4 Questions to Ask Before Investing in Bitcoin

The past week of market volatility and risk has been a textbook reminder of the benefit and disciplines of remaining a long-term investor. Over the past month I have received a barrage of questions about Bitcoin and how to invest. As a response, I began writing on the topic but was unable to publish prior to the market correction and drop in value of Bitcoin. With countries proposing new regulations on cryptocurrencies, Bitcoin’s value began to plunge. Nonetheless it was a great example of high risk investments, and hopefully these principles can be applied to your future investment impulses as you are reminded of Bitcoin.

Blockchain, nodes, cryptocurrency, algorithm mining, and a mysterious creator who goes by the name “Satoshi Nakamoto.” HUH?!

With all of the recent hype and excitement behind Bitcoin, I have seen many people jump into the craze with the mindset of, “They made thousands of dollars on this, why can’t I?” without fully understanding what they are investing in. (Here’s one of my personal favorites.) Though this story is fake, it is a great (and humorous) example of the lack of understanding around the currency.

With so many questions around the currency and the desire to invest, here are 4 basic questions that should be asked when investing in any individual stock or company:

1. What product or service do they offer?
2. What value do they add over competing companies?
3. How long have they been operating, and do they show market durability/longevity?
4. What is the risk and how would I respond to volatility?

Here’s how I would answer these questions as they relate to Bitcoin stocks:

1. My best understanding is that Bitcoin is a cryptocurrency, which isn’t traceable.
2. In its current form it is difficult to determine whether Bitcoin stocks are overvalued vs. undervalued.
3. The industry itself was only established in 2009, so with less than 10 years of history and a limited knowledge of the industry, it is difficult to say.
4. Viewed by most professionals as a high-risk sector, the current environment illustrates a “hyped up” activity in the stock with numerous inexperienced investors, potentially resulting in extreme price swings.

Peter Lynch, one of the most respected investment managers over the last 30 years, once wrote that his number one rule when investing was “Understand what you own.” Along with this rule, I have found that successful investing over time is a result of avoiding two basic human emotions: Fear and Greed. Ask yourself before you invest in Bitcoin whether you are being influenced by the latter. Trust this is helpful in your endeavor to invest successfully.

See also my recent post about the benefits of long-term investing for more applicable best practices.

Philip Tull

Philip Tull recently received his Master of Financial Planning from Kansas State University, and will soon sit for the CFP® exam. He is a skilled soccer player and coach, an avid snowboarder, and a fearless fisherman. One of his goals is to make sure his Millennial peers don’t spend the rest of their lives living in basements – whether real or proverbial.

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