What’s worse than missing out on bitcoin? Answer: hearing your friends talk about how much more money they made on it than you did. With bitcoin (CCC:BTC) and ethereum (CCC:ETH) once again pushing record highs, many people are revisiting the same old question, “Should I buy BTC?” (Or ETH, for that matter.)
The answer is complicated, as I’ve noted before. BTC, ETH and their peers are historically “risk-on” assets that go up when times are good and fall on bad news. That means cryptocurrencies will go up in 2021 if economic revival and the stock market run continues, but they’ll crash hard if the U.S. and world economies hit an unexpected snag.
So, where does that leave us? The 1990s tech boom/bust (and its eventual recovery) teaches us three key lessons for what will come next for BTC and ETH both.
- Winners will keep winning.
- Marginal players will lose out.
- Investors need to commit to the long run.
BTC and ETH Lesson 1: Winners Keep Winning
Cryptocurrencies are much like the glamor tech stocks of the late 1990s: They’re built on dreams of the future. And that makes their price a popularity contest — there are no earnings to report nor dividends to use in valuation. People don’t even judge cryptocurrencies on their underlying technology; bitcoin’s architecture is a decade old. Instead, cryptocurrency value lies in its user base. The more people buy a currency, the higher its price goes, and so on.
And that means winners will keep winning, much like tech stocks during the 1999 bubble. In the case of tech stocks, high stock prices feed a virtuous cycle: Amazon (NASDAQ:AMZN) used its high stock price in 2000 to secure cheap funding, tide it through the tech crash and gain millions of customers along the way. Its successes eventually pushed share prices even higher, leading to the Amazon we know today.
The same truth holds with bitcoin and ethereum, the #1 and #2 largest cryptocurrencies. Gone are the days of coding your wallet or forking over money to little-known cryptocurrency exchanges. Today, bitcoin is available to institutional investors via the Chicago Mercantile Exchange (NASDAQ:CME) and to mom-and-pop investors through apps like PayPal (NASDAQ:PYPL) and Square (NYSE:SQ).
Ethereum isn’t far behind. Smaller altcoins, on the other hand, often struggle for name recognition and availability. Bitcoin gold saw its value plummet 97% after it separated from bitcoin in 2017. Even dogecoin (CCC:DOGE), a popular meme coin, struggled for years to gain attention before breaking out.
A 2015 University of Pennsylvania survey counted over 1,100 e-commerce companies in 1999. By 2010, only 25 remained. Cryptocurrency will go through a similar shakeout. Of the 5,000 coins available today, only the most popular (if any at all) will reward investors in the long run.
Lesson 2: Ignore the Marginal Players
With bitcoin and ethereum trading at four-digit or five-digit prices, it’s tempting to try speculating on lower-priced coins. That’s a mistake — as tech stocks have taught, it’s easy to lose everything to failing momentum.
In 2000, Pets.com made its stock market debut with a highly anticipated IPO. Shares initially rose from $11 to $14. Its luck, however, started to fade as the tech bubble burst. Buyers trying to “catch the bottom” would have lost everything, because Pets.com’s sagging stock price meant the company couldn’t raise more money. Even if you bought shares for just $1, your investment would have still ended up at zero.
Cryptocurrencies usually follow the same path. Last year, altcoin CryptalDash (CCC:CRD) climbed from 2 cents to $1.10, earning investors 5,400% returns. But those who loaded up would have faced ruin. By the second week of January 2021, its price had fallen back to 2 cents.
Unlike companies, cryptocurrencies can languish near zero without ever dying. And many like dogecoin can catch a second wind. But these cases are rare. More often, these marginal players fade into obscurity and get replaced by more technologically advanced players.
That still leaves the door open for up-and-coming coins. Altcoins from Cardano (CCC:ADA) to Stellar (CCC:XLM) all hold promise. Just don’t go fishing for those that have floundered.
Lesson 3: Invest (Or Stay Out) for the Long Run
The value of tech companies comes from buying for the long term. Sometimes short-termism does work; early investors in Amazon would have celebrated selling out before the tech bubble burst in 2000. But that would have meant missing out on the 40,000% gains to come. Similarly, trying to time BTC and ETH is a fool’s game. And how much sense does it make to buy bitcoin at $10, sell at $11, buy again at $18,000 and sell at $19,000? Buy-and-hold would have outperformed by a mile.
Instead, investing in crypto needs long-term commitment, and a strong belief that people will one day view cryptocurrencies as an immutable store of value. Like collectible stamps and fine Bordeaux wines, cryptocurrency value must eventually come from scarcity relative to demand. (In other words, you can’t have new coins coming out every day.)
There are plenty of obstacles to navigate. The Chinese Communist Party has already started experimenting with bitcoin alternatives — the U.S. government doing the same could demolish both BTC and ETH. And improvements in quantum computing could make crypto mining a thing of the past.
But if you believe in cryptocurrencies’ long-term potential, BTC and ETH are a great place to start. The future of this massive digital popularity contest is still getting written, and tech stocks tell us one thing: When it comes to a beauty contest, buy the prettiest of the bunch.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.