How to Lose Money with a Bitcoin Investment, Part 1: The Easy Money Mantra

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Many investors holding Bitcoins naturally look for ways to put their money to work via investments that can generate capital growth, income, or both. Several worthwhile opportunities are available in the Bitcoin space, but one commonly mentioned trading method needs a crystal ball to work well.

Many self-proclaimed Bitcoin investors sound off about how straightforward it is to grow their Bitcoin holdings by trading in and out of Bitcoin, selling when its value is high against a fiat currency such as the dollar, and buying — more than originally sold, of course — when its value subsequently falls against fiat. Going by the number of people describing this tactic, or describing how all the big players with more capital than they have are already doing it — you could be forgiven for feeling a little left out. If you’re not doing it, what’s wrong with you? Do you just not understand Bitcoin well enough?

It is entirely possible to apply this strategy successfully and without taking on inordinate levels of risk, provided that you either:

  • have a highly capable magical crystal ball which you can use to foretell subsequent moves in the exchange rate, or
  • are willing to spend additional capital on derivatives to hedge against the risk of a subsequent rise in Bitcoin value versus fiat when you sell them and the risk of a fall in Bitcoin value versus fiat when you buy them.

However, few of those who repeat the “sell high, buy low, lather, rinse, repeat” mantra actually mention suitable derivatives strategies for managing risk. Maybe some are secretly using privately negotiated forward contracts, but going by volume and open interest on public exchanges offering options and futures, very few are using these types of derivatives in any volume. Fewer still have a highly capable magical crystal ball.

Naturally, there will always be a chance that some have done it successfully without any hedging and without caring about taking on very high levels of risk, just as there will always be a winner in any single elimination tournament decided by coin tosses: someone will always win every single coin toss, all in a row, one after the other, regardless of how many rounds there are in the tournament. In other words, it’s not that it’s impossible to see it work, any more than it is impossible to win single elimination coin toss tournaments (or games of Russian roulette, for that matter), it’s just that counting on such a strategy without appropriate hedging to reduce risk is a recipe for disaster. Even engaging in the activity with rational use of derivatives entails a significant risk of losing money anyway.

Despite the loud voices behind the easy money mantra, I take it that none of what I’ve described here is really in any way controversial; for every self-proclaimed practitioner of the unhedged long-then-short trading method, maybe there are five or ten or fifty or a hundred who fully understand the risks.

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