Despite a turbulent 2020, one investment stood head and shoulders above all others: bitcoin.
The largest cryptocurrency in the world by market capitalization has more than tripled in value during the period from 12 months to 17 January. This is a cool 9.310% increase over the next five years. Bitcoin has been blowing virtually all other equity investments out of the water since the beginning of 2016, in terms of total return.
Bitcoin enthusiasts continue to point to its scarcity – a maximum of 21 million tokens will be mined – and growing adoption among traders as reasons for its excellent performance.
While there are smart ways to get rich from bitcoin, I believe there are also three terrible ways to invest in this fad.
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Riots Blockchain
There is no shortage of listed cryptocurrency stocks that have achieved the astronomical rise of bitcoin to their own huge gains. Mining Company Riots Blockchain (NASDAQ: RIOT) is a perfect example. Riot’s shares have risen more than 1,700% in the past year, giving the company a $ 1.7 billion valuation. Going a little deeper, you will see that even a tenth of this market capitalization can be too aggressive a valuation.
As a cryptocurrency miner, Riot uses a system of powerful computers to solve complex mathematical equations that confirm groups of transactions on the underlying ledger of bitcoin (its blockchain). Because they are the first one to solve a block transaction, cryptocurrency miners like Riot get a block reward of 6.25 bitcoin. This 6.25 bitcoin is worth more than $ 224,000 as of January 19th.
Although it is a fairly simple business model, it is also very capital intensive and extremely competitive. Riot Blockchain generated only $ 6.7 million in revenue during the first nine months of 2020. It generated the same net loss ($ 16.6 million) to September as in the first nine months of 2019. In other words, Riot may not even fetching $ 10 million. in 2020, but it has a market capitalization of $ 1.7 billion.
Furthermore, Riot Blockchain’s business model is only minimally driven by product development. Rather, it depends on sustained bitcoin euphoria. History has shown that interest in bitcoin is declining and flowing. As bitcoin interest peaks at $ 40,000 again, experience suggests that cryptocurrency miners like Riot Blockchain are heading in the boring direction sooner rather than later.
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Grayscale Bitcoin Trust
Investors will also be wise to avoid buying Grayscale Bitcoin Trust (OTC: GBTC).
Grayscale Bitcoin Trust is the first listed bitcoin basket security. Since the U.S. Securities and Exchange Commission did not give the green light to bitcoin-based mutual funds or exchange-traded funds, the Grayscale Bitcoin Trust was a popular buy among investors. As of January 19, Grayscale owned 632,761 bitcoin tokens, which were kept cool at the Coinbase Custody Trust Company. As Grayscale regularly updates its outstanding stock and bitcoin per share, investors can easily calculate the net asset value (NAV).
While buying a security on the over-the-counter exchange probably sounds a lot easier than buying and storing bitcoin from a cryptocurrency exchange, there is one major problem: the Grayscale Bitcoin Trust is almost always priced.
Years ago, it was not uncommon to see the Grayscale Bitcoin Trust at a premium of 30 to 120% on its net asset value. Things are not so bad these days, but they are still valued at a premium of 11.7% for the net asset value on January 19th. As if it’s not enough for investors to pay grossly too much for the value of the underlying ‘asset’, the Grayscale Bitcoin Trust charges a surprisingly high 2% annual fee to know exactly who knows.
Suffice it to say that this is not how to invest in bitcoin.
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Bitcoin
Finally – and who could not see that this fate would come from fate? – I believe it is a bad idea to buy bitcoin directly on cryptocurrency exchanges.
Last week, I outlined the issue of why complementary bitcoin stocks are much smarter and safer ways to play the euphoria around the world’s largest digital sign. I also maintained my view that bitcoin is the most dangerous investment in 2021.
While bitcoin enthusiasts will not admit it, their digital gold mine is full of potential flaws. This is fueled, for example, by the idea of false scarcity. Currently, code bitcoin limits to 21 million tokens. However, community consensus can increase the number of tokens. Since so many investors ‘bitcoin’ HODL and refuse to spend it, the only way bitcoin can get a profit, is through a huge increase in its circulating offering.
Bitcoin does not have the game changing. It sees many daily trading volumes as day traders and computer trading programs gamble in and out of the highly volatile cryptocurrency. But only 2,300 businesses in the US accept bitcoin as a means of payment. This is out of about 7.7 million companies with at least one employee.
Bitcoin is not unique. Last year, there were more than 10,000 blockchain companies in China. There is essentially no barrier to access to blockchain development, and there are no guarantees that this next-generation technology will even require bitcoin or crypto tokens to transform payment processing or supply chains.
I suggest you avoid direct investments in bitcoin. Rather, buy the supplementary businesses that benefit from it, no matter what happens to the world’s largest cryptocurrency.