Future of crypto in the next 5 years

Bitcoin in 2023

It’s been difficult for many people to watch the meteoric rise of Bitcoin and remain on the sidelines as others have benefited from the vast wealth generated from the appreciation of digital currencies. I often chat with people that are considering an investment in Bitcoin and other cryptocurrency, and this month I wanted to summarize my thoughts on the role of cryptocurrency in an investment portfolio. It’s quite easy to get swept up in the euphoria, especially when the internet is filled with examples of people who invested $100 in 2010 and are now millionaires.

The case *for* investing in Bitcoin and other cryptocurrencies.

To understand why you might want to own Bitcoin, you need to understand what you’re purchasing. Other common investment assets are simple to understand. Property like land and houses are tangible, and stocks give you the right to own shares of a company that generates profits. But why would you want to own a digital currency that isn’t backed by an asset? Afterall, good currencies have a stable value, so the idea of investing in an unstable currency is rightfully confusing to many people.

Bitcoin, like any other asset is fueled by supply and demand. The supply of Bitcoin is limited by a complex digital mining process, and there are only so many available. But more importantly, there is immense demand to own digital assets that can cross international borders, avoid government regulation (although this is changing in most countries), and freely exchange digital cash without the involvement of third parties. If that wasn’t reason enough, major investment banks, tech-savvy companies, hedge funds, and brokerage companies now own Bitcoin, which has supercharged a market already on an upward trend.

So, the first reason to own Bitcoin is purely based on speculation. People want it, and that is going to drive the price upwards. The second reason is the technology behind cryptocurrencies is pushing the boundaries of innovation. Most cryptocurrencies use a ledger system to record digital transactions in a way that is decentralized, publicly validated, and permanently recorded. This blockchain technology is already widely used in a variety of ways and has thousands of use-cases across many different industries. For example, in the past few months “digital collectibles” in the form of non-fungible tokens (NFT’s) have grown in popularity and use the blockchain to validate and record the owners of digital art and other items. I would make the argument that its more important to own shares of companies that use the technology, rather than the cryptocurrency themselves, but these two assets are closely-linked and even tend to perform similarly in public markets.

The next reason to own Bitcoin is its emergence as an alternative to gold. Humans have valued gold for thousands of years, and its rarity has cemented its role as a “store of value” or method of exchange, even as governmental currencies and other forms of payment have failed. Bitcoin is a digital asset that can also be used as a method of exchange, and potentially a store of value, though its volatility is far greater than gold. It remains to be seen if Bitcoin can really become a storage of value over decades, though many who purchase it, anticipate it being stable for the foreseeable future.

The final reason to own Bitcoin is diversification. One of the central tenants of good investing is to purchase assets are that are not correlated with each other. Investment managers never want all their eggs is one basket, which is why they diversify into domestic and foreign equity, bonds, real estate, and an assortment of different sectors and industries. Bitcoin has proven itself as an asset that largely moves independent of the public stock markets and is a good diversifier for that reason.

The case *against* investing in Bitcoin and other cryptocurrencies.

History is filled with examples of speculative bubbles that have bankrupted even the most savvy investors. Isaac Newton famously lost millions (of today’s dollars) in the South Sea Company bubble of 1720, and the dot com bubble of the late 1990’s famously destroyed an immense amount of wealth for those betting that every internet company had inherent value, even if they had little revenue and no profits. The reality is that nobody knows if Bitcoin and other cryptocurrencies are going to retain their value over the long term. While the technology is certainly here to stay, the coins themselves clearly have inflated values from speculation. So, the long-term viability of bitcoin is certainly up for debate, and that is the primary argument against using Bitcoin as digital gold. It’s impossible to know if an asset can be a store of value without a robust history showing it can store value successfully.

Secondly, Bitcoin (and other cryptocurrencies) are incredibly volatile, far more than most domestic stocks that investors are accustomed to. For example, a $100,000 Bitcoin investment in December of 2017 would have turned into a roughly $20,000 investment in December of 2018. Certainly, that level of volatility is not realistic for conservative investors that are dependent on their investments for their livelihood. Bitcoin is not likely to be easily held by more conservative investors, and that will ultimately only lead to a situation where they are set-up for failure right from the beginning. In my experience, many investors think they can handle volatility, but the shock of seeing thousands lost overnight will often force their hands and make them realize they cannot.

Finally, there are some serious security concerns around holding cryptocurrencies in online wallets. Unlike SIPC and FDIC insured accounts, there is no guarantee that your assets are safe. In 2020 alone, billions of dollars were lost to hacking and cybersecurity failures. One of the primary benefits of cryptocurrencies (lack of regulation) is also the cause for one of its greatest risks. However, this is changing as more mainstream adoption has taken place. Larger companies like Paypal and Coinbase are better able to maintain platforms that allow investors to own these assets with the same type of stability as other brokerages. There is currently no way to directly own crypto assets with SIPC insurance, but it is possible to indirectly own the assets through investment trusts that are publicly traded, though these have exceedingly high fees. This is also likely changing, as Canada has approved the first Bitcoin ETF, and many are expecting the SEC to follow suit in the next year. This would allow investors to own cryptocurrencies with the same guarantees from fraud or brokerage failure that they have with stocks, bonds, ETF’s, and mutual funds.

Is cryptocurrency right for every portfolio?

Is cryptocurrency right for your portfolio? The answer (like most of investing) is “it depends”. If you’re an aggressive investor with extra discretionary wealth, then Bitcoin has a good place as a portfolio diversifier for you. If you are interested in speculation, there is a lot of wealth that can be made over the short-term. The future remains uncertain for the long-term viability of most cryptocurrency, though widely adopted ones like Bitcoin and Ethereum have immense market inertia and are used in a variety of other applications. I would strongly recommend against investing in niche cryptocurrencies with the expectation that those assets will be something to help fund your retirement plans 20 or 30 years from now. But a small allocation to widely established cryptocurrency like Bitcoin is a great way to diversify your portfolio and take advantage of a new asset class.

So, in summary, I suggest that aggressive investors that don’t mind the volatility have a small allocation to cryptocurrency, rebalance it appropriately, and hold it outside of a high-fee investment trust structure. When a Bitcoin ETF becomes approved in the United States, I think the long-term adoption case becomes even stronger.