It’s tempting. With a market value of nearly $ 2 trillion, of which $ 775 billion in
cryptocurrencies are now more important than the US junk-bond market. Fortunes have been made as prices have skyrocketed over the past year. Why not add some crypto for diversification and a chance to take advantage of technology that could revolutionize everything from stock trading to digital art?
Nothing about crypto is that simple, of course, including its value as an alternative asset. Yes, some brokerage firms argue that adding a spoonful can increase the returns of a well-diversified portfolio. But the market is moving so fast that data sets from even a year ago can now be out of date. El Salvador’s adoption of Bitcoin aside, more governments, including China, are cracking down on digital tokens than they are adopting them. Investors must also separate tokens from technology: Blockchain networks have the potential to revolutionize financial markets. If you bet on crypto, these companies may be safer than speculating on coins.
Advisory firms seem divided over whether to recommend cryptos as an alternative asset, other than stocks or bonds which can smooth portfolio volatility and / or increase returns. Fidelity Investments and
both published research indicating that Bitcoin could be a good alternative. Fidelity claims that holding 3% of Bitcoin from January 2015 to September 2020 would have increased returns by 3.4 percentage points on average per year on a 60/40 portfolio of stocks and bonds. According to Morgan Stanley, a 2.5% stake in Bitcoin would have increased returns by 1.6 percentage points on average from 2014 to October 2020.
Tom Jessop, president of Fidelity Digital Assets, describes crypto as a “venture capital investment”, similar to start-ups in Silicon Valley. “Like any business, it has high risk / return tradeoffs, but it should have the effect of diversifying and amplifying returns,” he says.
Morgan Stanley is still “constructive” on crypto, despite a recent drop in prices, says Lisa Shalett, investment director of wealth management. Bitcoin has had almost no correlation with interest rates over the past year and has maintained low correlations with stocks, she points out, offering diversification benefits. “We continue to view crypto as being at the bottom of the first round as an emerging asset class,” she said. “It has enormous potential with uses that are constantly evolving.
UBS, however, is not on board. “To invest strategically in Bitcoin, you have to assume that prices are going to continue to rise and we find it difficult to draw that conclusion,” said Michael Bolliger, director of emerging market assets investments. Bitcoin is often described as “digital gold” because they both have a fixed supply, imparting anti-inflation properties. But he also rejects gold, noting that it does not pay dividends or interest and has a poor track record in tracking economic growth. While tactical bets on Bitcoin and gold can pay off, he says, “we believe there are better alternative assets for strategic allocation.”
The divergent views reflect the fact that cryptos are like an unruly digital Rubik’s cube: incredibly volatile and rapidly changing. And they come with growing regulatory risks. Nothing on the market looks like it was three years ago when Bitcoin was dominant. There are now thousands of other underlying blockchain tokens and networks, including platforms for lending, trading, and other uses.
is now the second largest network, with tokens with a market value of $ 345 billion. Other networks with “native” tokens include Cardano, Solana, Uniswap, and crypto “memes” that started out as a joke, like Dogecoin (now worth $ 26 billion). New arenas include non-fungible tokens, or NFTs, from digital collectibles, from artwork to tweets. Gaming platforms integrate the NFTS and other cryptos as gambling currencies. Wall Street companies are developing ways to bypass exchanges and trade token versions of securities.
The expansion has attracted hedge funds, foundations and other large capital pools, turning cryptos into a tradable asset class. More than half of the 1,100 institutional investors surveyed by Fidelity this year said they had been exposed to digital assets. More than 75% of professional investors in Europe and Asia plan to buy digital assets, according to the survey, as well as 60% in the United States
Yet the flow of money has also made cryptos more like other risky assets, vulnerable to macroeconomic trends and global capital flight during times of stress. According to Bolliger, correlations with other risky assets have increased, causing cryptos to fall along with stocks during global mass sell-offs. Cryptos plunged in the spring of 2020, when the pandemic wiped out stocks around the world. The recent slump in China’s overheated real estate market has also rocked cryptos.
