Cryptocurrency has taken the world by storm, especially during the last few years. The total value of all these digital currencies has swelled to about $2 trillion, says Bloomberg. Of these, Bitcoin is the most popular, worth more than $800 billion itself, according to CoinMarketCap.com. Investors have swarmed to this digital gold rush, often with little knowledge and a lot of hope.
Cryptocurrency’s rapid appreciation has many investors questioning the place of stocks in their portfolios. But there are numerous differences between stocks and cryptocurrencies. The most important is that a stock is an ownership interest in a business (backed by the company’s assets and cash flow), whereas cryptocurrency in most cases is not backed by anything at all.
If you’re buying cryptocurrencies, it’s important to understand what you’re purchasing and how they compare to traditional investments such as stocks, which have a solid long-term track record.
Should you invest in cryptocurrency or stocks?
Any savvy investor needs to know exactly what they’re investing in. It’s crucial to weigh the risks and rewards of investing, and what will drive the investment’s success. If they don’t have this kind of information, they can’t make the calculation. In this case, it’s not really investing — it’s much more like gambling.
Here are the key things investors need to know about stocks and cryptocurrency.
A stock is a fractional ownership interest in a business. It’s easy to lose sight of this, if you become overwhelmed by the wiggling stock prices — and the potential for profit. As a legal ownership stake in the business, the stock gives shareholders a claim on the assets and cash flow of the business. These back your investment and provide a basis for its valuation.
Why stocks rise and fall: A stock price moves as investors assess the future success of the company. While investors may become overly optimistic about the stock in the short term, the stock price ultimately depends on the company’s ability to grow its profits over the long term. That is, a stock rises in the long term due to the success of the underlying company.
For a stock to be a successful investment, the underlying company must perform well over time. (Here’s a step-by-step guide for how to invest in stocks.)
Generally, cryptocurrency is backed by no hard assets (specialized stablecoins being an exception), and that’s the case for the most popular crypto coins such as Bitcoin and Ethereum. A cryptocurrency may allow you to perform certain functions, such as sending money to another person or using smart contracts that automatically execute after specific conditions are met.
Why cryptocurrency rises and falls: Because cryptocurrency is not backed by assets or cash flow, the only thing moving crypto prices is speculation driven by sentiment. As sentiment changes, prices shift — sometimes drastically. So cryptocurrency is driven only by the hope that someone will buy it for more in the future — what’s called the “greater fool theory of investing.”
For a cryptocurrency to be a successful investment, you must get someone to buy it from you for more than you paid for it. That is, the market must be more optimistic about it than you are. (Check out this beginner’s guide to investing in cryptocurrency.)
Pros and cons of investing in cryptocurrency vs. stocks
Pros of investing in cryptocurrency
- Possible hedge against fiat currency: For some investors, one of the biggest appeals of cryptocurrencies is its decentralized nature. It’s not controlled by central banks or governments who like to print money and generate inflation in fiat currencies such as the U.S. dollar or the euro. Cryptocurrency has been called “digital gold” by some investors who hold it because they think it will protect them from inflation.
- Potential for outsized gains: Buying cryptocurrencies creates the potential for large gains on your investment. Several cryptocurrencies have seen their prices skyrocket since first being introduced. These gains are the main reason people are attracted to cryptocurrencies, but the potential for price appreciation comes with significant risk.
- Growing number of coins: In the early days of cryptocurrencies, there were just a few coins that could be invested in, but the speculative interest has changed that. New coins are introduced regularly and there are now thousands to choose from.
- Wide interest in digital currencies: There seems to be a growing interest in cryptocurrencies from investors, companies and governments. Tesla holds Bitcoin on its balance sheet and briefly accepted the digital currency as payment before reversing course. El Salvador adopted Bitcoin as legal tender in 2021, though the International Monetary Fund has urged the country to reverse its decision. Increasing acceptance of digital currencies could be positive for investors.
Cons of investing in cryptocurrency
- Extreme volatility: Cryptocurrencies have been extremely volatile so far in their relatively young existence. They aren’t backed by anything, so the price they trade at is determined by the whims of traders. Fortunes can be made and lost quickly and there’s no telling where a coin might trade next.
- Cybersecurity risks: Despite cryptocurrency enthusiasts touting the security benefits of digital coins, there have been notable hacks involving cryptocurrencies. It is often difficult to recover stolen funds.
