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By Francis Bayes, WCI Columnist
I wrote the first draft of this column in December 2021, and since then, crypto (currency, assets, securities, whatever you want to call it) has entered winter. Instead of publishing a column that pretends to have seen it coming or writing a piece that makes me look like a fool, I want to share the original draft with my own up-to-date comments (in italics). I consider it akin to responding to reviewers after submitting a manuscript to a peer-reviewed journal.
Should You Buy Crypto in the First Place?
Many of the WCI readers have won the game or are well on their way to winning the game, so they can ignore crypto (or for Bitcoin maxis, Bitcoin and crypto) with their “serious money” and enjoy financial independence. Any extra return might not be worth the attention that their volatility attracts–or in the case of “stablecoins,” not worth even a hint of risk. The stock market falling 10% is a big deal. But Bitcoin and other crypto drop 10% almost every month. One can use “house money” to “buy the dip” in a disciplined manner with the goal of “wealth creation,” but their time might be more valuable than whatever absolute return they generate from following the prices.
Stablecoins DEFINITELY are not worth the yield; here is an update of what has happened in 2022: an algorithmic stablecoin TerraUSD and its sister Luna collapsed, Tether, the largest stablecoin, fell below its $1 peg, and Celsius–one of the largest crypto lenders–suspended transactions. While I bought crypto, I never used stablecoins or “crypto saving accounts.”
For those of us who are beginning our journey to financial independence (i.e., will be saving for the next 20-30 years), we should also ignore crypto until we (1) have term life and disability insurance in place and (2) max out the 401(k) employer-match, Health Savings Account, and Roth (or Traditional) IRA. Paying off debt first might have a bigger emotional and mental payoff, too. Building a personal safety net and saving habits are like installing an autopilot to financial independence.
Once the autopilot is in place, many of us ask questions on Reddit, The White Coat Investor forum, and the WCI podcast about what to do next. I buy crypto with a small portion of my additional savings for peace of mind. I will share why, but this column is not about the merits of blockchain technology and crypto. This is about how I protect my emotions, which affect my behavior and the amount of time I think about my finances.
The selfish side of me rejoices when the stock market crashes (SALE!). But I have realized I am more ambivalent about executions of hopeful limit orders on a Saturday morning (see the image below) because crypto crashes are so rapid and random. Crypto has not ruined my weekends because it has never been more than 2% of my portfolio. If it ever exceeds 2%, 2022 should be a reminder that I should sell, lock in my gains, and rebalance for my peace of mind.
I prioritize my emotional health in every aspect of my investment plan because I know I can win the game by doing so. I only own index funds because I tend to regret a lot of decisions. I do not want to think about which stocks I should have picked and when I should have bought or sold them. I just keep buying the same index funds every year and every month so that I minimize my regrets.
I am investing “actively” when I overweight certain asset classes (e.g., small-cap value stocks), but still, one of my main goals of asset allocation is to regret as little as possible in the future. I have overweighted each asset class to the point where I would not wish I had allocated more or less in hindsight. If the S&P 500 returns nothing for a decade, I hope to find solace somewhere else in my portfolio so that I can keep buying US stocks even after such historical underperformance.
People have many reasons for pessimism about our society and the world. But even if I were to think our society has declined in the past decade (and will continue to do so), I want to keep buying US stocks as long as the US economy continues to attract the best talent in the world. Medicine and biomedical research are good examples. As much as physicians want to complain about the US healthcare system, foreign medical graduates still want to practice here. Although funding for biomedical research has been woefully insufficient, American institutions still attract foreign researchers who transform their fields. No matter how much we discourage college students from pursuing medicine or research, the US will continue to have physicians and Nobel-winning laboratories.
For both crypto- and non-crypto-investors who are skeptical of the future of the US economy, here is a Warren Buffet quote: “In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
Is Crypto Having Its Own Dotcom Bubble?
Speaking of discouraging medicine, many talented college students do not need our advice. They are aware that jobs in other industries (or other professions in healthcare) are better than medicine for making money. Software companies have attracted talent because they are some of the biggest companies, and vice versa. Love them or hate them, but whoever such companies recruit knows how to hack computers and our brains.
