Benefits of stocks and cryptocurrencies: How do they stack up?
The advantages of the stock market are plainly evident. For the last 30 years, equities have consistently delivered returns to investors despite the dot-com crash of 2000 and the subprime mortgage crackup of 2008-09. The bellwether S&P 500 Index has has an average return of about 10.7% on an annualized basis since 1926, and it’s done so by spreading its exposure across 500 of the biggest US stocks and minimizing risk.
US lawmakers and taxpayers have become so comfortable with the stock market that they depend on it to augment Social Security and fund the retirements of tens of millions of workers through 401(k) plans and individual retirement accounts (IRAs). Moreover, a vast infrastructure of licensed investment professionals exists to help individual investors understand the stock market and set up plans to finance long-term goals such as saving money for a house, paying for university tuition, and securing a comfortable retirement. There’s nothing close to that in crypto, and investors are pretty much on their own.
Crypto has a very different allure: the potential for jaw-dropping profits. Setting aside the 245% jump in Bitcoin’s price in 2021, a raft of smaller and newer cryptocurrencies have been recording even bigger gains in very short periods of time. As of December 2021, Ethereum, the second-biggest cryptocurrency, is up 784% for the year, and Solana, which is challenging Ethereum’s position in the so-called decentralized finance or DeFi market, has multiplied hundredfold in value.
Cryptocurrencies also provide a potential long-term advantage: They just might be the building blocks of a new financial system, as their supporters claim. Influential global payments providers such as PayPal, Visa, and Mastercard are incorporating cryptocurrencies into their business models, as are powerful new entrants such as Square and Stripe. Back in the early 2000s, many investors deemed Google, Facebook, and Netflix high-risk bets and then watched them grow into the wealth-creation machines they are today. Some believe cryptocurrencies could follow the same trajectory.
What are the drawbacks of stocks and cryptocurrencies?
No surprise, there are many disadvantages to digital currencies. First and foremost is the fact that there’s no surefire way to assess how much digital tokens should be worth.
Unlike a share of stock, which represents the fortunes of a business, a cryptocurrency is a proxy for its underlying platform. While investors can assess a stock by analyzing the growth of an issuer’s profits, costs, and other variables, the same can’t be done with cryptocurrencies.
Bitcoin, for instance, isn’t a company—it’s a computer program that by its very nature is decentralized. While you can analyze how many Bitcoins are being mined and how many are in circulation, there’s no chief executive officer to provide a growth strategy, nor is there a chief financial officer to share insights on the company’s financial results. Come to think of it, there are no results.
The lack of metrics fuels another drawback for cryptocurrencies: their volatility. Digital assets are constantly whipsawed by investor psychology and short-term swings. FOMO, or fear of missing out, has driven tokens to the moon. On the flipside, fears of a sudden bear market have triggered steep plunges, such as the 13% drop Bitcoin suffered in a 24-hour period in May 2021.
As for stocks, they, too, are subject to bouts of irrational exuberance. Yet perhaps their most important drawback is the market’s sensitivity to interest rates. When rates are low, investors tend to shift their capital from the bond market, which relies on high rates to generate income, to equities, where much of the returns are generated by rising share prices. That’s usually a key driver in long bull markets such as the one that’s held sway since 2009.
Yet the opposite happens when rates increase. So if the Federal Reserve were to raise benchmark rates to curb rising inflation, investors may cash out of stocks and shift capital to the bond market, triggering a broad downturn. Another factor: High interest rates tend to slow economic growth, which can lower corporate earnings and dampen investor enthusiasm for stocks. Cryptocurrencies do not have this sensitivity to interest rates.