Bitcoin’s price — like the Dow Jones Industrial Average — does not mean what you think it does
Whether you follow cryptocurrencies like bitcoin or track stock market indicators like the Dow Jones Industrial Average, fast and dramatic changes can turn each day into an emotional rollercoaster. That’s particularly true on days like Wednesday, when the Dow closed at a record high above 26,000 just a week after hitting 25,000, and bitcoin fell below $10,000 — less than six weeks after topping $19,000 — before rebounding above $11,000 Thursday.
Those paying attention might wonder: “What does this mean? Is it time to sell my cryptocurrency and buy some stocks? Or should I actually sell my stocks and finally buy some bitcoin like my cousin keeps saying?”
This feels like a smart question. Momentum traders can make good money by leaning into trends, while value investors take a different tack, scooping up undervalued assets when others overreact to bad news.
But — unless you are a day trader, and among the mere 1% who are predictably profitable — what feels smart is probably not wise.
For one thing, big headline numbers tend to obscure more complicated stories. Likewise, the best financial decisions for most people, and the questions we pose to arrive at those choices, are oriented not toward short-term betting (“what should I buy and sell?”) but long-term planning: Am I investing what I need to in my retirement account — or in my technical knowledge and skills? Am I taking on too much risk, by gambling on stuff I don’t understand? Or am I not taking on enough risk, in fact?
Here are two major misunderstandings about investing — whether in stocks or cryptocurrencies — and the bigger-picture lessons we should be focused on instead.
The stock market, the economy and your financial fate are intertwined but separate
The Dow Jones Industrial Average, a bellwether index of large U.S. companies meant to represent the broader stock market, closed Wednesday at a high over 26,000 — for the first time in its history — with a faster-than-ever 1,000-point rise in the past seven trading days.
But the significance of the Dow’s moves is easily overstated. How so?
Let’s first set aside the perennial flaws in reading too much into the Dow — as its record highs seem less meaningful when you remember the highly curated group of just 30 stocks rises along with inflation and obscures losing streaks by periodically removing its poorest-performing members. Likewise, let’s forget for a moment that the Dow is not even the best gauge of the U.S. stock market, reflecting a tiny number of huge multinationals that are easily buoyed by global growth rather than domestic strength.
Let’s even set aside quibbles with the attribution of the Dow’s performance to President Donald Trump’s “bump” — which looks less unprecedented with historical and international context: U.S. stocks were actually surpassed in 2017 by markets in other developed countries, including Germany, China and South Korea, as Derek Thompson wrote in the Atlantic. And earnings growth and market gains look similarly more earthbound when compared to those under other Republican presidents or Democratic President Barack Obama — who saw the Dow rise more than 31 percentage points in his first 234 market days (inauguration through mid-December) versus 24.8 points during an equivalent period for Trump, as Philip Bump at the Washington Post pointed out.
Crucially, not only are stock market gains more modest in global and historical context, but the effects of those gains on Americans’ economic fates tend to be overstated. The stock market, simply put, is not the same as the economy, and its gains can and should not be conflated with an “economic boom,” as veteran Marketplace host Kai Ryssdal tweeted.
Data suggest only about half of U.S. households hold equities at all, and if you are among those that do, you likely own relatively little in those stocks — with the top 10% of households by net wealth controlling 84% of all shares.
What does this all mean for you?
On a personal level, if you have effectively sat out this stock rally because you haven’t been saving the recommended minimum 10% to 20% for retirement — with roughly one times your annual income stashed away by age 30 and three times your pay by age 40 — it’s a reminder to get moving.
Don’t yet contribute to a tax-advantaged retirement plan, like a 401(k) or IRA? Use any FOMO you feel about missing out on big gains to motivate you to start. Set an asset allocation that aligns with your risk tolerance; holding some bonds can be a hedge against potential stock losses undoing gains in your portfolio. Then forget it.
Importantly, forget it even if the market takes a downward turn — as it well might, given warning signals like flattening yield curves in the bond market and stock price gains outpacing real earnings. Instead, learn from the last financial crisis, when those who stayed invested through the worst ended up with more money than those who dropped out to limit losses.
If you’re a worker, lean into positive economic trends: On one hand, Bureau of Labor Statistics data suggests new job creation has ticked down, totaling 2.1 million jobs in 2017 versus 2.2 million in 2016. Yet unemployment remains low and falling, which gives workers leverage to bargain for higher pay. So make 2018 the year you consider a job change or push for an overdue raise.
Finally, if you’re among the lucky bunch who is already invested, happily salaried and doing great, take the opportunity now to shore up your emergency fund — and pay forward some of your good fortune to those who need it more.
Even though most signs today suggest the economy is healthy, “expansions don’t last forever,” as University of California, Berkeley, economics professor Barry Eichengreen wrote on Project Syndicate, and “a sunny day is the best time to check whether the roof is watertight.” Alas, Eichengreen argued, a storm is coming and the U.S. is “poorly prepared for the deluge.”
The reason: “Policymakers normally respond to recessions by cutting interest rates, reducing taxes, and boosting transfers to the unemployed and other casualties of the downturn,” he wrote. Yet U.S. interest rates are already low, taxes are already cut and the current administration has made clear its mission to slash, not boost, spending that helps those struggling financially.
Not to mention, “the kind of international cooperation that helped to halt the 2008-2009 contraction has been destroyed by Trump’s ‘America First’ agenda,” Eichengreen posited.
So be prepared for the worst, even as you expect the best. The good news, despite the fact that the current economic recovery is nearing a decade — placing it on the older side of expansions, historically — is that data suggests these expansions don’t simply die of “old age,” and can keep going and going.
In other words, it’s possible the economy could have several healthy years or more left before the next recession: Take advantage of them.
The Bitcoin story is just the beginning for cryptocurrency
While stock market bulls might gloat right now, so too might cryptocurrency bears; the price of bitcoin — as well as those of other leading coins and tokens, including Ethereum-traded ether, Ripple, Litecoin and Cardano — took a harsh dip this week following regulatory crackdowns on trading overseas.
While they had mostly bounced back by Thursday, there’s still a strong case that the per-unit prices of these cryptocurrencies — and bitcoin in particular — are overly inflated.
Why? As people continue to pile in to cryptographic digital coins, driving exchange rates up, there is a fundamental fallacy at play for many “investors,” at least according to New York University Stern School of Business finance professor and stock valuation expert Aswath Damodaran.
Specifically, when enthusiasts talk about bitcoin, they tend to describe it as a new asset class — comparable to cash-flow generating assets like businesses, bonds, stocks and options — that everyone will want to have one day to help diversify their portfolios. Painting this picture helps justify sky-high prices.
But all signs suggest bitcoin (and those cryptocurrencies that behave like it) are really currencies, not assets, a point made in an October blog post by Damodaran. What that means is, unlike stocks, you can’t “value” bitcoin, just price it; you can’t “invest” in it, you can just trade it. You can certainly make a lot of money by trading it smartly (or luckily), buying low and selling high. But an investor that does not make.
Now, if you do treat bitcoin as a currency, in theory you can predict the long-term exchange rate using the “quantity theory of money”; one extremely back-of-envelope attempt from September found a more reasonable price would be about $1,000 — roughly 10 times lower than the current figure.
But even that assumes, as Damodaran put it, that bitcoin will be “accepted widely as a medium of exchange.”
The problem is that, as a medium of exchange, bitcoin is slow and expensive to use — with average transaction fees around $28 and transaction times that can range from more than an hour to nearly 20 on average. Yet bitcoin’s pricing doesn’t reflect those drawbacks.
“If it becomes gold-like, a fringe currency that investors flee to during crises, its price will be lower,” Damodaran argued. “Worse, if it is a transient currency that loses all purchasing power, as it is replaced by something new and different, it will crash and burn.”
It’s hard to know if or when a changeover to “fringe” or “transient” could occur. Even bitcoin futures can’t tell you much about the actual future of bitcoin and other cryptocurrency prices, including whether there is a bubble, and when such a bubble might pop, as Bloomberg’s Stephen Gandel argued. One worrisome observation by researchers is that bitcoin’s price has likely already been distorted in a big way: A new study — published in the Journal of Monetary Economics by researchers from Tel Aviv University and the University of Tulsa — found that “a single actor likely drove” bitcoin’s price to jump from $150 to $1,000 over two months in 2013.
