Since launch of Bitcoin in 2009 cryptocurrencies gain more and more traction every year. Many people hear and research cryptocurrencies when next boom happens and price grows rapidly. Significant number of people already hold cryptocurrencies, even more plan to hold in the future.
Disclaimer: This article is not a financial advice to invest in cryptocurrencies. Reader needs to conduct own research before purchasing any amount of cryptocurrencies and understand the risks associated with it.
Dutch Bank ING conducted a survey in March-Arpil 2018 (~15K respondents) and provided interesting statistics (click to enlarge):
Based on these results one can grasp three main average metrics:
- Roughly 60% of population heard about cryptocurrencies;
- Roughly 7-8% own some;
- Roughly 20% plan to own in the future.
For many people cryptocurrencies are seen as a means to invest and diversify own wealth. With increased number of ways to purchase cryptocurrencies (online exchanges, bitcoin ATMs, other cash accepting services), it is nowadays more a question when to buy, rather than how to buy. Price of Bitcoin grew up to almost $20’000 in December 2017 and went down to approximately $6’000 as of writing this article.
“Buy low sell high”
Golden rule of any investment is buy when asset / currency is low priced / underpriced and sell it when it is overpriced. However, while it is easy to evaluate such periods looking at historical chart, it is hard to do in practice when you don’t know what happens next. Apart from fears like when bitcoin was at $300 in 2015 and one thought “probably bitcoin has not yet reached bottom level price, why should I buy now, I need to wait more”, there is also a greed when bitcoin was $19’000 and one thought “probably bitcoin will go to the moon and I need to wait and sell it for at least $30’000 just in several weeks”. In practice a good investor will make many purchases in low level range prices and many sells in high range prices. Buying all at $152 on 14th January 2015 and sell all at $19666 on 17th December 2018 is impossible. A good strategy would be to buy at price levels of $200-700 and sell at $10000-19000, while those periods lasted for longer than one day periods (especially low range lasted more than a year, and this is crucial for cost averaging, see below).
Tim Draper purchased 30000 bitcoins in first US government auction when price was roughly $640, then he was able to buy 2000 more during second auction when price was roughly $370. Many people were making jokes about such investments in 2015 when price went down to $200, however, from the price information available today Mr. Draper was investing at a very good market moment.
For an ordinary person it is hard to spend time evaluating plenty of news and take investment decisions. Many have regular jobs, families, hobbies. Under these circumstances USD cost averaging investment is a great way to smoothen sharp price falls and increases and get very good long term results, given that financial instrument has good fundamentals to grow long term.
Dollar cost averaging investment in Bitcoin
The idea of dollar cost averaging investment is defining an amount which you regularly plan to spend on buying cryptocurrency and do it at regular intervals. E.g. buy bitcoins worth $100 on 1st day of each month. This is very easy to follow and to do irrespective of anything that happens. There are also services allowing to do this in automatic way (like Coinbase).
Dollar cost averaging (DCA) is an investment strategy with the goal of reducing the impact of volatility on large purchases of financial assets.
Cryptocurrency market cycles in the past comprised several stages:
- Stage 1: Sharp rise (bubble phase);
- Stage 2: Correction;
- Stage 3: Mild price decrease;
- Stage 4: Sideways movement;
- Stage 5: Mild growth;
- Go to Stage 1, but starting at a higher price level.
The nice pattern is that while phase 1 is the shortest and phase 2 is relatively short, phases 3-5 take much longer time. If you do regular purchases for the same dollar amount over those periods, in the end your portfolio will have low average acquisition price.
One of the advantages of such a strategy that it can be initiated at any moment of the market development, and as long as investment asset has fundamental growth reasons, the portfolio might be very profitable in the future. In one of the past articles we looked at such portfolio, which was initiated at previous price peak level in November 2013, at the end of 2017 the total investments were $5000 and resulting value of portfolio was $122242 (even when invested via bitcoin ATMs), which is more than 2x cumulative growth per year. This example illustrates that even starting investing at the very peak levels of the market, long term the cost averaging strategy is still very profitable.
