Cryptocurrencies represent a relatively new class of assets, prompting questions about their role in overall investment strategies.
What exactly is cryptocurrency? Beyond being an investment, it serves as a medium of exchange. Distinct from traditional equity markets, it resembles alternative investments such as real estate or commodities, but with the added advantage of high liquidity, trading around the clock.
According to Adam Blumberg, a certified financial planner and founder of Interaxis, an institution providing digital asset education for financial advisors, “This asset class is unlike anything we’ve encountered before.”
Despite its elusive nature, cryptocurrency is gaining increasing attention. Despite potentially high transaction costs, it has delivered impressive returns, albeit with significant volatility. Bitcoin, for instance, has increased by over 400% compared to this time last year. Furthermore, businesses built using the Ethereum blockchain are transforming the financial services sector.
While many have approached cryptocurrency as a speculative venture, allocating funds to a range of digital assets and tracking their performance, wealth managers are increasingly integrating cryptocurrencies like Bitcoin and Ether into long-term investment plans. This approach aims to hedge against risk, enhance returns, and improve diversification. Some investors are even giving digital assets their own dedicated allocation within portfolios, similar to international stocks or precious metals, and adjusting these holdings periodically. The launch of the first Bitcoin futures ETF is a significant step in this direction.
However, there is no shared understanding of the ideal positioning or function of digital assets within a portfolio. Projecting the long-term performance of an investment or asset class is challenging, particularly when data is limited. Cryptocurrencies have only been around since 2009, and active trading by institutions only began a few years ago.
Inflation Resilience
Before investing in any asset, it’s useful to have a rationale for including it in the investment mix. For example, some equities are chosen for their potential yield, while bonds may provide consistent, reliable income. Alternative assets may be selected to diversify a portfolio and mitigate losses during market downturns.
Cryptocurrency is demonstrating a variety of uses. Here are some current investment perspectives:
–Long-Term Value Storage: Investors confident in the long-term stability or growth of specific cryptocurrencies may choose to invest a significant amount and hold it, possibly complemented by regular, recurring investments.
–Portfolio Inflation Shield: Investors concerned about the decreasing value of the U.S. dollar may allocate a portion of their portfolio to currencies independent of it. However, the effectiveness of crypto as an inflation hedge is a point of debate.
–Risk Mitigation: Some investors use cryptocurrencies to increase portfolio diversification and shield against potential declines in the U.S. stock market. This is because crypto assets aren’t linked to governments or traditional institutions.
–Return Enhancement: Given the current low interest rates, some investors are increasing their cryptocurrency exposure in order to boost their yearly investment returns.
According to Blumberg, the appropriate strategy depends on the investor’s goals. They might, for example, acquire Ether and keep it for 15 years. Conversely, to protect against inflation, they may prefer to rebalance their Ether holdings quarterly by selling Ether if its value rises, or buying more if its value falls, maintaining a predetermined allocation.
How Does Crypto Impact Portfolio Performance?
Even with the volatility of crypto, some data indicates that holding crypto can significantly benefit a portfolio.
According to research by Bitwise examining 60/40 portfolios (60% equities, 40% bonds), portfolios with a 2.5% Bitcoin allocation saw an 18.7 percentage point increase in returns between January 2014 and March 2020. A 5% Bitcoin allocation would have doubled returns. (Disclaimer: Bitwise offers cryptocurrency-related investment funds.)
Here are Bitwise’s findings: