MARKETS IN A MINUTE: CRYPTOCURRENCY, KARA MURPHY, CFA | 10/12/2021
Is it wise to invest in Bitcoin and other cryptocurrencies? The question has been hotly debated across kitchen tables, institutional boardrooms, and even among financial advisors and their clients. As might be expected, there are divergent opinions on the issue and a wide range of potential outcomes for investors.
For many investors, the world of cryptocurrency remains, well, cryptic. So, what exactly are cryptocurrencies or cryptos, and what’s all the fuss about?
- Bitcoin and other digital currencies have several unique features that differentiate them from other forms of currency:
- Cryptos are not associated with a government or financial institution.
- They can be transferred from one individual to another without the help of a central organization (i.e., bank).
- The supply of the Bitcoin is governed by a fixed formula, in contrast with a central bank that increases and decreases the supply of money to help smooth out economic cycles.
- Cryptos can still be used to buy traditional currencies, goods, or services – usually online and with some anonymity despite their digital nature
- Bitcoin, the oldest and largest crypto by market cap, was developed in 2008 by an unknown person or group using the pseudonym Satoshi Nakamoto. In the white paper that founded the currency, it was described as a “peer-to-peer electronic cash system.”
- Bitcoin now has plenty of (much smaller) competition. By some accounts, there are roughly 6,000 brands of cryptocurrencies and counting.
Bitcoin has seen tremendous gains, benefiting from increased demand from individual and institutional investors alike.
- During the financial crisis, cryptos began to attract investors seeking a safe haven from currency devaluation, higher inflation, and other economic challenges across the globe.
- Investors large and small have moved into the space over the last several years, driving assets under management in digital-asset funds to $50 billion in late September, reports digital-asset manager CoinShares.
Despite this newfound attention, Bitcoin and other cryptos lack some of the qualities that more-established asset classes exhibit:
- Unlike bonds, for instance, cryptos don’t generate steady, reliable cash flow on a contractual basis. Unlike stocks of companies that benefit from economic tailwinds, cryptos don’t generate earnings through exposure to economic growth.
- The price of cryptos tends to be highly volatile. This year, Bitcoin hit a new all-time high above $63,000 in mid-April, only to lose more than half its value by late July, before climbing to about $49,000 in early October.
- As a result, cryptos have not offered consistent or reliable diversification for portfolios. In fact, Bitcoin’s correlation to traditional asset classes has risen during recent periods, possibly because of increasing adoption.
Cryptocurrencies lack the infrastructure and regulatory oversight of more traditional financial assets.
- According to a Federal Trade Commission alert released in May, since October 2020, consumers have lost more than $80 million in cryptocurrency investment scams.
- That represented an increase of more than ten-fold on a year-over-year basis.
- The FTC also notes that cryptos don’t come with important legal protections for consumers. For instance, crypto accounts (unlike U.S. dollars deposited in banks) are not insured by the federal government. So, if you store cryptos with a third-party company, and the company goes out of business or is hacked, the federal government has “no obligation to step in and help get your money back,” the FTC warns.
- In September, El Salvador’s adoption of bitcoin as a legal currency highlights some of the opportunities and pitfalls of digital currencies. While bitcoin itself has appreciated in value since the introduction, only a small fraction of small businesses have used it and the government’s cryptocurrency app has faced technical problems.
Regulators appear to be gearing up to increase their oversight of the popular new vehicles:
- SEC Chairman Gary Gensler recently told the Washington Post that his agency has “robust” authority to regulate the crypto industry. He has also compared the market to the Wild West. Cryptos, he said, haven’t been used much as “a medium of exchange.” Instead, he added, they’re often used to “skirt” laws related to money laundering, sanctions, and tax collection and may enable extortion via ransomware, as Colonial Pipeline recently learned.
- The White House is also weighing greater oversight of the market in order to combat the growing threat of cybercrime.
There remains little consensus on these emerging assets. Even high-profile investors who generally adhere to the same strategy are coming down on different sides of the crypto debate. Value investor Charlie Munger, for instance, has reportedly called Bitcoin "disgusting and contrary to the interests of civilization." Yet Bill Miller, another well-known value investor, is reportedly a Bitcoin bull and Bitcoin billionaire, owing to early investments in the currency. With that lack of consensus comes both opportunity and risk. It’s important for individual investors not to confuse trading in ultra-risky assets, such as cryptocurrencies, with more tried-and-true approaches to investing. For individuals with a long time horizon, a high tolerance for risk, and the discipline to keep wagers very small, there can be a place for buying assets that swing wildly from day to day, sometimes hour to hour. Investing, though, is more about growing and/or protecting your wealth to meet specific goals, whether a vacation or safe retirement. To meet those goals, investors are well-served to continue to rely primarily on assets such as stocks and bonds that have reliable track records and safeguards. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Advisor Services Holdings C, Inc., d/b/a Kestra Holdings, and its subsidiaries, including, but not limited to, Kestra Advisory Services, LLC, Kestra Private Wealth Services, LLC, Kestra Investment Services, LLC, Bluespring Wealth Partners, LLC, and Grove Point Financial, LLC. The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. It is not guaranteed by any entity for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was created to provide accurate and reliable information on the subjects covered but should not be regarded as a complete analysis of these subjects. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation. Kestra Advisor Services Holdings C, Inc., d/b/a Kestra Holdings, and its subsidiaries, including, but not limited to, Kestra Advisory Services, LLC, Kestra Private Wealth Services, LLC, Kestra Investment Services, LLC, Bluespring Wealth Partners, LLC, and Grove Point Financial, LLC does not offer tax or legal advice.
ABOUT THE AUTHOR: Kara Murphy, CFAAs Chief Investment Officer of Kestra Investment Management, Kara brings her extensive expertise to partner with the independent financial professionals associated with the Kestra Holdings ecosystem. Kara and her team provide hands-on support, that includes market commentary and research, guidance on portfolio construction, and a broad array of investment solutions designed to empower financial professionals to serve their clients’ wealth management needs.