It is actually quite fascinating to look at the chart of Bitcoin. You will get to hear some Bitcoin success story India and you need not get carried away by that. There are also those friendly tipsters who will advise on how to earn Bitcoins in India. If one were to look at the 5-year Bitcoin chart below, there are 2 things that stand out. Firstly, the rally in Bitcoins is one of the craziest in all of history or at least close to being the craziest. Secondly, the huge returns on Bitcoins have also come at the cost of huge volatility.
Source: Google Finance
Between its launch in 2008 and 2015, the price of Bitcoin moved from $0.01 to $100. If you thought that was humongous returns then in the second half of 2017 it went up 10-fold from $200 to #20,000. What are the key lessons for India from Bitcoins?
Avoid investing in things you do not understand
If you are wondering what to do with Bitcoins, remember the basic rule in investing. Avoid investment in assets that you do not understand. Remember, Bitcoin is a crypto currency where the supply is determined by a series of algorithms about which you understand very little about. Also the control of currency creation is in the hands of a few programmers and not any central banks. Rather avoid something you do not understand!
Don’t worry about missing the Bitcoin train
If you heard your neighbour’s software programmer son boast about how he made money on Bitcoins, you do not need to overly exert yourself about it. After all, you never know whether Bitcoins are going to be legal in India or not. There is no asset class that has helped some investor become a millionaire without the concomitant risks. Equities over the longer run have delivered returns of 13-14% in India. Obviously, something is not adding up!
Prices will always climb farther than you think is possible
That is true of most bull market rallies. We have seen that in equities, and we have seen that in tulips and even in the South Sea Bubble. Between 1971 and 1979 the price of gold went up from $35/oz to $920/oz. Eventually, gold gave up more than 70% of its gains. Of course, the speculative bubbles like the Tulip mania and the South Sea bubble came to nought. But the moral of the story is that Bitcoins could go higher even from here!
Big gains come with big volatility
A long term chart of Bitcoin can be quite appealing but remember that this growth has come at the cost of huge volatility. The Bitcoin had touched a high of $1000 nearly 3 years back but then lost over 80% of its value. From $200 levels, the Bitcoin appreciated all the way to $20,000. Even from those levels, Bitcoin has lost more than 35% in a month. So if you are looking at Bitcoins that is the kind of volatility you need to be prepared for.
Be cautious of those who jump on the bandwagon
Any trend will have a lot of institutions trying to ride the bandwagon. They are just trying to catch up with the trend and hive off the risk to you. There are some Bitcoin funds that come with a huge cost of 2-4%. That is the kind of cost that you pay from your principal. After paying that kind of costs it is going to be hard to make money, unless Bitcoin continues to repeat its stellar performance till date.
Market has the capacity to speculate on almost anything
Markets are indifferent to the nature and the quality of the asset. As long as demand is in excess of supply there is going to be speculation on the upside. Most of these speculative assets are essentially based on the Greater Food theory. The hope is that at some point in the future there will be a greater fool who will absorb the asset at a higher price. We have seen that in the Tulip mania, South Sea Bubble and even in technology stocks in 1999.
There are flaws in the monetary system that needs to be fixed
This is perhaps the most important takeaway. Indian regulators and central banks need to take this lesson very seriously. Why did Bitcoins gain currency? It began when central banks decided to pump in unlimited liquidity into the financial system in the aftermath of the sub-prime crisis. This devalued currencies but the loss in value was not visible as all central banks were following a similar policy. That is where a non-fiat currency like Bitcoin gained popularity. The biggest lesson here is to put the monetary house in order. This applies not only to India but to all central banks across the world. Central banks holding $10 trillion of bonds is a basket case for the rise of crypto currencies like Bitcoin. Address the fundamental flaws, rather than worry about the Bitcoin rally!