But what Damodaran’s analysis shows — correct pricing aside — is certainly not that cryptocurrency in general is worthless.
For one thing, when a more ideal coin or token one day comes along — that’s the absolute quickest, easiest and cheapest to use (and is perhaps more environmentally-friendly than bitcoin) — it could be adopted worldwide, and early buyers could reap big gains. While they have their own flaws, other existing cryptos do improve on bitcoin as a medium of exchange, with lower transaction fees and faster transaction times. Whether that “ideal” crypto yet exists (or can meet other standards, by being sufficiently decentralized, for example) is another question.
Still, Damodaran wrote in a follow-up post that certain cryptocurrencies, like Ethereum-traded ether tokens, might actually act like promising commodities rather than currencies because of the role they play in smart contracts: traceable, transparent, self-executing programs that automate transactions.
Success for early buyers, though, still requires a few assumptions, specifically that “blockchains and the smart contracts that emerge from them will replace conventional contracts ... and that will generate cash flows to the contract providers” — and also that “cryptocurrencies are a necessary ingredient to make smart contracts work efficiently, and that the demand for them will then rise as smart contracting expands.” In other words, there are a lot of “ifs” involved for you to get rich from ether in the long run.
It is clear that the innovation powering bitcoin and Ethereum alike — the blockchain — seems to have the potential to disrupt many spaces beyond currency, from health care to voting. Writer Steven Johnson argues in the New York Times magazine that the most exciting part of blockchain technology is “its potential to break up large concentrations of power and explore less-proprietary models of ownership.”
“The blockchain may seem like the very worst of speculative capitalism right now,” Johnson wrote. “But the beautiful thing about open protocols is that they can be steered in surprising new directions by the people who discover and champion them in their infancy.”
Now, even these hopes must be tempered somewhat: Blockchain is powerful, but not infallible, particularly if a major black swan event were to occur, making it easier for bad actors to hack or cheat the system — say through a faster-than-expected advance in quantum computing, as a recent report in MIT Technology Review highlighted.
But if one thing is for certain, it’s that those with more knowledge and understanding of coding and cryptography will have more power in the future.
If you want a piece of this movement, you’ll have to do far more than just “research” (#DYOR): Buying random altcoins based on random tips on the internet is a recipe for getting scammed. Just like the best question to ask after watching the Dow hit new highs is not “should I buy or sell stocks” — but rather, “am I saving enough money?” — the question to ask as bitcoin plunges or rises is not “should I buy or sell bitcoin?” or even “which cryptocurrency should I buy?”
Instead, it’s: “Do I understand cryptocurrency? Do I believe in blockchain? Do I care about this topic enough to not just place bets with my cash, but to put time and energy into further education?”
If your answer is yes, then by all means “invest” in cryptocurrency — by studying blockchain, cryptography and coding. Crypto-related job postings are on the rise, and even if you have a non-technical background — like in law — it’s still worth learning what you can. The tangled thicket of new legal challenges created by bitcoin and blockchain’s rise means there’s already growing demand for lawyers that can navigate around the thorns.
Put another way, “a gold rush is a good time to be selling shovels,” as Jeff Koyen wrote for New York magazine.
And if the siren call of buying cryptocurrency outright is too loud for you to ignore? At the very least, trade coins with only that cash you can afford to lose completely, read up on stop and limit orders to help protect from devastating losses, and never ever borrow money to buy crypto.
It’s only human to mistake good luck for expertise, and to allow the fantasy, FOMO and impatience of trading stocks and cryptos distract from the real key financial questions in our lives: How prepared am I for a big downside shock? Am I committing regular acts of kindness to my future self (by saving money)? Am I ultimately chasing luxury or security?
In short, the best lesson we can take from following stock and cryptocurrency markets is not how to suss out buy or sell signals: Too much information on a daily basis can in fact be harmful if it triggers us to buy high and sell low. But headline numbers can alternatively be helpful, if they are a wakeup call to finally build an all-weather financial plan — and then commit to sticking to it, no matter what you see in the news.
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