It’s easy to get caught up in the excitement that cryptocurrencies draw. Between the wild market swings and the volume of trading, one can’t avoid stories about people who have made a fortune in the span of a few days. So, naturally, we at SYM Financial get our share of questions from clients, prospects, and family members about “investing in cryptocurrency.”
Here is our take on this topic.
A Question Old as Time: Are You Investing or Speculating?
The subject of cryptocurrencies is fairly recent. Bitcoin came on the scene when the programmer (or a group of programmers) known as Satoshi Nakamoto introduced bitcoin in 2009. However, for the past decade or so it wasn’t easy to get your hands on cryptocurrency. You had to either be “mining” it (which involved running multiple dedicated computers to solve problems) or be willing to go through the technical intricacies of setting up a digital wallet and figuring out how to buy crypto on unregulated websites. People’s ability to simply walk in and buy crypto with regular money on a trustworthy portal is fairly brand-new.
However, the question at the core of cryptocurrency is as old as time. Throughout human history, people have made investments in the hopes of striking it rich. Some of those investments were based on solid analysis and strategy. Others were purely speculative. Let’s look at the difference between the two.
Here at SYM Financial, we strive to help clients become successful long-term investors by sticking with what we believe are proven methods for building long-term wealth. That means periodically investing in diversified, low-cost funds that fit clients’ needs and goals.
Speculating, on the other hand, is making a bet on an unproven asset with the hope of making a big, often quick, payday. While we understand that having a little fun can add excitement to your day, speculating is fraught with danger. Before embarking on trading cryptocurrencies, an individual must be aware of the high risk and volatility that comes with speculation — which to us means being 100% comfortable with losing 100% of that investment.
So, if you are curious about dipping your toe into cryptocurrencies, here is your homework.
Cryptocurrency: Do Your Due Diligence
At SYM Financial, we did not simply dismiss the potential merits of crypto. We are constantly in search of new options that can help our clients move closer to their goals. So, what about Bitcoin and other cryptocurrencies?
Let’s start with the basics.
Webster defines cryptocurrency as “any form of currency that only exists digitally, that usually has no central issuing or regulating authority but instead uses a decentralized system to record transactions and manage the issuance of new units, and that relies on cryptography to prevent counterfeiting and fraudulent transactions.”1
So, crypto is a digital currency that generally stands outside of any government regulation and that uses encryption and decentralized record-keeping to keep things civilized. The technology that makes crypto possible (called “blockchain”) is likely to have a growing role in the way we transact.
But what does this mean for investors?
Future Currencies and Technologies—A Worthy Investment?
Is there a future for decentralized finance, digital currency, and the blockchain? Quite likely. Are cryptocurrencies a viable asset to own? Maybe. Are they optimal? We don’t think so.
Let us explain.
It is true that the technology behind crypto has merit. Imagine a world where title insurance is made obsolete by blockchain, where every transaction is locked in code and can be traced and verified digitally (a platform called Propy is doing it right now). Blockchain has tremendous potential in the field of shipping and logistics — and has already been embraced by giants like DHL and Maersk.2
However, having faith in blockchain technology and buying crypto are two different propositions.
At SYM Financial, we look for well-grounded and proven asset classes that can generate cash flows for our clients. When we buy a fund, it is invested in companies that typically produce profits and dividends which ultimately flow to its shareholders. By owning equity in a company, we have a claim on the business. For fixed-income securities and bond funds, we are buying the company’s promises to pay coupon amounts over time and then return the principal at maturity. Those promises don’t always work out exactly as intended, but we have rating agencies and analysis tools to help us make sound choices.
Cryptocurrencies, on the other hand, do not generate cash flows, promise to repay our principal at some later date, or give you a stake in a company that produces goods and services. It’s a pure wager that someone will pay you more for this digital coin in the future than you are willing to pay for it today.
High Uncertainty Typically Means Extreme Volatility
What’s more, the volatility of Bitcoin and Ethereum (the two biggest cryptocurrencies by market cap) is through the roof, both on an absolute basis and when compared to regular stocks and bonds. It is difficult enough to forecast future income streams of real, well-established companies and to gauge how safe a corporate bond is. However, that exercise pales in comparison to forecasting crypto’s future supply and demand dynamics.
This high degree of uncertainty leads to extreme levels of volatility and risk. Research shows that volatility, as measured by an asset’s standard deviation, has averaged more than 400% that of equity market benchmarks (like the MSCI ACWI and S&P 500).
