Bitcoin Is a Penny Stock

Bitcoin is probably one of the more interesting phenomena I’ve seen in my many years of investing. I find it fascinating that the creator of Bitcoin is an unknown person who created a non-productive asset out of thin air that is now worth over $1 trillion! Not only that, Bitcoin has made multi-millionaires out of novice traders almost overnight!

While cryptocurrencies like Bitcoin may be attractive, they can also be risky! An investment is an asset that you buy intending to generate income or appreciation over time—sound investments tend to be more predictable. Speculative investments add a high level of risk and unpredictability—they are akin to gambling. Bitcoin falls is considered a speculative investment.

Today, I will attempt to put Bitcoin in perspective and identify some potential risks.

A New Trade Bead

Trade beads were decorative glass beads used as currency starting in the 16^th century—they facilitated the international trade of slaves, gold, and other goods. These ornate beads were highly prized in Africa and were considered a sign of wealth. Because the beads were difficult to manufacture and only a few places in Europe knew how to make them, Europeans used them as a cheap and efficient means of exploiting African resources.

In today’s world, where bead manufacturing is commonplace, it is difficult to understand why someone would sell their gold, silver, and precious gems for glass beads. And yet, at the time, it was very logical to exchange real valuable assets for something that was created in a kiln.

So, whatever happened to trade beads? If they were such a fantastic thing—why don’t we use them anymore? Why can you only find them as antiques for sale on eBay? The truth is that beads were only valuable until the manufacturing of beads because so common that they lost their uniqueness.

Cryptocurrencies were created on many of the same premises as trade beads, with one notable difference—the blockchain code that forms the foundation of Bitcoin is finite. If Bitcoin were the only digital currency that could ever exist, it could hypothetically retain value for as long as we were willing to use it for trade. However, that is not the case. There are already over a dozen digital currencies—this may mean that Bitcoin and other cryptocurrencies may have already begun to lose their uniqueness and, subsequently, their value

Beware the Allure of Penny Stocks

Penny stocks are publicly-traded companies that are so cheap that you can buy thousands of shares for almost nothing. Conceptually, if you buy a stock for $0.01 and then it goes up to $0.02, you have doubled your money. A major downside to penny stocks is that they are so small that they are open to manipulation by stock promoters and pump and dump schemes.

Imagine a company whose market cap (value of all their stock) is worth $10 million. Now imagine a huge hedge fund placing a $10 million purchase order in a single day—all the available shares will be immediately sold, and the price of the remaining shares will skyrocket until they too can be acquired. Even if the company’s performance has not changed, its stock value will increase due to the supply and demand of its shares.

Because cryptocurrencies don’t produce anything, some people believe they are similar to penny stock investing—investing in hopes that you can catch it on its next upward swing.

Conclusion

Bitcoin’s volatility and speculative nature make it very risky. Bitcoin doesn’t produce anything—its value is derived solely from the money people add to it and its intrinsic supply and demand. If everyone stops buying it tomorrow, what happens to its ‘value’? Is there someone willing to exchange real assets for Bitcoin if there is no way to exchange them into fiat currency?

If you are considering an investment in Bitcoin, I highly recommend evaluating your risk tolerance before investing. If you don’t know your risk tolerance, please give my office (Sterling Wealth Management) a call at 702-228-0500 for a consultation.