Active vs Passive Crypto Investment: the Pros and Cons
When it comes to any type of investing, there are two distinct ways to do it — active or passive investing. The same idea applies to.
When it comes to any type of investing, there are two distinct ways to do it — active or passive investing. The same idea applies to crypto investments. Both active and passive crypto investments have their distinct advantages and disadvantages – both of which will be the highlight of this article.
What is active vs passive investing?
Now, before we jump into the pros and cons, it’s important we get on the same page regarding the idea behind active and passive investing.
Active investing involves actively managing the investment portfolio, analysing the markets, choosing what seems to be promising short-term or medium-term investments, and choosing when to buy the asset and how much to invest.
Passive investing involves taking a buy-and-hold mentality, choosing and buying assets less frequently, usually sticking to investing the same assets, and this can also involve the dollar-cost averaging buying strategy.
Now with that out of the way, let’s talk about the pros and cons of active and passive investing – and why you should consider both.
The pros and cons
Below are the summaries of what you should expect if you invest in crypto, actively or passively. Detailed explanations are in the next section.
Active crypto investing – Pros:
- You could gain more profit if your timing is right.
- You could avoid the risk of a major correction as cryptos are volatile.
- It’s easy to decide whether to swap for crypto assets associated with a promising project.
Active crypto investing – Cons:
- You need to learn to analyse price charts.
- You need to actively monitor price charts and follow crypto updates closely.
- You could be easily influenced by market euphoria or panic.
Passive crypto investing – Pros:
- Less mental pressure; you could buy and forget about it for a few years.
- You’re not going to be alone on your journey to “Hodl” crypto assets.
- You could potentially perform better than active crypto investors.
Passive crypto investing – Cons:
- It’s still not yet clear what the average annual return for crypto assets is.
- You need to put a lot of faith in the crypto asset over a long period of time.
- You could miss out on high-potential projects that can revolutionise crypto space.
What is the average annual return, and why is it important for HODLers?
An asset class usually has a more or less predictable “average annual return”, which is a rough estimate of how profitable an instrument is if you were to employ the dollar-cost averaging method for a given period of time, from past to present.
Although the average annual return does not, and will not, guarantee future profitability, many asset classes have been around for a very long time that a distinct pattern is noticeable.
For example, US stocks, as measured by the S&P 500 index, have had an average annual return of 10% since 1900, but annual returns each year can wildly deviate from the average.
Gold has had an average annual return of 10.44% since 1971, according to Statista. Note that the furthest year for this is when the gold standard became disused, at which point the US dollar (the reserve currency at the time and, well, even today) became inflationary.
Why is this important for passive investors?
Holding an asset can be scary, because prices can fluctuate in the short term, and in many cases, it is the temperament of investors that determines their success rate.
As legendary long-term stock investor Warren Buffet puts it:
“The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.”– Warren Buffet
In other words, long-term passive investing requires a high level of stubbornness and unshakable faith in the invested asset.
Of course, blind faith isn’t the best approach to investing either, so for many stock or commodity investors, the average annual return is one of their greatest measuring tools.
Price analysis of Bitcoin and why passive investing may be a good idea
I use bitcoin as an example because it is the oldest cryptocurrency and has undergone some incredible cycles of booms and busts.
You may know that the last boom and bust cycle for bitcoin happened in 2017, but did you know that similar cycles occurred years before, on a smaller scale?
Here is a table that shows bitcoin’s cycle of all-time highs and the lows that follow, from 2010 to 2020. I define one cycle as the period between two all-time highs that share a record low price between them.
So, for example, one cycle has spanned from July 2010 to November 2010, according to the chart below.
|Week range||All-time high price (US dollars)||All-time low price since ATH (US dollars)|
|12 – 19 Jul 2010||0.09|
|4 – 11 Oct 2010||0.01|
|1- 8 Nov 2010||0.5|
|6 – 13 Dec 2010||0.17|
|7 – 14 Feb 2011||1.1|
|4 – 13 Apr 2011||0.56|
|6 – 13 Jun 2011||31.91|
|21 – 28 Nov 2011||2.17|
|1 – 8 Apr 2013||164.9|
|15 – 22 Apr 2013||50.1|
|25 Nov – 2 Dec 2013||1,242|
|17 – 28 Aug 2015||162|
|11 – 18 Dec 2017||19,804.25|
|10 – 17 Dec 2018||3,124.51|
|12 – 19 Apr 2020||64,898.56|
From this table, we can deduce two things:
- 1. There is a strong pattern of an overall bullish or rising price of bitcoin for one whole decade, as shown by higher highs and higher lows. The next higher low could surpass the previous low by at least 200%.
- 2. On average, the new all-time high surpasses the previous all-time high by 800%. This means, while there is a chance for someone to risk 80-90% of their investments if they had bought at the highest price possible, they could still enjoy absolutely higher returns from holding onto the asset.
Most other cryptocurrencies follow bitcoin’s price movement, and it is almost certain that people are beginning to use bitcoin as an alternative to gold for hedging against monetary inflation.
You are welcome to use bitcoin’s price history as a reference, but in order to truly become confident and responsible for your own investment in other cryptos, it’s highly recommended that you analyse the price charts yourself.
Further reading: What is Bitcoin? A complete guide.
Why this is also excellent news for active investors
From the table, we can see that bitcoin experiences a predictable cycle, which means there are lucrative trading opportunities for short to medium-term investors looking to gain larger profit margins.
Suppose an active bitcoin investor has a good temperament and is not influenced by the market sentiment (a very difficult thing to do). This investor would buy at near-record-low prices and then sell near all-time highs, for 10 years straight.
Based on the above table, starting with just $1, the investor would now have 88 trillion dollars. Of course, this investor may not actually be human, but instead, a time-traveling android who can know all future events.
In the grand scheme of things, it seems reasonable to believe that it’s never too late to buy bitcoin. Those who ‘come late’ in the game will have to endure another cycle of price corrections. However, when it comes to cryptocurrency investing, holding power is everything.
Don’t invest in cryptocurrencies with the money that you will need in the next few years. But if you could only afford to lose $50 over the next several months, by all means, you can choose to grow that $50 in bitcoin or any other cryptocurrencies — and more importantly, be patient.
There is nothing wrong with investing a small amount of money in crypto right now. If the bitcoin price would dip, as it does from time to time, you can choose to double down on your initial investment, if you are comfortable with more risk.
Investing is not about the numbers as much as choosing where you invest your money, and for how long you can hold — or hodl, in the case of crypto.
Further reading: Explore our library of crypto investment topics on our Learn Site.
Note: The discussions presented in this article are meant to serve as informational and educational content. It is not to be interpreted as financial advice. As with any investment endeavors, it’s best to conduct your own empirical research and understand the fundamental risks involved.
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Disclaimer: Information is current as at the date of publication. This is general information only and is not intended to be advice. Crypto is volatile, carries risk and the value can go up and down. Past performance is not an indicator of future returns. Please do your own research.
Last updated October 20, 2022