As market overcome another bubble stage in December 2017, we allocate and track new dollar cost averaging portfolios since this moment.
Sample portfolio calculation
We look at portfolios of two cryptocurrencies:
- Bitcoin (BTC)
- Bitcoin Cash (BCH)
Both originate from Bitcoin pre-hard fork, which happened in August 2017, and produced a lot of contentious discussion in Bitcoin community.
Bitcoin (BTC) technically follows the previous chain, however, continues to apply artificial limit of 1Mb per block, which resulted in tremendous growth of miner fees in December of 2017 (average miner fees reached $55 per transaction, and medium fee reached $35 per transaction). The idea behind limiting block size to 1 Mb is to preserve decentralization in the way that it will be easier for users to run fully validating nodes. The major effort now is put in development of Lightning Network, which is a layer two protocol on top of Bitcoin. LN is an advanced technical solution, however, the future is not clear and many opponents mentioned a number of design flaws of the system. The following article gives a good overview of them. LN is already functioning on mainnet of Bitcoin, however, still a young technology and implementations still have many bugs. It is not recommended to use it only for small amounts at this stage. Technical problems will definitely be solved over time, but design problems potentially will be left, and usability of the system in a decentralized fashion is still questionable.
Bitcoin Cash (BCH) technically was a hard-fork of Bitcoin, which means software was changed in the way that it is not compatible with previous versions of software. But at the same time it preserved economic qualities of the system, mainly ability to transact at low fee per transaction, as well as security model and economic incentives (e.g. with LN part of reward is going to be passed to relaying LN nodes and taken away from miners). The priority with Bitcoin Cash was given to increase a block size (initially to 8Mb, and later in May 2018 to 32Mb), which guarantees that practically any transaction is included in the next block and is very cheap. The following chart illustrates the difference in median fees between BTC and BCH:
Yes, red horizontal line which coincides with X-axis is the median transaction fee size in USD on BCH network, which are practically zero. At the moment of writing, Bitcoin (BTC) fees are also very low (you can do regular 1 sat/byte transaction, which is for average transaction of 250 bytes is about 1.5 cents), however, the reliability of the system is still limited, e.g. when you send 1 sat/byte transaction given that mempool is empty, you can face an increase of transactions with higher fees before next block mined, and you might need to wait several hours to get first confirmation for your transaction.
Definitely, Bitcoin Cash (BCH) has some cons compared to Bitcoin (BTC), e.g. BCH was forced to change difficulty adjustment algorithm and switched to faster difficulty adjustment to sustain existence. This results in the higher risk of contentious hard-forks survival in the future as well within BCH network.
In a nutshell, comparing the two, Bitcoin Cash (BCH) is a technical hard-fork of Bitcoin and Bitcoin (BTC) is an economic hard-fork of Bitcoin (if to apply similar terminology). One can argue that BTC is real Bitcoin, while another will say BCH is real Bitcoin, however, both are chains of Bitcoin that existed pre-1st August 2017 and have different approaches to scaling the network, while BCH is closer to initial version of Bitcoin described in whitepaper and how it worked the first 8 years before hard fork. Today Bitcoin (BTC) preserves majority of hash-power (8:1) and market evaluation based on price (9:1). At the same, even now when Bitcoin (BTC) fees are significantly lower than during peak usage of the network capacity, it is still much cheaper to transact on Bitcoin Cash network.
For calculating dollar cost averaging portfolios, we allocate $100 in each coin on 1st day of each month. To show the strength of the strategy the portfolio investment is initiated on 01.01.2018 (assuming someone jump on the train of Bitcoin investment during peak prices in December 2017). As a price source we use Bitstamp:
|Date||BTC Price||BCH Price||USD investment||BTC||BCH|
Performance of portfolios:
Bitcoin Cash (BCH)
|Last 6 months||-20.6%||-19.7%|
|Last 3 months||-15.1%||-23.1%|
The following chart illustrates change of dollar cost averaging bitcoin investment performance over time: