Cryptocurrency: A New Frontier
Dylan Potter, CFP®, Vice President, Wealth Manager
We’ve received a number of questions about our thoughts on cryptocurrencies and ways in which to gain exposure to the ecosystem. The eyepopping returns and incredible volatility capture the headlines on a daily basis, so in today’s StreetSmarts we’ll provide a brief overview of the space and offer some of our thoughts as well. Cryptocurrencies now represent a $3 trillion market!—so it’s becoming harder to ignore the space completely.
First, its important to note that this is a new frontier. What I mean by that is this space is evolving, changing and growing on a daily basis. Some investors are attracted to the extreme price swings as a potential for profit. Some investors believe that if the lack of correlation with other asset classes continues, cryptocurrency could add diversification to a portfolio. For now, cryptocurrency prices historically have been highly volatile, and fluctuations could result in significant financial losses regardless of whether you have direct or indirect exposure. We simply don’t have a historical lens in which to frame cryptocurrencies. It’s a new frontier. So, let’s dive in.
Cryptocurrency is a digital currency secured through one-way cryptography. It appears on a distributed network ledger called a blockchain that’s transparent and shared among all users in a permanent and verifiable way that’s nearly impossible to fake or hack into.
Diving a little deeper, the blockchain is simply a public record that has some very unique attributes that makes it incredibly secure and trustworthy. This public record exists on tens of thousands of computers around the world simultaneously, called nodes, and is updated in real time. No one person or business controls these nodes, making Bitcoin and many cryptocurrencies decentralized. The original intent of cryptocurrency was to allow online payments to be made directly from one party to another without the need for a central third-party intermediary like a bank. However, with the introduction of smart contracts, non-fungible tokens, stablecoins, and other innovations, additional uses and capabilities are rapidly evolving. These transactions are just like every other financial transaction you’re already familiar with: a transfer of value from one person to another. But, instead of routing that transaction through a bank or other financial services provider, it’s validated, recorded and secured directly on the blockchain by all the nodes in the Bitcoin network. This process makes transactions on the Bitcoin blockchain secure and verifiable.
Cryptocurrency’s value stems from a combination of scarcity and the perception that it is a store of value, an anonymous means of payment, or a hedge against inflation.
Cryptocurrency investors can buy or sell them directly in a spot market, or they can invest indirectly in a futures market or by using investment products that provide cryptocurrency exposure.
So how does one invest in cryptocurrencies and what are our thoughts on the ecosystem? For investors interested in cryptocurrency, Schwab and Fidelity have several choices for gaining exposure to cryptocurrency markets, though spot trading of cryptocurrency is not currently available. We’ll talk about that in a second.
The first way to gain exposure is through Cryptocurrency Coin Trusts.
These products allow investors to trade shares in trusts holding large pools of a cryptocurrency, although these can involve high volatility, hefty fees, and other risks. They trade over-the-counter (OTC) and behave like closed-end funds. You may have seen some of these touted on the news, but some examples are the Grayscale Bitcoin Trust (ticker: GBTC) or the Grayscale Ethereum Trust (Ticker: ETHE). Of note, these are not ETFs, but many of the players in this space are actively filing to get their products re-flagged as ETFs so they may trade like any other ETF.
Next, some companies provide indirect exposure to cryptocurrency due to the company’s relationship to digital assets.
If owning the asset is like panning for gold, imagine these companies as the ones supplying the picks and shovels. Here are just a few examples: Coinbase (Ticker: COIN), PayPal (ticker: PYPL), MicroStrategy (Ticker: MSTR) and Square (ticker: SQ). All either hold digital currencies as assets or specialize in making markets and providing exchanges in which to trade them.
Finally, you can open an account to trade the actual underlying cryptocurrencies like Bitcoin or Ethereum. This can be done through a number of different companies like Coinbase or Gemini. Once you have an account, you can purchase the actual coins you are interested in.
So, to sum up, you can own the assets outright by opening your own account at a place like Coinbase, you can gain indirect exposure by owning the companies that provide the picks and shovels for the space, or you can gain exposure through a fund that invests its assets in cryptocurrencies.
So, what’s our perspective? We suggest that investors who are interested in cryptocurrency approach them as speculative investments and consider their goals as well as the risks involved. For those who already have a diversified portfolio and a long-term investment plan, we see cryptocurrency as being used primarily for trading purposes outside the traditional portfolio. It’s like any high octane, volatile investment. With the opportunity for outsized returns comes an extreme amount of risk. You should only consider investing in a riskier asset class, like cryptocurrency, once there are “no other buckets to fund and you still have excess cash flow.”
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