November 20, 2018

Are Cryptocurrencies Indeed Currencies? Part 2

Are Cryptocurrencies Indeed Currencies? Part 2

To further understand the nature of Bitcoin and other cryptocurrencies and how they relate to traditional assets, we need to examine the differences between investing and trading them. Key to this is the fact that you can both price and value assets. Interestingly though, you can price commodities more easily than you can value them, while currencies can only be priced.

 

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Investing vs. Trading Cryptocurrencies

This is a point made in the previous part of this article, and one that is worth revisiting. If you are to invest in an asset, you have to assess its intrinsic value and then compare it to its current price.

You may then act on the basis of that comparison, buying the asset if its price is less than its value, or selling it if the price is higher.

Conversely, trading is much simpler; you set a price, make a decision on whether the price you have set is going to be higher or lower at the end of a particular time period, then you invest or wager on that price.

Although you may be successful at both trading and investing, they require different tools and skill sets since the characteristics of a good trader are far different from those required from a successful investor.

The table below clarifies the essential differences between trading and investing.

Trading Cryptocurrencies vs. Crypto-Investing
 Trading (Price)Investing (Value)
Underlying PhilosophyIn trading, you can only really act on price. It is impossible to determine the value of a traded asset, such as a digital currency.All assets that you can invest in have a true or fair value attached to them. This value can be estimated, with the price eventually converging on the value.
How it WorksWhen you trade, you are essentially guessing the price movement of the asset. To get ahead, you need to guess correctly, often, and make an exit before a shift in the pricing trend.Investment involves estimating the value of an asset, buying if it is undervalued or selling when it is overvalued. To get ahead, you must be right about the true value and the market should be moving toward that value.
Main DriversA traded asset’s price is determined by the forces of demand and supply, both of which are effects of momentum and sentiment.Value is established by understanding the asset’s cash flow, risk and growth potential.
Effect of InformationNews stories and rumours shift market sentiment and affect the price in the short-term, as we have seen with regard to Bitcoin in the past year, even if the stories do not really have a long-term effect.The only information that can affect the value of an asset when investing is altered cash flow, slowed or increased growth or changes in risk.
Tools·         Technical indicators
·         Price charts
·         Investor sentiment
·         DCF valuation (discounted cash flow)
·         Ratio analysis
·         Accounting research
Time HorizonsTrading in assets, like cryptocurrencies, is often short-term (as little as a few minutes) to medium-term periods of a few weeks or months.Investment is usually a long-term game.
Essential SkillsYou need to be able to assess shifts in momentum or sentiment ahead of the market.In spite of uncertainty, you must be able to place a value on the asset, then act on that value.
Main Personality Traits·         Gambling instincts
·         Market amnesia
·         Quick action
·         Immunity from peer pressure
·         Faith in the market
·         Faith in an asset’s value
Biggest Danger(s)Quick momentum shifts could quickly wipe out months of continuous profits.Even if you correctly value an asset, the price may fail to converge on this value.
Delusional PlayerThe trader bases actions on the assumption that the asset (cryptocurrency) has an intrinsic value.An investor assumes that all market movements are rational and reasonable.

The Final Word

It is evident that you may find success in either trading cryptocurrencies or investing in them, but if you are not clear with regards to what you are doing by using the wrong tools or utilizing the wrong set of skills, it might only end in disaster. Understand the differences between trading and investing before you step into the cryptocurrency arena.

 

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