What Is Cryptocurrency and Should I Invest In It?

Cryptocurrency is a relatively new concept that has been a hot topic in the financial world. With it being so new, it’s often hard to know whether it’s a reliable investment and what its presence and popularity means for the future of markets and investments. BerganKDV’s Chief Investment Officer of Wealth Management, Derek Hoyt recently wrote a short resource detailing what cryptocurrency is, the history of the currency, and what you should be aware of as a potential investor. If you are interested in learning more about cryptocurrency as it relates to wealth management, we have included the full essay below.

BerganKDV offers a wide range of wealth management services to accommodate your financial wellness goals, whatever it may be. From navigating new concepts like cryptocurrency, to establishing a financial plan or investment portfolio to meet your unique needs, our advisors would be happy to assist. Schedule an introductory call on our advisor calendar here to learn more about our wealth management solutions.

Full Cryptocurrency Resource:

In January 2009, the pseudonymous Satoshi Nakamoto launched Bitcoin, an open-source financial network characterized by a decentralized, peer-to-peer system. It used a programmable, fungible token that could be spent or saved, distributed to a subset of users who compete to secure the network, and in return are rewarded with Bitcoin. Twelve years later, the market-cap of Bitcoin sits at over 1 trillion dollars. Its success as an experiment in the concept of digital and decentralized finance spurred the development of other projects and applications within the cryptocurrency space, launching an entire industry centered on blockchain technology.

Technology and Applications

Blockchain technology, though conceptualized back in the early 1990’s, was originally successfully developed for Bitcoin. When two users partake in a transaction, information about this transaction gets broadcast from their wallets to every other user in the network. This information is digitally signed and time-stamped, so that anybody who reviews it knows who sent the money, who received it, how much money it was, and when. Once the nodes have validated the information and confirmed the transaction (that is, checked that everything is legitimate), they each update their copy of the blockchain on their computers to include this new data. While Bitcoin was the first cryptocurrency, its applications are somewhat limited. Second and now third generation blockchains are emerging which seek to provide better usability, sustainability, scalability, and interoperability to their users. Additionally, while blockchain is the base technology for cryptocurrencies, it can be deployed in numerous other functions. Given the broad applicability of the technology, the cryptocurrency universe, which numbers in the thousands, in a sense resemble the equity universe. There exist many different sectors represented by different currencies (coins/tokens/securities). For example, decentralized financial applications, smart contracts, oracles, stable coins, non-fungible tokens, yield farming, and so on are all examples of development within the digital asset space. Even centralized entities like world governments are exploring the creation of Central Bank Digital Currencies (CBDC’s).

Investment/Access

 While the technology is interesting and evolving, the current primary interest in cryptocurrencies focuses on their nature and opportunity as an investment. While Bitcoin receives the most attention, it is fair to apply a summary of the investing characteristics to the entire crypto space. Cryptocurrencies are obviously volatile. Price swings within the cryptocurrency markets are many times the magnitude of the stock market, where 20-30% (or more) price movements over a period of just a day or two can occur with regularity. These price gyrations take place within bull and bear market cycles, which heretofore have occurred (understanding that the historical data range is very limited, given the newness of the assets) in a similar pattern in terms of scale and duration. The long-term trend has been positive for Bitcoin, though there have been massive variances in price during its ascent. Adding to the volatility of cryptos is the get rich quick or pump-and-dump nature of many projects. There have been numerous examples of projects launched possessing no fundamental use case or prospects that investors have flocked to, only to have the founders sell their holdings, close shop, and disappear, leaving investors high and dry. This phenomenon is a byproduct of little or no regulation or oversight; the industry, though progressing, has been a little like the Wild West in terms of the rules.

Another defining characteristic of cryptocurrency space relates to the difficulty of access. Because all assets are stored on the blockchain itself (or an exchange connected to the chain), there is somewhat of a technological barrier which investors must overcome or navigate to buy and store different cryptos. Currently, to enter the market, one must register on an exchange, link a bank account for the transfer of fiat currency, and then buy Bitcoin or some other token. The investor can keep either keep those assets on the exchange, transfer to a different web-based or online wallet (referred to as a hot wallet), or they can transfer those funds to a hardware wallet (referred to as a cold wallet) for safer keeping. It should be noted that the wallet is not a wallet in a traditional sense. The tokens are not kept in the wallet itself. The wallet simply acts as an interface to an address on whichever blockchain one is accessing. It does so securely by using cryptographic keys, hence the term cryptocurrency. Transacting across a blockchain from an exchange or to outside wallets is fast and efficient, though not without issues. The tradeoff for personal custodial control of your assets and the ability to send them quickly anywhere at any time is the risk of loss. If you send assets to the wrong address, for whatever reason, there is no way to reverse the transaction. There is no one to call to help get your money back; it is already gone. As one can see, the custodial process is not as straightforward and comfortable as the traditional security universe.

Summary

Obviously, the cryptocurrency industry is still in its infancy. As with anything new, it possesses much potential, though it is layered with many risks and unknowns. We believe that there is little doubt the blockchain technology and the digitalization of finance will continue to evolve and disrupt existing legacy industries in the years and decades to come. However, from an investment perspective, we do not believe that the default inclusion of the assets into an investment portfolio as a standard allocation makes sense this time, as its volatility and nascency cannot be relied upon in a traditional wealth management context. Additionally, the products and infrastructure required for Registered Investment Advisors (RIA’s) to access the asset class do not yet exist (other than Greyscale, which acts somewhat like a closed-end fund). However, as the space develops and Institutional interest, infrastructure, and products (ETF’s, etc.) emerge, this could change.

Key Takeaways:

  • Nascent – New but developing asset class/industry.
  • Volatile – Has moved in cycles with massive drawdowns, though so far long-term positive trend (Bitcoin).
  • Speculative – Not able to be relied upon in terms of a predictable financial allocation.
  • Self-custody – There are technological barriers/risks to ownership.
  • Inadequate Infrastructure – May become more appropriate to hold as institutional infrastructure evolves and more securities become approved and available.

 

Diversification and asset allocation do not ensure a profit or guarantee against loss.

The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.

The views expressed are those of BerganKDV Wealth Management. They are subject to change at any time. These views do not necessarily reflect the opinions of any other firm. Investment advisory services and fee-based planning offered through BerganKDV Wealth Management, an SEC Registered Investment Advisor.

CATEGORIES: Wealth Management
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