The crypto market is in free fall.
Bitcoin and Ethereum are down roughly 50% from their all-time highs.
Both cryptocurrencies have unique characteristics that make them good long-term buys.
Early morning, Saturday, Jan. 22. Freezing temperatures sweep across south Texas, reviving memories of Winter Storm Uri, which struck the state a bit less than a year ago. But there’s a fiercer and more widespread winter storm blowing through now — the crypto winter.
About 4 a.m. Central Time, Houston residents toss and turn as icicles start to form on shingles that only a week ago were kissed by bright rays of 80-degree Texas sun. It’s also at this time that Bitcoin (CRYPTO:BTC) dips close to $34,000, Ethereum (CRYPTO:ETH) falls to about $2,300, Solana falls below $90, and Cardano drops below $0.95. All four major cryptos are now down by roughly 50% from the all-time highs set just a few months ago, and several smaller altcoins have declines exceeding 75% in their rearview mirrors.
With crypto prices approaching their 2021 summer lows, would investors today be better off buying Bitcoin for less than $35,000 or Ethereum below $2,500?
The case for Bitcoin
Just a few months ago, the bull case for Bitcoin included its inflation resistance, limited supply, safe and secure network, and role as a viable store of value in countries that lack stable fiat currencies of their own. There was also an argument that it can act as a better inflation hedge than gold.
Bitcoin’s huge decline puts some of those arguments in doubt. Despite becoming more sophisticated, the crypto market remains incredibly speculative and leveraged. The Jan. 22 plunge saw over $1 billion in liquidations due to traders who had borrowed crypto on margin. Margin can inflate gains on the upside and amplify losses on the downside. Leverage is a double-edged sword, and it is used rampantly in the crypto market.
Adding leverage to an asset class that is already volatile is damaging the investment thesis for Bitcoin. As long as Bitcoin is seen as a trading opportunity or even a commodity, it is unlikely it will be used as a currency.
Looking back, it is easy to see that the crypto market went up too far too fast in the short term given that Bitcoin’s utility and adoption are still in the early stages. But zoom out, and there’s also a good argument that Bitcoin could easily set new highs in the future as the supply of new tokens being mined becomes negligible, its adoption increases, and more companies hold Bitcoin on their balance sheets.
The reality is that the crypto market is immature. Institutional inflows and retail investors looking to include crypto as a new asset class in a diversified portfolio have added many new players to the market. Bitcoin’s potential is undeniable, and it’s certainly a better buy at about $35,000 than close to $70,000. But investors considering Bitcoin today would do well to remember that until the crypto market matures, it’s anyone’s guess what Bitcoin’s price could be in the short term.
The case for Ethereum
Ethereum and Bitcoin are the two largest cryptocurrencies by market cap, but they are completely different investments. Bitcoin wants to be boring and stodgy, while Ethereum is best when it’s dynamic and growing. Ethereum’s value comes from what its network can create, while Bitcoin’s value derives from what its network can protect.
The Ethereum blockchain is the largest decentralized app (dApp) platform, supports the most decentralized finance (DeFi) projects, and is the go-to currency for buying and selling non-fungible tokens (NFTs), those digital ownership representations of art and video clips that are all the rage. In short, its blockchain is the bedrock upon which many other crypto projects operate.
Ethereum’s transition from a proof-of-work consensus mechanism to a proof-of-stake consensus mechanism is expected to happen when it completes its Ethereum 2.0 upgrade later this year. That should drive down costs, improve speed and scalability, reduce the toll Ethereum’s network imposes on the environment via energy consumption, and make the network more decentralized. Despite the upgrade’s potential, something like this has never been attempted in the crypto industry, so there’s a great deal of risk until the upgrade is complete.
A cautiously optimistic approach
No one knows when this crypto sell-off will end or if we’ll revisit these lows some time in the future. This bout of plunging prices is a reminder that crypto downturns can be swift and brutal. The adage that stocks go up more than they go down but go down faster than they go up applies even more to crypto.
A silver lining of the downturn could be its painful reminder that most investors should not allocate too much of their portfolio to crypto. If anything, it’s best to keep it simple with Bitcoin and Ethereum. The risk-reward profiles of Bitcoin and Ethereum are attractive enough as is. Expanding into altcoins, NFTs, or the metaverse may seem interesting. But for most investors, those choices are simply not worth it.
The crypto industry has plenty of potential to grow over time, and there’s a good chance that Bitcoin and Ethereum will play big roles in its future. Investors could do well to consider both for small positions in diversified portfolios. But no matter how optimistic you may be about crypto, it’s important to only invest money you can afford to lose. For most investors, a portfolio allocation of 1% to 10% would be the best way to gain exposure to the potential upsides while limiting the potential pain that catastrophic crypto declines could inflict on your finances.
Disclaimer: These are the writer’s opinions and should not be considered investment advice. Readers should do their own research.