bitcoin increases, the incentive to mine them will become that much greater because the reward for each coin will offset the cost of consuming more electricity, giving miners an incentive to use even more power, at least in the short term until the scheduled payout decreases.
And while, sure, there are new cryptocurrencies like Chia and Burstcoin that purport to consume far less electricity by using the blockchain differently (“proof of time” instead of “proof of work”), all the rest of these arguments still apply to any crypto.
For those who’d argue that the biggest server farms mining bitcoins and processing blockchain transactions aren’t hurting anything because so many are located next to hydro dams in China and geothermal vents in Iceland, so are not the same as burning fossil fuels or taking power away from major cities, there’s still a tremendous opportunity cost. We could be using that power to add value to the actual economy.
Transaction times are getting longer, which affects your value
The bitcoin blockchain is now so big and unwieldy (and getting bigger every day) that the network is struggling to process more than four transactions per second. Which means two things:
1. Fees associated with Bitcoin transactions are skyrocketing.
And as any reasonable investor knows, fees are the fastest wealth killer. If you moved your money out of a high-fee brokerage and over to Vanguard or Fidelity because you prefer low fees, then this alone should be reason enough to stay away from Bitcoin. But the longer transaction times also mean:
2. It can take days to process a single transaction, and given the huge price volatility (see B$ vs. gold and S&P chart above), you could potentially end up paying tons more than you intended to — or cashing out far less than you’d hoped — at the time when your transaction actually clears the network. Would you ever sell stock shares if someone told you, “Well, right now the shares you want to sell are worth $1000, but when they sell, they could be worth anywhere from $400 to $2000”? If you say yes, then accept that what you’re fundamentally doing is not investing, it’s gambling.
Read: Don’t write off high-cost states for early retirement
You don’t own anything of value
This is an old-school economics 101 argument, but as someone old enough to have lived through the tech crash at the turn of the millennium, I remember when some investors lost absolutely everything because so many of those dot-com boom darlings didn’t own anything. When they folded, they didn’t own any bricks-and-mortar buildings, or equipment, or anything to liquidate that would have paid forlorn shareholders something.
If you own stock in a company with physical property that folds, you can at least get the proceeds of the sale of those properties, so in a sense, you are diversified in those stockholdings by owning both the company and its real estate. With crypto, you own nothing. If people stop speculating and this bubble bursts, there’s no thing underlying your bet.
Read: 5 cryptos to keep an eye on this year, according to Katy Perry’s fingernails
More than that, something only truly has value if we all agree it has value. Gold has value beyond being an investment instrument, and everyone in the world sees the U.S. dollar as being worth something. A dollar is also backed by the full faith and credit of the U.S. Treasury, which is unlikely to disappear anytime soon. There’s consensus around a dollar’s value, and that is one of several forces keeping that value stable.
While anyone could argue that cryptocurrencies are still new and therefore don’t have that consensus yet, there are a lot of good reasons why getting to that consensus is unlikely. And for those who argue that Bitcoin and other cryptos do have underlying value, because theoretically people could also decide to stop trusting the U.S. government, for example, a currency that is backed by a central bank (especially the most powerful one in the world, which is decently good at doing things like controlling inflation through monetary policy) is fundamentally different than a currency backed and guaranteed by no one.
Read: Why early retirement is a trip back in time
You will virtually always do better not trying to beat the market
The first rule of sound investing is not to try to beat the market. That’s when you fall prey to hot stock tips that later crash and get emotionally invested, which leads to buying high and selling low. Very smart and successful investors like Warren Buffett remind us that you don’t need to beat the market at all to amass wealth, you just need to match it. Historically markets return well above the rate of inflation, which means that in the long term your money will always grow in value if it’s invested in a broad swath of the economy, in things like the low-fee index funds that many of us financial independence enthusiasts love. Also, does it need saying? Get rich quick schemes don’t work, except for the tiny fraction who go on to star in the infomercials.
Read: Heed Warren Buffett’s warning: bitcoin is pure FOMO
Buying Bitcoin is the very definition of trying to beat the market, and history shows that doesn’t work out well for most people. (Even the pros!)
The role cryptocurrency can play
If you want to make bitcoin or any other cryptocurrency part of your portfolio, just treat it as your gamble. Whatever you’d be comfortable putting on a craps table or roulette table in Vegas and potentially losing in its entirety, use that money to buy crypto. Or whatever money you would otherwise have used on gaming or some hobby, use that. But don’t treat this volatile, insecure, speculative bubble “asset” as an investment. Put your real money into index funds, dividend stocks, real estate or other assets that will generate passive income and reliably grow wealth for you.
But if you do buy it, by all means, keep your wallet secure.
Thiscolumnwas published with the permission ofOur Next Life.