Bitcoin is kicking sand in the face of traditional investments. Between July 1, 2013 and June 13, 2017, it gained 3,130 percent. To put that in perspective, it took Vanguard’s S&P 500 thirty years (from its 1976 inception) to make investors that much money.
Bitcoin, for now, isn’t slowing down. Its price has risen more than 170 percent in just the past six months. If you had invested in Bitcoin’s rival, Ethereum, you might be even giddier. During the six-month period ending June 13, 2017, it gained more than 3000 percent.
These are called cryptocurrencies. Bitcoin was the first. It’s also the most widely accepted. Satoshi Nakamoto (not a real name) created it in 2008 as a peer-to-peer electronic cash system.
Drug dealers were among the first to use Bitcoin. That’s because it’s tough for authorities to follow the transactions. But since its introduction, Bitcoin’s price has yo-yoed like a junkie on speed. A $1000 investment in Bitcoin in November 2013 fell to just $150 two months later.
This kind of drop could leave its users or investors with a really big headache. Business Insider UK interviewed a drug dealer in 2015. He had been burned by Bitcoin’s then-recent crash. “It’s pretty damn sad,” he said. “We have worked so hard over the past 3 months, and for profits to get halved? It’s hard to swallow, simple as that, but what can you do. It’s a gamble, whether you hold or sell.”
It’s tough to feel pity for a guy who pushes drugs. But there’s truth to what he says. Bitcoin and other cryptocurrencies aren’t businesses, bonds or real estate. They don’t create cash. They rely, instead, on the greater fool theory. They’re only worth as much as the market wants to pay.
Short-term, that’s also the case with stocks. But if they produce cash–from reinvested earnings or dividends– their prices can keep rising. If they don’t create profits, their prices won’t increase. Apple, for example, might create a planet-changing gizmo. But if net income doesn’t follow, its price won’t rise.
Each generation has to learn the same lesson. In the early 1700s, Sir Issac Newton fell for a company that promised to shake the business world. He bought South Sea Company stock. It was meant to facilitate trade with the Americas. Back then, that was like a promise to bring riches from the moon. The stock rose on hope. But the business didn’t earn profits, so the price soon collapsed. Newton, who lost a small fortune said, “I can calculate the movement of stars, but not the madness of men.”
“This Time It’s Different.” These are the four most dangerous words for investors. They were whispered during The South Sea Bubble. They were uttered during The Dutch Tulip Craze. They were shouted from the rooftops during the 1990s Dot-com charade.
Bitcoin and its contemporaries don’t make profits. As a medium of exchange, they’re like new-age checks or fancy money orders. Much like a gold rush, those making profits will be selling pics and shovels. One such firm is iPayYou.io. It charges shoppers who use Bitcoin to buy from Amazon.com. As Money’s David Jacobson says, most mainstream companies don’t directly accept cryptocurrencies.
As for investing in Bitcoin or other cryptocurrencies, it might be best to turn an ear to Warren Buffett.
In an interview with CNBC he said, "Stay away. Bitcoin is a mirage. It's a method of transmitting money… The idea that it has some huge intrinsic value is just a joke in my view."
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and The Global Expatriate's Guide to Investing: From Millionaire Teacher to Millionaire Expat.