Over the past year, the pricing of cryptocurrency has been a rollercoaster ride to say the least. However, despite this volatility, both Bitcoin and Ethereum have boasted over 250% growth over the same period.
This has elicited much discussion as to whether fund or asset managers should include the block chain driven medium of exchange in their portfolios.
Overview
Cryptocurrency (CC) started approximately twelve years ago with the release of Bitcoin. The intangible asset is a digital one, designed to work as a medium of exchange, where individual coin ownership records are stored in a ledger existing in the form of a computerised database.
It is a supply and demand driven asset, whose price is driven up when the demand increases and down when the demand decreases. This creates a highly volatile environment, as the price is principally determined by consumer sentiment, as opposed to measurable economic fundamentals.
Pros of Investing in Cryptocurrency
CC can play a part in the diversification of a portfolio. Given that price fluctuations are a result of the supply and demand of the coin, it would likely have a weak correlation with the price of traditional equity investments, whose returns are market oriented. The combination of two diametrically opposed assets, can enhance diversification through market cycles.
CC’s have indicated a huge potential for returns since the first initial cryptocurrency offering. One of the statistics that makes everyone consider investing in cryptocurrency is that if you invested $1,000 in Bitcoin in 2013 it would be worth $400,000 today. That is a 40,000% increase!
Investing in a CC, provides an opportunity to gain substantial profits in the short term, given the rapid price movements we have witnessed. This interest becomes infectious, drawing further short-term flows, only fuelling volatility further. Invariably, any asset that provides an environment conducive for a fast profit, is the most fertile ground for even faster losses.
Cryptocurrency is highly liquid compared to equity investments of a similar risk profile – such as investing in a startup. When you purchase equity in a startup, to realise profit, you need to find a buyer, or wait for an acquisition or an IPO to occur ‒ these options do not allow the investor to control when he/she can realise the value of their investment. On the other hand, a cryptocurrency with a solid network, affords investors a much higher level of liquidity.
There is a growing acceptance and usage of cryptocurrency around the world. A 2020 article on Coindesk.com indicated a 600% increase in cryptocurrency merchant transactions over 2018. In addition to this, there has been a dramatic increase in the opening of cryptocurrency wallets. Due to the limited supply of crypto coins in circulation, the increase in demand for cryptocurrencies would further increase the value of each coin.
Cons of Investing in Cryptocurrencies
I have personally experienced cryptocurrency associated pricing volatility. After owning Ethereum for one month my investment was up 42% – this gain quickly subsided to 15% before I cashed out. To illustrate the inherent volatility of cryptocurrency, statistics show that the annualized volatility of the price of Bitcoin, in US Dollars, has been around 90% over the last 5 years. This is extremely high when compared to the S&P 500 or Gold for instance, whose respective annualized volatility, is 15.3% and 13.4% respectively. In plain English – CC is roughly 6 times more erratic than stocks/Gold.
Although it is true that Bitcoin will be capped at 21 million coins, this does not eliminate the opportunity for new cryptocurrencies from being launched. This would suggest that the supply of cryptocurrency is potentially limitless. There is a finite amount of Gold on earth. Creating Gold out of thin air, still eludes man to this day.
Cryptocurrencies are a poor store of value and have limited acceptance. Although cryptocurrencies are slowly becoming accepted across more payment platforms, the number of places where one can exchange cryptocurrencies for real goods and services, remains limited. In addition to this, the volatility of cryptocurrencies makes them a poor store of value. Should an investor require cash on short notice, it would entail exchanging the CC into their base currency (Rands). The inherent volatility and unpredictable movement in the CC’s price, currently undermines its ability to be an effective store of value.
Cryptocurrencies are unregulated and have no economic fundamentals that support a long-term pricing average. This simply means that trying to plot a likely trajectory for the price of CC’s is nigh impossible at this stage. Cryptocurrencies are wide open to being exploited by criminals as a mean of scamming investors as proved by the MTI scandal in 2020. An academic study conducted in 2019 identified that 46% of bitcoin transactions are associated with illegal activity. Furthermore, there is no business operation or assets that create the value of a cryptocurrency, the value is purely a result of supply and demand. This makes it difficult to justify the inclusion of the asset in a portfolio, as there are no fundamentals underpinning the value.
Conclusion:
Although cryptocurrencies have shown tremendous growth, Harbour Wealth is still not considering including them in our investment strategies. This is largely due to the lack of measurable economic fundamentals underpinning their value. Our clients’ wellbeing is our upmost priority, so it is critical we ensure that every investment consists of underlying assets with justified fundamentals. This creates a reasonable level of certainty about the movement of underlying assets, and subsequently the investment strategy. If we were to include cryptocurrencies, the growth and risk metrics of our traditional investments could easily be offset by the unpredictable pricing nature of cryptocurrency.
The process of purchasing a cryptocurrency is relatively simple, so if you are convinced that Cryptocurrency is for you then by all means, give it a ‘punt’ on your own account.
If you require professional financial advice, contact one of our qualified independent Financial Advisors at Harbour Wealth.
