By Tim Courtney, Chief Investment Officer
Cryptocurrencies have once again returned to the limelight due to many digital currencies hitting record highs. Within the last 12 months, bitcoin is closing in on a nearly 1,000% return.1 Dogecoin, which was originally started as a joke, has surged over 5,000% this year alone.2
With these enticing numbers dominating headlines, many are feeling remorse about not buying cryptocurrencies sooner, and several are looking to do so now. With that, we wanted to address some key points that investors should consider when deciding whether cryptocurrencies make sense in portfolios.
Utility: This is the main selling point for cryptocurrencies. They can be easily stored and accounted for, and some people like the fact that this is done outside of traditional banking and financial structures. The easy transferability of assets is a great feature, particularly to those lacking access to bank accounts, which is a reality in a large part of the world.
Additionally, cryptocurrencies provide individuals with an alternate store of value, which is especially beneficial to those in countries whose national currencies have been devalued such as Venezuela.3 Like gold, cryptocurrencies could be used to hedge against the inflation risk of traditional currencies. Many digital currencies have limits on the number that can be created (only 21 million Bitcoin, for example), although they can be very thinly subdivided and new cryptocurrencies are being continuously created.4
Value: There is disagreement about how cryptocurrencies should be valued. They produce no cash flows but have some utility. It is unclear just how much demand is genuine (coming from unbanked citizens, or those looking to transact normal business or maintain purchasing power) and how much demand is coming from investors/companies who just don’t want to miss out. For these reasons, we consider them speculative assets (as we do with all currencies and gold), with their value being purely driven by supply and demand. This is in contrast to assets such as stocks, bonds or real estate, which create cash flows and, as such, allow for clearer valuation methods.
The value of cryptocurrencies is subject to several market and regulatory risks. New digital currencies could be introduced that may drive down demand for those currently in favor. China recently launched its own state-backed digital currency and there will likely be others.5 Additionally, regulatory changes could impact cryptocurrency valuation —negatively and/or positively. For example, Gary Gensler, who is well acquainted with digital currencies, has recently been appointed as chair of the Securities and Exchange Commission and may finally approve a bitcoin exchange-traded fund (ETF).6
Access: While the U.S. does not have a bitcoin ETF yet, there are several ways to gain exposure. The easiest option is via an exchange such as Coinbase and then held in a digital wallet on your phone or computer. However, this is also the riskiest method, as there is no party responsible for maintaining and reporting on your digital assets. Another option is to purchase using an asset manager and custodian. This method provides a custodian that reports on holdings and, in many cases, holds them in “cold storage,” which is a system regarded as more secure and less vulnerable to hacking. This option can be accessed outside of your brokerage account through private placement funds or purchased over-the-counter within your brokerage account through trusts that trade throughout the day. Private placement funds are illiquid though and daily traded trusts can trade at deep discounts and/or premiums to the underlying cryptocurrency they hold.
Under the current circumstances, we don’t believe digital currencies should hold a dedicated place in investors’ portfolios. We think there are more reliable ways to hedge against dollar decline and maintain purchasing power. With that noted, however, if you have any questions about or are interested in digital currencies, please contact your Exencial advisor.
Sources
1. CNBC.com (3/13/21) – Bitcoin surpasses $60,000 in record high as rally accelerates
2. USA Today (4/16/21) – Not a joke anymore: Dogecoin, the cryptocurrency created as a spoof, sees its market value top $40B
3. Cointelegraph (4/4/21) – Exploring Venezuela’s crypto ecosystem since the start of the pandemic
4. Investopedia (2/21/21) – What happens to Bitcoin after all 21 million are mined?
5. Axios (4/20/21) – China leads the world with new state-backed digital currency
6. ETF Trends (4/19/21) – A new SEC chair ignites hopes for a bitcoin ETF
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