In the long run, the stock market is driven by earnings growth, and earnings tend to grow when talented individuals create value for the society. Some who flocked to software companies, such as Facebook and Square (aka Meta and Block, respectively), are joining projects related to layer-1 or -2 blockchain protocols, decentralized finance (DeFi), non-fungible tokens (NFTs), and the metaverse. Venture capital firms that invested in household-name companies have poured more than $27 billion into such “Web3” projects in 2021. Most of the projects will probably fail. Many observers have compared the influx of cash into crypto with the Dotcom bubble.
In 2022, the bubble popped. Software companies and crypto are in a bigger drawdown than the broader market (Meta, Netflix, and Zoom are now value companies). People discovered that some of the “talented individuals” can also be good charlatans, gamblers, and scammers (as hinted by Sam Bankman-Fried, the founder and CEO of crypto exchange FTX). Many VC firms will continue to lose money, and most projects will fail for good reasons (as per someone who said many “no’s”). Buffett is right again when he said, “only when the tide goes out, do you discover who’s been swimming naked.”
But some also note that many of the grandiose predictions about the internet during the Dotcom bubble were not wrong but just too early. Although we cannot envision the use cases for the crypto-related projects (such as DeFi), when I reflect on what talented people have achieved writing codes for the internet, I want to bet on what a new generation of talent will figure out for crypto and Web3. I do not know which, but some projects, such as those based on Ethereum, could become a sizable part of the US economy because talented people are improving the technology, starting interesting ventures, writing about it, and believing in it.
Because I share some of the optimism, I am comfortable buying crypto even though I cannot address the following concerns. (1) A common argument against the Dotcom bubble comparison is that the internet was still useful at the time, but crypto still is not. (2) Will the “talented individuals” and crypto be our generation’s Isaac Newton and alchemy? (3) Bitcoin, Ethereum, or another blockchain may survive and become useful for “Web2” companies, financial firms, or the music industry; however, “another blockchain” may not exist yet.
Why I Bought Crypto; Should You?
I do not mean that I trust the crypto-related projects to solve the problems on the internet or in the financial industry. I do not look forward to the society where my children’s friends are living in the metaverse (no way I let my children spend any time in it!) If all the metaverse-related projects fail, I will not only rejoice but also not feel any economic pain. But if the metaverse becomes a trillion-dollar industry, I do not want to regret that I did not invest in it.
After more than a year of skepticism, I made my first purchase in May 2021 because of crypto’s potential for positive returns in the next 20-30 years. When the price of Bitcoin dropped by half in May, enough people believed in it to not panic and sell. If anything, they bought more. The same applies for Ether. With less than 5% of my new savings, I will keep buying a basket of cryptocurrencies, little by little, even if their prices, which seem to be correlated to one another, could fall 80% between now and when this column is published. My purchases are mostly automated so that I am not tempted to “time the market.” My small allocation to crypto will not move the needle in terms of how soon I can be financially independent. But at the very least, buying crypto will not significantly delay my financial independence if it prevents me from envy and greed.
If you do not own crypto, how you are behaving as an investor in the current S&P 500 bear market should be a litmus test for whether you should own crypto in the future. Bitcoin, Ether, and other crypto fell below their 2020 levels because enough people were afraid and sold. They could fall more because they have no “intrinsic value.” Thus, even in the “intermediate case” in which crypto’s returns are 2-3x that of equities, Big ERN does not think crypto is attractive due to its volatility and correlation with stocks.
But I am passing the test, and I do not see a reason to change my thesis: some smart people will figure out some useful things with crypto, and I do not want my FOMO to affect other aspects of my financial plan. I have not sold any crypto, though I am reluctant to buy crypto other than the mega-cap crypto (i.e., Bitcoin, Ether, and maybe Solana) during this crypto winter. Even though I try to buy a “basket” of crypto, it feels more like stock-picking than buying the whole market, and I can only tolerate buying the new lows with the mega-cap crypto. Hopefully, more diversified and value-oriented crypto investment products become available. Until then, I am going to stay the course with my allocation to crypto and have some fun with ridiculously hopeful limit orders to make myself feel better.
Is now the time to buy crypto? Would you be getting them on sale? Or will it just continue to fall into irrelevance? Comment below!