The better question – should cryptocurrencies be a part of your investment portfolio? It may appear completely foolish to invest in a digital asset that does not exist physically and is not backed by a real commodity, government, or governing financial intermediary. Yet the price of bitcoin has surged to new highs at the tail end of 2020, the start of 2021, and the bullish case for cryptocurrencies is captivating, while far from obvious to the average investor. Yes, there are real risks to investing in crypto, but there is an opportunity with enough merit to garner investors’ attention.
The case for cryptocurrencies is incredibly complex and has multiple individual merits and data points that may justify an investment. Each one of these points could be discussed in much further detail. However, the purpose here is to give a broad-based overview so you, the investor, can make a more informed and rational decision.
This is not an investment recommendation, and you should always consult an investment professional before making a purchase decision. When ‘cryptocurrencies’ are mentioned below, it is in specific reference to Bitcoin and Ethereum – though there are many more. If you’d like to discuss this topic further, please shoot us an email here.
Unsure what Bitcoin is? Here is an Investopedia definition that can give you a base-level understanding before reading this article.
Why should crypto be a part of your investment portfolio?
- Cryptocurrencies are now viewed as a legitimate asset class. They are attractive in part due to the fact that they are largely uncorrelated to equity markets. As you may know, it is prudent from a wealth management perspective to diversify across a wide range of asset classes. Just as you are invested across geographical areas, industries & sectors, company sizes and asset classes, and other differentiating factors, you should normally be invested in different currencies, digital or not.
- Bitcoin is poised to be a frontrunner to replace fiat currency & replace USD as the global currency. There is an ongoing vote of nonconfidence in USD as their central bank continues to print money as if it is going out of style (maybe because it is).
- They are now accessible via traditional stock markets. Exchange-Traded Funds and Mutual Funds have now been financially engineered with cryptocurrencies as their underlying asset, so they will track the price of bitcoin. This means that self-directed money, as well as managed money, both have an opportunity to participate.
- Fixed Supply. Few principles are more true than supply and demand. In the case of bitcoin, there will only ever be 21 million bitcoin. Demand has been strong and should continue to increase over time. Unlike traditional currencies controlled by central banks that print money when needed, bitcoin has a fixed supply, which is a significant catalyst to drive up the price as demand increases.
- Infrastructure investments & growing corporate interest. The world and the internet are both beginning to be built on bitcoin and ethereum blockchains. DocuSign, Morningstar, Square Inc & American Express to name a few (there are hundreds) are all making massive investments in the space.
- Inflation hedge. Bitcoin has a 0% terminal inflation rate by design because there is a fixed supply of coins (21 million). Bitcoin as an investment is very much like a non-counterparty insurance policy on the legacy technology of central banking. It is an insurance policy that gets more valuable the more money is printed.
- Retail & Institutional Adoption. Robinhood, Cashapp, and PayPal are now allowing crypto payments and trading to 300+ million users. Additionally, Square Inc., a leading global payment processor, has made massive investments into the space.
Why shouldn’t bitcoin be a part of your investment portfolio?
- Protocol Risk. The protocol that bitcoin is built on could have a design flaw, or it could be broken by the development of quantum computing. If the underlying protocol is broken then the faith in bitcoin may be severely damaged. This is the smallest known risk to investing in bitcoin, however, it does not make it any less real.
- Exchange Shutdowns. Bitcoin is decentralized by nature, however, the exchanges where people can exchange fiat currency for bitcoin are highly centralized and could be regulated or closed by various governments. The growth of bitcoin would then be severely hindered, however, a complete shutdown would be extremely unlikely.
What about the ethics of Crypto Currencies?
Yes, bitcoin is officially an asset class and there are many reasons to invest. However it is unregulated, it is complex, and it is not your traditional investment vehicle. And what of the ethical and environmental considerations? Are there specific implications of a technology like bitcoin?
We continue to move into a new age of capitalism, one that considers sustainability and practices a more ethically-minded business, and one where capital formation is unbounded by traditional legal, social, and structural constraints. It is a system where everybody has access to a more democratic financial system. Intermediaries are becoming a thing of the past, and we are now empowering everybody in the world through decentralized currencies and market places.
