Bitcoin's recent run offers valuable insight to new investors
Recently Bitcoin (BTC) eclipsed $13,000 for the first time in years. And although the price has dipped a bit since, BTC is still worth a lot more than it was a year ago. The steep price fluctuations Bitcoin is known for are part of what makes trading in so enjoyable for so many people. It is a roller coaster ride unlike anything else.
Perhaps BTC's recent run has you considering a sizable investment. Perhaps you are no longer content just to be a casual user, relying on your limited holdings for making online purchases. That's great. There is plenty of room in the cryptocurrency pool. But before you jump, take some time to learn the lessons this most recent BTC run offers. There is some valuable insight to be gained here.
The state of Bitcoin
Investors are an interesting breed of people. They are people willing to put their own money at risk by giving it to others in hopes of turning a profit on what the recipients do with that money. This is true regardless of the asset. When you are talking BTC, you're talking an entirely different kind of investment not represented by a tangible object.
Bitcoin exists as nothing more than computer code on a global network. That is its state. Contrast that to buying stocks and shares. They represent ownership in the company that issues them. So if you buy Amazon stock, for example, you will own an interest in the company in proportion to the amount of stock you purchase.
Investing in commodities is different altogether. If you put your money into gold, your purchase gives you ownership of either physical gold or a certificate that represents physical gold. What you have purchased is a tangible asset.
The state of Bitcoin, being digital only, makes a difference if you are the kind of investor who is generally reluctant to hold non-tangible assets. Buying Bitcoin will never result in an exchange shipping coins to your door. You are never going to find yourself walking down the street while playing with a bitcoin in your pocket.
The speed of price changes
As a new investor, be prepared for speedy price changes. We call this 'volatility' in the investment world. Whether you use the official term or not, get ready for the fact that the price of Bitcoin can change drastically in mere minutes. Yesterday's price drop is a fitting example.
Bitcoin peaked at just over $13,000 yesterday. But in a short, 15-minute span during the late afternoon hours, it dropped $1,500. Experienced Bitcoin traders did not panic. Why? Because these sorts of fluctuations are fairly common. It is part of the game.
It is technically possible for individual stocks to exhibit comparable price fluctuations. However, most of the major stock markets have safeguards in place to prevent price drops significant enough to do major damage. That's why you seldom hear big news of a single stock dropping 15% of its value in a quarter of an hour.
Two kinds of buyers
So, who is actually behind the recent BTC run? Well, there are typically two kinds of buyers for digital assets. You have new buyers and existing buyers. New buyers are obviously those getting into a particular asset for the first time. They are using either fiat or another coin to purchase their BTC.
Existing buyers are those who already hold BTC and are simply adding to those holdings. They can also use either fiat or other coins to make their purchases. Before you dismiss this as being inconsequential, continue reading to find out why it is not.
According to data cited by CCN, BTC's recent rally is not being supported primarily by new investors. The data shows that online searches relating to buying Bitcoin have not demonstrated any significant change in recent months. On the other hand, the data also shows that investors are moving holdings from stablecoins into BTC.
That means the recent BTC search is being fueled by digital asset investors with holdings in multiple assets. They see BTC is on the move, so they use some of the value they have stored away in their stablecoins to purchase more BTC.
This is a common strategy that investors use to protect themselves against volatility. They might purchase BTC when it's on the way up, waiting for it to reach what they think will be the peak. Then they sell and move that money into stablecoins. Their money stays in the stablecoins until they see another opportunity to buy BTC.
Protecting your portfolio value
This process of buying, selling, and moving money to stablecoins is one of the best ways to protect the value of your cryptocurrency portfolio. It is also yet another way to diversify. Needless to say that diversification is one of the fundamental principles of sound investing.
It works because volatility is not a problem for stablecoins. By their very design, stablecoins are backed by some other kind of asset that maintains a stable value. You might have one stablecoin backed by a fiat like the U.S. dollar and another backed by government securities or commercial stocks.
The point of the stablecoin is to give access to digital currency without the volatility. Just as a side note, Facebook's new Libra coin will be released as a stablecoin backed by a basket of fiat currencies and government securities.
As its name implies, a stablecoin enjoys price stability. You are not going to see a stablecoin surge 30% during this hour and then fall 15% in the next hour. Price changes are a lot more subtle. That's why it makes so much sense to sell other coins at their peak and then put your profits into stablecoins.
Timing is everything
We have thrown a lot of information at you so far. We have just two more things to talk about, beginning with the fact that timing is everything in cryptocurrency. Because BTC and its main competitors are so volatile, when you choose to buy and sell will have a considerable influence on the amount of money involved.
In the world of stocks and shares, trades are carried out in seconds. You may put in a bid for stock trading at USD $50 using an online brokerage. In the time it takes to execute the trade, the price could go up 10 or 20 cents. It could also fall by the same amount. So while there are fluctuations in play, they are not a big deal because trades are executed so quickly.
Trades in the cryptocurrency world do not happen as quickly. It could easily take a couple of minutes to buy or sell at any given time. And as was the case for a brief time yesterday, exchanges can crash if they are overwhelmed by activity. A crash could have you out of commission for an extended amount of time, even while the rest of the world continues to trade.
The point of all of this is to say that you should anticipate being 10 to 15 minutes ahead of the game at all times. If you are watching the price of BTC in hopes of selling at peak, don't rush to make that decision. Follow trends for at least a few minutes to see which way things are going. Then make your decisions based on where the price will likely be 15 to 20 minutes into the future.
Be too early on a downward trend and you could pay more than you otherwise would have. Be too late on an upward trend and your coins will cost you more. The same principles can be applied to selling, but in reverse.
What determines price
Finally, the most important lesson to learn from the recent BTC run is the fundamental truth that price is set by demand. We have addressed this at length in many previous blog posts. However, it bears repeating in light of the fact that so many people misunderstand how investing works.
Cryptocurrencies are often criticized as being assets with no value. Because there is no tangible object backing them up, critics say, there really is nothing there to invest in. They say that BTC only has value because a core group of people agree to that value.
Those criticisms are true for the most part. But what most people do not realize is that they are equally true of every kind of investment. It doesn't matter whether you are talking stocks, commodities, or even currencies, investments only have value because people agree to it.
Amazon is one of the most lucrative stocks you can buy. But it only has value because buyers agree to that value. If every single Amazon shareholder decide to sell their stock today, the price would plummet to near zero. Amazon stock is only valuable because people want it. If they don't want it, shares instantly becomes worthless.
The importance of this last lesson is found in whatever it is that gives you confidence to invest. You absolutely should do your homework before putting significant amounts of money into BTC. But do not let your decisions be swayed by the emotional reactions on either side of the value debate. Make your decisions based on the facts you uncover in your research, your aversion to risk, and your goals and priorities as an investor.