Yesterday, crypto prices dropped a dramatic 40%, which should remind investors of the asset class’ volatility. Bitcoin, the most famous, dropped within the day from around £30,600 to around £22,700, although the price rallied by the end of the day. Ethereum dropped similarly from £2,400ish to a little over £1,400. Both drops may be a buying opportunity for the cash-flush speculator, but FI investors should beware volatility in cryptocurrencies.
Why did crypto prices drop today?
Who knows? Coindesk suggested that this was the result of macroeconomic forces on a market that needed a pull back; the website National World claimed that it was due to a combination of Tesla deciding not to accept Bitcoin as payment and China making its most recent decrees about use of cryptocurrencies. In reality, it doesn’t matter much. What’s important this isn’t the first time that cryptocurrencies have dropped by 20% or more.
Is this an anti-crypto rant, like 90% of the personal finance media?
I’m not going to tell you not to buy crypto if you want to. I’m a big fan myself. I’ve written before about using stablecoins to earn interest and I’ve admitted that I buy a few cryptocurrencies with side hustle money in my 2021 campaign plan. I completely believe that crypto is the future of finance, but I don’t rely on it for my financial independence campaign.
Why too much volatility is a bad thing
Crypto speculation offers some amazing gains. Even after the dip, I think I’ve made on-paper gains of four times my capital deposits on my crypto portfolio. This would have taken me 20 years to raise through shares and ETFs. Still, this could have just as easily gone the other way. Many of the altcoins that existed in 2016 didn’t survive the 2017 crypto bear market. Unlike in index funds, where the chances of every share in the index becoming worthless is infinitesimally small, there is a reasonable prospect of any one crypto becoming obsolete or rendered worthless. This much crypto volatility could make you a millionaire overnight: or it could squander your current financial independence fund.
Kahneman and Tversky said that a loss is felt twice as strongly as a gain feels satisfying. If that’s true, you’d be a rare investor if you could stomach losing 40% of a crypto-heavy portfolio in a single day. You’d need to wonder if you could still campaign for financial independence after taking that much of a setback: I know I’d find it difficult.
If you think crypto is the future, why not go all in?
Crypto volatility can be a big boost to financial independence funds. The technology is revolutionary; having automated, trustless exchanges and contracts that replace escrow accounts will transform how banking systems work. However, there’s no guarantee that any of the current generation cryptocurrencies will survive. Investing in Bitcoin and Ethereum might be the smartest plays today, but equally it could be like investing in Bebo and Myspace when Facebook is just starting out. The awesome tech might not continue in its present form, and there’s absolutely no guarantees of backing the right horse – or horses.
Diversification is everything
To get around crypto volatility, I believe strongly in diversification across asset classes. Why own “just crypto”, “just shares” or “just gold“, when you could own a mix of everything and cover all bases? My strategy always has been and will continue to be to spread my wealth across diversified assets and diversify within asset classes, giving me the best chance of making net gains across my portfolio while giving me some protection from the worst of the markets. Yes, that includes crypto, too – but maybe not too much.
