Is Investing in Cryptocurrency a Good Idea?
Millennials, who are considered the most risk-averse generation, are investing in cryptocurrency with borrowed money. About 21 percent of college students are using loan money to buy digital currency, a new survey by the Student Loan Report shows. College students, however, are not the only ones who are borrowing money to invest in cryptocurrency. Another survey of more than 3,000 people — conducted by CoinDesk, a New York City–based provider of price data, information, and news about digital tokens — indicates that nearly 20 percent of people who own cryptocurrency went into debt to buy it or bought it on margin.
The Stats on Millennial Money Habits
These findings are quite alarming and somewhat counterintuitive. To understand why it may seem illogical, let’s look at some other findings first:
- Eighty-two percent of millennials surveyed said their investment decisions are influenced by the financial crisis, with 57 percent saying that they are “strongly influenced,” a 2017 Legg Mason report reveals.
- The majority of millennials distrust institutions, according to polling by Harvard University’s Institute of Politics. Three in four millennials (74 percent) sometimes or never trust the federal government to do the right thing, and two in three (63 percent) feel the same way about the president. Wall Street doesn’t fare much better, with 86 percent of millennials expressing distrust for it, and 82 percent for Congress.
- Millennials, especially in developed countries, are anxious about their future,and many of them are not sure whether they can trust the promises of their respective governments, the 2017 Deloitte Millennials Survey found.
The disconnect between millennials’ distrust in institutions and feelings of uncertainty about the economy and the fact that they’re investing in cryptocurrency with debt is more than evident.
Further Reading: “If You Put 1 Bitcoin In, Will 2 Come Out?”
Why You Shouldn’t Borrow Money to Invest in Cryptocurrency
Investing with debt is never wise, no matter the type of investment. You should always invest with money you have to spare. Borrowing money to invest in cryptocurrencies — one of the riskiest and most volatile assets — is even more questionable.
If millennials distrust financial institutions as a result of the financial crisis, then why are they not trying to avoid their own personal financial crisis?
Perhaps people have forgotten how and why the financial crisis happened. It most definitely did not come out of thin air. There were events leading to it. A quick refresher on the circumstances of the financial crisis might help.
2008 Financial Crisis: Debt as a Ticking Bomb
With a decade’s hindsight, it is clear the crisis had multiple causes. The collapse of Lehman Brothers, a sprawling global bank, in September 2008 almost brought down the world’s financial system. It took huge taxpayer-financed bailouts to shore up the industry.
At the core, one thing stands out as the main cause of the crisis: too much risk and too much leverage — that is, debt.
Further Reading: Read up on potential debt-relief options.
Selling Mortgage-Backed Securities
Hedge funds, banks, and U.S.government agencies such as Freddie Mac and Fannie Mae sold mortgage-backed securities, collateralized debt obligations, and other derivatives. A mortgage-backed security is a financial product whose price is based on the value of the mortgages that are used for collateral. Once you get a mortgage from a bank, it sells it to a hedge fund on the secondary market.
The hedge fund bundles your mortgage with a lot of other similar mortgages. It uses computer models to figure out what the bundle is worth based on several factors, and then sells the mortgage-backed security to investors.
Since the bank sold your mortgage, it can make new loans with the money it received. It may still collect your payments, but it sends them along to the hedge fund, which in turn sends them to its investors. Along the way, everyone takes a cut, which is one reason they were so popular. It was basically risk-free for the bank and the hedge fund. (At least it seemed so at the time.)
The investors took all the risk of default. But they didn’t worry about the risk because they had insurance, called credit default swaps. These were sold by solid insurance companies, such as AIG. Thanks to this insurance, investors snapped up these derivatives. In time, everyone — pension funds, large banks, hedge funds, and even individual investors — owned them.
Further Reading: “Investment Risk Is a Double-Edged Sword”
The Biggest Players
Some of the biggest owners of these derivatives were Bear Stearns, Citibank, and Lehman Brothers. These are the three institutions that suffered the most when the financial crisis hit. The reason? Not only did they invest in these highly risky financial instruments, but they were also highly leveraged (that is, they took on a lot of debt in order to invest).
Citibank had a leverage ratio of about 36; Bear Stearns, 37; and Lehman Brothers, about 44, which was far beyond competitors like Goldman Sachs and Morgan Stanley, who had ratios in the 20s. These three institutions borrowed the most, and thus when they lost money on their investments, they were not able to pay their lenders back. Bear Stearns was rescued by J.P. Morgan, Lehman Brothers went bankrupt, and Citibank has struggled for almost a decade to stay afloat, with major layoffs and cutbacks.
If there is one lesson that we should all learn from the financial crisis, it’s don’t borrow money to invest.
Back to 2018 and Investing in Cryptocurrencies
We can all agree now that borrowing money to investing can have severe consequences on your financial future and stability. It does not matter whether you are a big financial institution or an individual. Whether you invest hundreds of dollars or hundreds of millions of dollars, a loss on investment with borrowed money can lead to bankruptcy.
Further Reading: Learn how one woman recovered from bankruptcy.
Bear in mind that borrowed money must be repaid. That does not depend on the results of your investment, and lenders will not wait until you recover your losses.
If millennials distrust financial institutions due to the consequences of the financial crisis, then why are they now following in those institutions’ footsteps instead of learning from their mistakes? Why are millennials trying to create their own personal financial crisis by investing with borrowed money, let alone in one of the most volatile and risky assets?
So Is Investing in Cryptocurrency a Good Idea or Not?
This is not to say that you should not invest in cryptocurrency — or anything else, for that matter. But there is always a wise way, a better way, to invest. We will discuss how to invest intelligently — in cryptocurrency or any other asset or financial instrument — in future articles.