Cryptocurrency in your portfolio
High risk and volatility
First and foremost, it’s important to keep in mind that cryptocurrency is a high-risk, highly volatile asset. If the prospect of a wild investment roller coaster makes you uncomfortable, crypto may not be for you.
This extreme volatility reflects the fact that cryptocurrency is still a relatively new type of asset, and values are pushed and pulled even more than established investments by media hype, investor sentiment, potential regulations, and short-term profit taking. Put simply, investors are uncertain how to value crypto. The reason for this uncertainty is that most cryptocurrencies, including the two most common forms, Bitcoin and Ether, are not pegged to any government-issued currency and have no intrinsic value other than what investors might pay for them.
Stablecoins, which are pegged directly to the value of the U.S. dollar or other reserve assets, are intended to remove cryptocurrency’s volatility while preserving some appealing features, such as ease of digital transfer. However, stablecoins still carry significant risk.
Value and speculation
When you buy stock, you purchase a share of a business and are entitled to a share of the business’s earnings. When you buy a bond, you purchase the right to the interest and return of principal (assuming the issuer does not default). You are likely also hoping that the price will rise should you choose to sell, but the investment has underlying value regardless of price movement. By contrast, when you buy cryptocurrency, you are engaging in something close to pure speculation — the possibility that another investor might consider the digital asset more valuable in the future, even if there is no underlying value.
Cryptocurrency can be used to purchase some products, and the governments of El Salvador and the Central African Republic have made cryptocurrency legal tender.2 It’s likely that a broader range of opportunities to use crypto will develop. Still, dollars or other government-sponsored currency will generally remain easier and more appealing for most transactions because the buyer and seller can have confidence that the currency’s value will not change dramatically before or after the transaction.
Some proponents see cryptocurrency as a hedge against inflation. Still, there is no evidence that this is true, though any investment that consistently returns more than the inflation rate might be considered a hedge. Most proponents see crypto as a store of value, similar to gold. However, gold has real-world value as a metal with unusual properties and has been a widely accepted store of value for thousands of years.
The key factor that may give crypto long-term value is limited production. The two most common forms of cryptocurrency, Bitcoin and Ether, have built-in safeguards limiting the number of Bitcoins and Ether. Once those limits are reached, value may grow, assuming that investors continue to want cryptocurrency.
Ups and downs without a historical baseline
Some investors may look at the extreme volatility of cryptocurrency as an opportunity to make quick profits by buying low and selling high, but this requires timing a market sector that is very difficult to predict, and the risks are extremely high. In May 2021, when China banned financial institutions and payment companies from offering services related to cryptocurrency, Bitcoin dropped almost 30% in a day, and the capitalization (total value) of all cryptocurrencies fell 35%. Two other common cryptocurrencies, Ether and Dogecoin, fell 43% and 53% respectively.3
Over the longer term, Bitcoin has experienced dramatic losses in three out of the last ten years, ranging from -61% in 2014 to -73% in 2018 (and most recently, -64% in 2022). On the upside, it has had seven years of positive returns, ranging from a solid 35% in 2015 to an astonishing 1,338% in 2017. Bitcoin returned 156% in 2023.4. This is an impressive performance, and returns were even higher in the first few years, so those who invested early received remarkable rewards. However, this kind of growth is likely unsustainable, based on speculation about a new asset with unknown value.
The question for investors today is, where does cryptocurrency go from here? It is impossible to predict market direction accurately, but stocks and bonds have a long history that can give investors a general sense of long-term trends. This record does not exist for cryptocurrency. Bitcoin, which was released in 2009, has the longest record, followed by Ether, which was released in 2015. Neither offers enough history to establish a long-term trend, especially with the extreme volatility of a brand-new type of asset. Other cryptocurrencies have even shorter records.
Balancing risk and potential
Considering all these factors, it should be clear that putting cryptocurrency in your portfolio involves adding volatility and risk in return for an unknown potential for gain. This kind of trade-off is not appropriate for all investors.
Like most investment decisions, the role of crypto in your portfolio depends on your time frame, personal goals, and risk tolerance. It also may depend on your personal opinion of the future of cryptocurrency and the role it might play in the global financial system. If you want to include cryptocurrency in your portfolio, more well-established forms of cryptocurrency might be a wiser choice than less-established crypto assets that may carry even higher risk. In January 2024, the Securities and Exchange Commission approved the first Bitcoin “spot” exchange-traded funds (ETFs), providing a simpler way for investors to gain exposure to Bitcoin without holding it directly.5
It may be appropriate to consider cryptocurrency a high-risk, potentially high-reward asset, similar to a start-up or small tech stock. You should not invest in crypto instead of other investments necessary to pursue your long-term goals. To look at it another way, you should not invest more than you are comfortable losing.
Is cryptocurrency in your portfolio appropriate?
To determine whether cryptocurrency is appropriate for you, it would be wise to consult a financial professional. Although there is no assurance that working with a financial professional will improve investment results, a professional can evaluate your objectives and available resources and help you consider appropriate long-term financial strategies.
All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful.
Cryptocurrencies are not traditional investments; they are highly speculative instruments, carry significant risk, and are not suitable for all investors. Cryptocurrencies are not typically subject to the same reporting and data integrity requirements that apply to more traditional investment products. The IRS treats cryptocurrency as an asset subject to capital gains taxation rather than as currency.
Stablecoin reserves may not be subject to rigorous audits, and the quality and quantity of collateral may not, in some cases, correspond to the issuer’s claims. Stablecoins that maintain their value through algorithmic mechanisms are potentially subject to failure due to market pressures, operational failures, and other risks.
Exchange-traded funds are sold by prospectus. Before investing, carefully consider the investment objectives, risks, charges, and expenses. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