- No intrinsic value: Cryptocurrencies have no intrinsic value, which means they aren’t backed by underlying assets or earnings the way that stocks are. Stocks have value because of their future earnings power and what they will return for their owners, while cryptocurrencies offer nothing of the sort.
- Regulatory risks: While El Salvador has embraced Bitcoin, many governments are much more skeptical about cryptocurrencies. China has banned them altogether and other countries could follow suit.
Pros of investing in stocks
- Long history of solid returns: Stocks have a long track record of producing solid investment returns, with the S&P 500 returning about 10 percent over the long-term. Though stocks can be volatile in the short term, they have generally been safe to hold over long periods of time.
- Have intrinsic value: A stock represents an ownership interest in a company and its value over time depends on the success of the underlying company. Companies own assets that produce earnings and cash flow for investors, creating what’s known as intrinsic value.
- Accessible: It is easier than ever to invest in stocks these days with many online brokers cutting trading fees to zero. You can invest in individual stocks or choose to purchase a diversified basket of stocks through an index fund. Index funds help keep costs low and you can build a diversified portfolio even if you don’t have much money to start with.
- Stronger regulation: Stock exchanges, brokers and companies are all heavily regulated through various government agencies. Companies are required to provide certain information to investors through the Securities and Exchange Commission. No regulatory body is perfect, but stocks have been around for a long time and there are certain investor protections in place.
Cons of investing in stocks
- Volatile: When you hold a broad basket of stocks through index funds, stocks are less volatile than cryptocurrencies. Individual stocks can be more volatile, but typically less so than cryptocurrencies. Because of this volatility, stocks are best held as part of a long-term investment plan, so you have time to recover from any short-term losses.
- Lower potential for extreme gains: Broad stock indexes like the S&P 500 likely have less potential for the extreme gains that can sometimes be found among cryptocurrencies. Stocks have returned about 10 percent over the long term, whereas it’s not uncommon for cryptocurrencies to move 10 percent in a single day.
Other considerations when investing in stocks vs. crypto
Your time horizon — when you need the money from an investment — is a key criterion. The shorter your timeline, the safer your asset should be, so that it’s there when you need it. The more volatile an asset, the less suited it is for those with a short timeline. Generally, experts suggest investors in risky assets such as stocks need at least three years to ride out volatility.
- Stocks are often volatile, but they tend to be less volatile than crypto. Individual stocks are more volatile than a portfolio of stocks, which tends to benefit from diversification.
- Stocks are better suited to investors who can leave their money alone and don’t need to access it. Generally, the longer you can leave it invested, the better.
- Some stocks can be more volatile than others. For example, growth stocks tend to fluctuate much more than value stocks or dividend stocks.
- Investors may shift from more aggressive stocks (growth stocks) to safer ones (dividend stocks) as they need to tap their money, such as when they approach retirement.
- While stocks are volatile, cryptocurrency is ridiculously volatile. For example, during 2021, Bitcoin lost more than half its value in a few months and later gained 100 percent. Such volatility makes crypto unsuited for short-term investors.
- Crypto is better suited to traders who can leave their money tied up and wait for it to recover. Think years rather than weeks.
As you’re thinking about constructing your portfolio, you don’t have to make an either-or choice between cryptocurrency and stocks — or other kinds of asset such as bonds or funds, either. It’s all about weighting your portfolio in a way that fits your risk and time horizon.
- Given its inherent risks, cryptocurrency works better with a small allocation in your overall portfolio. Think 5 percent or less.
- Even a small allocation could do wonders for your portfolio if cryptocurrency really takes off. Also, limiting to a small allocation protects you against a complete loss if crypto goes nowhere.
- If crypto grows to be a significant portion of your portfolio, you can re-allocate more of your money to stocks to lower your portfolio’s overall risk.
- Given stocks’ strong long-term record, a diversified collection of stocks should make up the majority of your portfolio, especially if you have decades until you need to tap it.
- If you’re investing in individual stocks, you’ll need to research your stocks carefully to achieve good returns.
- If you’re investing in funds, you can buy a broadly diversified fund such as an S&P 500 index fund without significant research and enjoy the potential for high returns.
Some cryptocurrencies have soared in price since being introduced over the past few years, but investors need to understand what they’re investing in, instead of just rushing in because other traders are. If you decide to take a stake in crypto, consider how it fits with your own risk tolerance and financial needs. Investors can earn good returns without investing in cryptocurrency, and some investors, including legends such as Warren Buffett, won’t touch cryptocurrency.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.