The Cryptocurrency Bubble: Risk and Reward of Investing in Cheap Altcoins

Bitcoin Bubble

2017 was the year of the cryptocurrency. Bitcoin began the year at $993/BTC and ended at over $13,000/BTC, a 1,200% gain. Other major players like Ethereum and Litecoin saw similar gains. However, even more impressive was the rise of altcoins and ICOs in 2017. While Bitcoin rose by 1,000% over the course of the whole year, alternative cryptocurrencies such as Ripple rose by 1,000% over the course of the month of December alone.

Other smaller cryptocurrencies have seen similar increases. These fast growers often gain significant market capitalization on the back of good marketing. Individual investors hear about a rising project and don’t want to miss out on the investment opportunity. This cycle drives an investment frenzy, occasionally leaving even the founders of an ICO or altcoin baffled by the rising coin price.

Does this mean we’re in a bubble?

Many investors have noticed similarities between the current cryptocurrency landscape and the dot com bubble of 2000. Back in 1998-2000, internet companies became wildly overvalued on the stock exchange. Investment poured into any company that claimed to be internet-based, even if the company showed no real inherent value or innovative ideas. In those days, many traditional companies added “.com” to their names and immediately saw increased investment.

The same is true today. Companies add “blockchain” to their names and attract investment. Iced Tea manufacturers and bovine reproduction companies have changed their names to be blockchain-friendly, all with major success. In addition to traditional companies changing their names, all you need to make millions of dollars with an ICO is seemingly a flashy website and a white paper. Forbes estimates that ICOs raised $5 billion in 2017.

A key axiom in investing is, “Things that don’t make sense don’t last.” When ICOs that are little more than two dudes and a white paper raise millions of dollars, that doesn’t make sense. When a bovine reproductive company changes its name and sees a spike in investment, you should question the market. And when altcoins that nobody has heard of rapidly and repeatedly climb the charts to the top ten cryptocurrencies, you know you’re in a bubble.

Everything you buy, even if the coin has no real concept behind it, has a high probability to rise. Comparing that with 2000 and the 2007 crisis, this looks very similar. Even the bitcoin chart is indicating that a topping formation is coming. We can expect the crypto market to pop. The difficult thing to predict is when.

bitcoin chart

Bubbles always last longer and go higher than you expect

We could continue to be in this bubble for another month or several years. For example, experts warned in 1998 that there was an internet bubble. However, it took 2 more years for it to burst. With crypto it might be the same. It still might take years until everything crashes, or the crash might come soon.

This prediction problem is one of the reasons why it’s difficult to short a bubble. You know a crash is coming, but you don’t know when it will happen. If you withdraw all your funds from cryptocurrencies right now, you could stand to lose a significant amount if the markets continue to climb the way they have been. On the other hand, if you leave too much invested in cryptos when the crash does arrive, you’ll lose a lot of your assets.

Investing in a bubble is notoriously risky and not for the faint of heart. If you have a low risk tolerance, it might be best to withdraw all your crypto assets and reinvest in traditional equities. You will likely miss out on incredible opportunities for massive gains, but you’ll also be shielded from the stomach-churning volatility of investing during a bubble. Once you’re out of the market, it’s easy to believe you would have predicted correctly had you continued to invest. Don’t be so certain. The current cryptocurrency landscape is mostly a high-stakes casino. Nobody can predict how it will turn out.

If you feel you have the risk tolerance for this kind of volatile investing, it’s still wise to only invest a small portion of your funds in cryptocurrencies. Only invest what you can afford to lose. This is doubly true for investing in cheap altcoins. Speculative investment in penny altcoins should only make up a tiny sliver of your overall portfolio.

But are bubbles necessarily bad?

Bubbles don’t necessarily have to be bad for your investments or for technology in general. In fact, smart investing during a bubble and limiting downside can bring big rewards. Bubbles are also the way technologies get developed, tested, and strengthened over time. In fact, it’s probably a good thing that cryptocurrencies are currently in a bubble.

In the past, overinvestment has been the way investors have shown enthusiasm for technology. Over the past 20 years, there have been numerous instances of investors overbidding new technology once it hits the market. The dot com bubble is one example, but this pattern of overinvestment also happened with 3D printing, genome mapping, and e-commerce when they first debuted.

These technologies had potential, and investors could see that potential. However the technology wasn’t ready to reach that potential. Most of the companies in these emerging industries experienced short-term exponential gains and then got destroyed in the marketplace when the technology ran into challenges. The same thing will likely happen with cryptocurrencies, especially ones with little inherent value as a token that powers a larger technology.

Bubbles drive attention & investment

Although these early companies were hit hard after the bubbles burst, the investment that came during the bubble helped them build new infrastructure. This infrastructure of technology and ideas meant that new companies could build upon the platform the failed companies had built. The internet industry recovered after the dot com bust. Many of the original 3D printing companies are out of business now, but the technology they developed lives on and has been improved upon.

Blockchain’s bust could provide a similar spark for figuring out how to best use the blockchain. The weakest companies will die off. The strongest ideas, concepts, and technologies will regrow from the ashes. Companies will be forced to focus on cash flow, user adoption, and working with corporate partners once easy investment capital goes away. But they’ll be doing so in a time where most people have now heard of the blockchain.

The investors who lost money in the dot com bubble subsidized the creation of the internet as we know it today. The same will likely be true for blockchain investors when this bubble bursts.

Investing in altcoins during the bubble

Knowing that bubbles are the market’s way of encouraging and then weeding out new technologies is helpful on a macro scale. However, the micro decisions about how an investor should approach cryptocurrencies are more challenging. The strategy that seems to be working for many investors now is to diversify their investments with small bets on many projects.

Penny altcoins

penny altcoins image

There are hot new cryptocurrencies emerging every month. In recent weeks, Ripple, Stellar Lumen, Tron, Cardano, Stratis, and Verge have been among the leaders who have seen massive gains in a short period of time. The prevailing investment strategy involves putting, for example, $100 into many cheap penny cryptocurrencies. These are the currencies currently valued at less than $2 apiece. Some of these currencies will hold steady or fall in value. However, one is likely to increase in value exponentially, leading to an overall profit for the whole portfolio.

Contrary to what you’d see in a typical market, the cryptocurrency market favors cheap assets. This is a paradox for most financial analysts. The cheaper the price of the cryptoasset, the greater the chance of a return. As we established earlier, this inversion of typical asset growth is characteristic of a system where the asset has no inherent value. ICOs and altcoins based on a whitepaper alone fall into this category, so if you choose to invest in these penny altcoins, you are merely speculating. These gambles can make you a 1,000% return, but they’re also inherently very volatile.

Managing risk

As with any investment, there’s serious risk involved in buying cryptocurrencies. This article should not be construed as investment advice from us. If you’re inclined to invest during the current bubble, penny investing is one strategy that has worked for other investors. Keep in mind that this strategy can work spectacularly, bringing in a large return, but it can also backfire if your investments all decrease in value.

Never pour all your money into a volatile investment. It’s important to manage your risk by only investing a small percentage of your overall capital in such volatile investments.

Regularly rebalancing and cashing out your gains is another key aspect of managing risk. Once you’ve recouped your initial investment, withdraw that amount and only continue to invest with what you’ve earned. Now, you’re playing with house money, and your downside is effectively zero.

Market volatility

The cryptocurrency market is volatile. Take Ripple’s recent 1,000% price increase over the course of December 2017, for example. Ripple has an experienced team, fully built product, and some institutional test users. This is far more legitimacy than most cryptoassets, but it doesn’t come close to warranting its current market cap of $201 billion (based on total supply, not just circulating). XRP adoption from major banks is low and not eminent, so why is XRP valued so highly right now?

The cryptocurrency market is incredibly volatile and sharp movements often provoke a feeding frenzy. Investors are largely individuals, not institutions. As such, they don’t use formal frameworks for evaluating companies and removing greed and fear from the equation. Instead, investors mostly operate from a fear of missing out. As an example take John McAfee’s Twitter predictions. When he promotes a new altcoin, the price immediately jumps as investors join the fray, not wanting to miss out. This crowd mentality is also driving XRP’s price until major investors begin to sell XRP for another altcoin. The XRP price will collapse and the cycle will begin all over.

The future of cryptocurrency and the blockchain

To review, we’ve seen in this article that cryptocurrency is almost certainly a bubble. When every idea seems to receive investment, regardless of its merits, then the market isn’t functioning properly. Herd mentality fuels the current cryptocurrency bubble. Fear of missing out drives overinvestment in any asset that is appreciating.

Knowing that we’re in a bubble doesn’t mean you necessarily need to stop investing. In fact, if you have the risk tolerance, penny altcoin investing can be quite profitable. The key here is risk management, and understanding that market volatility means you won’t be able to predict outcomes very well. There will inevitably be surprises. As such, you should only invest what you can afford to lose and withdraw funds when you’ve recouped your initial investment.

After the bubble, expect blockchain technology and cryptocurrency to change significantly. A bubble popping will likely lead to greater regulation from the US and EU, making it more difficult to create ICOs and limiting scams. This will in turn make cryptocurrencies more like securities, functioning like a stock market with more stable equities. These equities will still likely be young companies, though, so they’ll still likely be more risky but generate greater returns than the traditional stock market.

More generally, the future of blockchain technology is moving away from currency and securities to other forms of data protection. Health records, identity services, secure file transfer, and other important data protection applications are well-suited to the blockchain. However, these services wouldn’t necessarily require a token or currency to operate. After the bubble, it’s likely the number of ICOs will decrease, and blockchain applications will get funded through traditional means of institutional investment.

While it’s difficult to predict when the bubble will pop, you can prepare yourself for the major changes that are coming. Limit your downside, invest wisely if you have the risk tolerance, and plan for the downturn. Blockchain isn’t going anywhere, so you’ll want to be prepared to take advantage of low prices once the current bubble has passed.

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