Another changing dynamic is global liquidity. Cryptos have benefited from central banks injecting liquidity into capital markets, increasing demand for stocks, bonds and other assets. This may be coming to an end: The Federal Reserve recently signaled that it would start cutting bond purchases in November, a step towards an interest rate hike in 2022. The impact may be gradual, but this will increase the barriers to capital investment in crypto and other speculative assets.
The other major concern of the crypto markets is regulation. Led by Gary Gensler, chairman of the Securities and Exchange Commission, regulators are looking to get crypto under control. Decentralized Funding Platforms, or DeFi, used for lending and trading, are coming under scrutiny in Washington, along with Stablecoins, tokens designed to maintain a stable $ 1 value. The Treasury Department is expected to release a framework soon to regulate stablecoins, as state banking regulators slowly crack down on high-yield crypto accounts.
The Chinese government is also turning against crypto. Beijing, which banned crypto mining some time ago, recently announced a ban on business transactions, warning residents not to even try to use a token to buy a cup of
Coffee. The ban could dampen the growth of cryptos in the world’s second largest economy, affecting prices and demand around the world. Other governments see the threats of cryptos and DeFi networks where anyone can trade 24/7, under the radar of regulators and tax authorities.
Does all of this mean investors should avoid crypto altogether? No. One of the strongest arguments in favor of the asset remains diversification. From 2015 to 2020, Bitcoin was almost entirely uncorrelated to U.S. and international stocks, high yield bonds, real estate, and gold. Bitcoin also appears to be inversely correlated to the dollar.
“You want to own assets that offer you fair expected returns but that are not correlated with other asset classes, which is the case with cryptos,” explains Yukun Liu, an economist at the University of Rochester who studied the investment. He recommends an allocation of 1% to 2%, or up to 3% if you are “very optimistic” about the technology. Cryptos are additive at these levels because they won’t torpedo your portfolio if they collapse, he says, and if their returns exceed those of stocks, you’ll be fine in the long run.
Yet a diversification asset can be very volatile. This is because Bitcoin’s chances of a collapse are six times higher than that of stocks. There is a 30% chance of losing 63% in Bitcoin from a two-year high, according to Fidelity. For the
There is only a 5% chance of a similar withdrawal, based on data since 1900.
Plus, cryptos have other downsides: They’re high-speed investments – you have to catch a wave before it turns to foam. And 38% of the Bitcoin that has been produced, roughly 7.2 million tokens, may be lost forever or not circulating on trading platforms, according to data provider Glassnode. It takes less than $ 100 million in net admissions to push the price up 1%, according to
Bank of America
This is 20 times less than it would take to have a similar impact on gold.
Crypto supporters argue that the rewards are well worth the risk. “Cryptos offer investors exposure to a technology so disruptive that it threatens the profits of Wall Street and Silicon Valley,” says Matthew Sigel, head of digital asset research at VanEck. “Because of the impressive characteristics of the technology, every investor should have some exposure. “
Cryptos, he adds, held up fairly well in China’s latest debt crisis. While taking a hit, cryptos did not crash, in part because automated ‘liquidation bots’ swept through decentralized lending platforms, slipping borrower guarantees and returning them to lenders (for a fee). “There is a lot of leverage in cryptos, but a lot is liquidated on the basis of formulas,” he says. “That’s why we haven’t seen any systemic risk associated with cryptos. Losers get wrecked very quickly.
Yet even supporters argue that investors should spread their bets, owning multiple tokens or companies involved in blockchain-based services. “You don’t want to make simple bets,” Shalett explains. “You want to be exposed to a diverse set of players: coins, miners, custodians, transactional services. This is all at stake.
Some advisers like index funds for exposure. Hal Anderson, managing partner of Utah-based Soltis Investment Advisors, owns up to 7% of some crypto client portfolios, including the
Bitwise encryption index 10
funds (ticker: BITW) and the
Bitwise crypto industry innovators
exchange-traded fund (BITQ). “Crypto is here to stay,” he says, “but there is a lot to be worked out.”
Write to Daren Fonda at [email protected]