As an example – Square Inc. says they
One might be reminded of a quote from Clean Money Revolution by Joel Soloman, founder of Renewal Funds. When we talk about the distribution of wealth via a new decentralized currency he comments that
To be very clear, we do not yet realize what the implications will be for investors and other market participants who want to track and understand their cryptocurrency investments. The traditional paradigm of buying and selling shares in the company will not and cannot apply here.
Buying bitcoin does not promote one company or another, nor does it take power out of the ‘bad guys’ hands and put it in the hands of the ‘good guys’. Ownership does not equal control. There is no fundamental analysis in trading or owning bitcoin.
This is the wild west. For those who care deeply about transparency as a part of their value system, this may be hard to get your head around. The same goes for the US dollar. The ethics are unclear. However, the argument for having digital currencies as a part of your portfolio from a financial perspective is far easier to see and comprehend.
In our view – the rationale listed above for holding cryptocurrencies gives it merit enough to be included in most people’s portfolios, should their risk tolerance and time horizons align with the characteristics and volatility of the asset class. This is a five to ten-year investment at a minimum, and with two very speculative investments (bitcoin & ethereum), we must recognize this will likely be a volatile ride. As rational investors, we must allow time for things to unfold.
As mentioned, bitcoin is the only currency to have a 0% terminal inflation rate. Many feel this is a key ethical aspect to bitcoin, reasoning that inflation itself is a financial mechanism designed in many ways as a pyramid scheme, benefiting primarily those at the top. The more money you have, the more it grows, the less money you have, the less you are able to save, the less you are able to keep up with inflation, and the less your money grows. We see this taking place in the disappearance of the middle class and the widening of the wealth gap.
The volatility of bitcoin is extreme. It is an extreme asset class and thus might comprise just a small portion of some investment portfolios. However, through diversification, the risks associated with cryptocurrencies can be somewhat mitigated.
The blue sky case for Bitcoin and Ethereum is the possibility that these currencies become the new global money standard, much as the classic gold standard of the 19th century. The case for Ethereum is simply that the infrastructure of tomorrow will be built on the blockchain and its smart contracts, as much of it already is. The website you are reading this on was built on the internet.
There is still an environmental problem to be solved, that of the immense energy usage Bitcoin eats simply to exist. At the root of this problem is bitcoin mining, which works by solving cryptographic puzzles, also referred to as Proof of Work. The miner that’s first to find the solution receives a Bitcoin reward. This computing process is a resource-intensive process requiring a lot of electricity. The University of Cambridge claims that bitcoin has the same energy usage as the whole of Switzerland. More important is the carbon footprint of Bitcoin. The electricity generated for powering the Bitcoin network equals 22 megatons of CO2 on a yearly basis. You can compare this carbon footprint with the footprint of a midsized American city. This is an ongoing issue, however there are alternative mining verification methods being explored.
The energy usage is high. However, from an ethical standpoint, we believe it is both important and prudent for international trade to be established with one indisputable, decentralized, and democratic monetary base – one that does not bear the mark of any country, one that is free from the negative properties of inflation and one that every person on planet earth can participate in.
We are not experts in the space however we are well-read observers of what is happening in the world. Like any investment, nothing is guaranteed and this is a very speculative asset class. We must recognize that the value of cryptocurrencies could plummet to zero. Does this feel like a bubble in some ways? Yes, however, Google once felt like a bubble. And ‘feelings’ have close ties to emotions, the emotional investor is not a successful one. The rational investor is far more likely to see long-term success.
All things considered, it is advisable to only invest a small amount or percentage of your portfolio, if at all. The risk may simply be too large for some investors, while at the same time, a phenomenal opportunity for others.
The comments and opinions expressed herein reflect the personal views of Tony Edwards and Joss Biggins. They may differ from the opinions of Leede Jones Gable Inc. and should not be considered representative of the research beliefs, opinions, or recommendations of Leede Jones Gable Inc. The information included in this document, including any opinion and linked sites, is based on various sources believed to be reliable, but its accuracy and completeness is not guaranteed and Leede Jones Gable Inc. does not assume any liability in providing it. The information provided is current as of the date appearing on the document and Leede Jones Gable Inc. does not assume any obligation to update the information or give a description of further developments relating to the securities or material discussed. © Leede Jones Gable Inc. 2021. Member CIPF and regulated by IIROC