Figure 1: Bitcoin’s Volatility
Data Source(s): CoinDesk, Morningstar Direct. Note(s): Calculations were made using daily returns and closing price data from 10/1/2013 to 6/30/2021. Past performance is not indicative of future results.
Here’s what this chart (and the previous paragraph) means in normal human-speak.
For most investors, a 100% stock portfolio would be the maximum limit in terms of volatility. Many investors choose to include a bond allocation to decrease the portfolio’s volatility to a lower level than that of a straight-up stock portfolio. Take that maximum limit of volatility, multiply it by four, and you’ve got Bitcoin. Does it look exciting yet?
Cryptocurrency for Diversification?
Some individuals make a case for cryptocurrencies providing possible diversification benefits to the portfolio. After all, you have an asset that is quite different from equities and bonds.
At SYM Financial, we have explored possible diversification benefits of crypto and have not found a compelling case. Even when isolating the diversification potential in a vacuum, there is not a clear case for cryptocurrency. Bitcoin has had some correlation to stocks, but it has not shown to be stable over the short term (sometimes the correlation is positive, sometimes it’s negative). Importantly, crypto had some meaningful declines when diversification would have been most welcome, specifically during stock market declines.
For example, in the two most recent sizable stock market declines:
- In the 4th quarter of 2018:
- the MSCI ACWI stock index declined 12.75%
- Bitcoin had an even greater decline at 44.13%
- During the Covid-19 bear market slide from February 15, 2020, through March 23, 2020:
- the MSCI ACWI stock index declined 33.65%
- Bitcoin had an even greater decline at 36.97%
Cryptocurrency as an Inflation Hedge?
There is also an argument that some people make about crypto being an effective hedge against inflation.
While the data are limited, this year has not supported that idea. As of July, US core CPI is at the highest level since 2008 while Bitcoin has pulled back hard from its springtime level.3 As of July 30, Bitcoin is suffering a 39% drawdown following its April high.
Going back further, we can see these massive pullbacks (we could even use the term “crash”) are a feature of Bitcoin that investors must come to expect. Eighty percent to ninety percent declines have occurred every few years.
Figure 2: Bitcoin’s Historical Drawdowns (Koyfin Charts)4
Government Intervention Could Mean Extinction
A natural extension to Bitcoin’s being digital and decentralized are the questions of how private it is and how the government will react to it. As bitcoin and cryptocurrencies at large continue to grow in popularity, it will be increasingly likely that governments will act to invade the privacy, prevent the use, or attempt to provide centralized alternatives to cryptocurrencies. This creates some real risks to crypto owners.
We believe the likelihood of an increased regulatory landscape isn’t a remote possibility. Several of the world’s largest economies5 have publicly stated regulation intentions or have already taken action to restrict cryptocurrencies. Atop that list, the United States’ SEC chair stated that the agency will “continue to take our authorities as far as they go” and called on congress to close regulatory gaps in August of 2021. 6 China has banned financial institutions and payment companies from providing any crypto-related services, and half of the country’s bitcoin miners are now inactive. 7 One of the world’s largest crypto exchanges, Binance, was banned from operating in the U.K. and has received several warnings from Japan that it is operating without legal permission in the country. 8 India has proposed legislation banning cryptocurrencies, criminalizing possession, issuance, mining, trading, and transferring crypto-assets altogether. 9
While lighter-handed forms of government regulation may prove helpful to cryptocurrencies’ broader institutional acceptance, it could still trigger selling by some of its largest existing owners—who seem to prioritize a lack of public oversight over all else.
SYM Financial: Our Thoughts on Cryptocurrency and Bitcoin
It is a tease to watch the news of “regular people” making substantial profits by buying and trading crypto assets. Seeing others make big quick scores can create a powerful fear of missing out, which often gets new investors into trouble.
This is the part you don’t see in the news or in glossy magazines. This year alone, many people have lost fair amounts of money in the crypto space, considering Bitcoin’s crescendo was near $65,000 before dropping to under $30,000 in July.
And so, SYM Financial continues to watch this exciting new space. At this time, we don’t see the evidence that cryptocurrencies are a reliable growth engine, an effective portfolio diversifier, or a good hedge against inflation. For most investors, buying crypto is not in fact traditional investing — it’s speculation. And while it may be fun to put a little money into crypto just to see what happens, you must be fully prepared to watch that money evaporate overnight — and not lose any sleep over it.
5 International Monetary Fund’s World Economic Outlook database (April 2021). https://www.cnbc.com/2021/04/21/coronavirus-worlds-10-biggest-economies-before-covid-pandemic-vs-now.html