Price volatility notwithstanding, virtual currency is here to stay, said Ric Edelman, founder of Edelman Financial Engines.
Allocating 1% of a portfolio toward bitcoin could give exposure to this asset class without damaging finances, Edelman said.
At its zenith on Dec. 15, 2017, one bitcoin was worth close to $20,000. The price is currently around $9,300.
If you can’t beat the crypto crowd, it might be time to join them, experts say.
Virtual currency and its underlying technology, blockchain, are here to stay – and that means both will play some role in investors’ lives.
“It’s actually very hard to decouple blockchain and bitcoin,” said Sunayna Tuteja, head of digital assets and distributed ledger technology (DLT) at TD Ameritrade.
She spoke at the TD Ameritrade LINC conference in Orlando, Florida, on Wednesday.
“On the one end, how do we commercialize the value of DLT and blockchain to bring more innovation to traditional markets?” Tuteja asked. “On the other end of the spectrum: How do you tap into this nascent asset class?”
Cryptocurrency – at least bitcoin – has staying power. “Because there’s a fixed number of bitcoin, it’s inflation-proof and it’s virtually instantaneous,” said conference speaker Ric Edelman, founder of Edelman Financial Engines.
Even investors in retirement plans are dipping a toe into the asset class.
In the third quarter of 2019, the Grayscale Bitcoin Trust, which tracks the price of the cryptocurrency, was the fifth-largest holding among millennial investors in Charles Schwab’s self-directed brokerage accounts.
Self-directed brokerage accounts are sometimes offered within retirement plans and allow investors to select individual stocks, bonds and other assets that aren’t on a 401(k) plan’s general investment menu.
The price of bitcoin surged to its zenith on Dec. 15, 2017, when one unit of the virtual currency was valued at $19,650. The price cratered a year later, slumping to $3,183 on Dec. 14, 2018.
As of Jan. 30, one bitcoin is equal to about $9,300.
Volatility notwithstanding, this virtual currency also carries little correlation with other asset classes investors may hold in their portfolio, including stocks and bonds, Edelman said.
A 1% allocation to bitcoin – that is, going from 60% in stocks and 40% in bonds to 59% in stocks, 1% in bitcoin and 40% in bonds — just might be enough to give investors the benefit of diversification without risking the whole portfolio, Edelman said.
“We need to acknowledge that 1% allocation isn’t going to materially harm a client,” he said. “It isn’t going to prevent them from achieving their financial goals, and won’t damage their personal finances.”
Making a tiny allocation toward bitcoin doesn’t absolve investors of the need to do their homework before buying, say experts. They should get schooled on digital assets, as well as the underlying blockchain technology, first.
“Don’t consider investing unless you understand the technology,” said Edelman. “Otherwise, you’re not investing; you’re spending.”
Investors hoping to jump into the crypto pool should approach it with a long-term mentality and prepare to ride out volatile times – including the chance of a 100% loss from that digital currency, he said.
Finally, don’t forget that if investors acquire, sell or exchange cryptocurrency, they’ll need to report it to the IRS. The tax agency treats bitcoin holdings as property, the same way it would regard stocks and other investments.
Cryptocurrency exchanges may provide investors with a Form 1099-K detailing capital gains and losses, but there is no guarantee that they’ll get one.
That means it’s up to bitcoin owners to track their basis – their original investment in the virtual currency — and their transactions for accurate tax reporting.
As more investors eye cryptocurrencies such as bitcoin, it’s key to keep in mind that many asset classes once thought too volatile for average investors are now common.
Some recent research finds small weightings of bitcoin have an outsized positive impact on risk-adjusted returns and diversification relative to other alternative assets.
When a financial advisor discusses the appropriate asset allocation for a portfolio, they are essentially trying to construct a plan that maximizes expected returns based on a given level of risk.
The advisor pays less attention to the behavior of an individual security and instead focuses on how different asset classes work together as a group.
So, what is bitcoin’s role in an investment portfolio and does it make sense to incorporate it?
Conventional wisdom suggests that while bitcoin has delivered great returns, it will add substantial risk to a traditional stock/bond portfolio.
With that said, it’s important to remember that many asset classes that are now commonplace in a portfolio were at some point considered far too volatile for the average investor. We don’t give it a second thought to include emerging markets or technology stocks into an allocation today, and yet there was a time when the pundits believed they were far too risky.
Their concerns were justified.
Since the 1988 inception of the MSCI Emerging Markets Index, there have been seven drops of 25% or more. Moreover, Nasdaq stocks collapsed by 79% during the dot-com bust as technology companies fell at a stunning pace.
Nevertheless, they both rebounded and paid off handsomely when included in a diversified portfolio that considers time horizon and risk tolerance.
It seems that the same arguments have been made about digital assets, even as a long-term study by VanEck found that bitcoin had exhibited lower volatility than 112 stocks of the S&P 500 in a 90-day period and 145 stocks year-to-date as of Nov. 13, 2020.
This begs the question about the impact bitcoin has on a well-constructed portfolio and whether it is suitable for the average investor to have some exposure.
Many may recall the bell curve that assesses the number of potential outcomes. When a portfolio is constructed, each additional possibility on that bell curve increases the volatility. If the objective is to receive the greatest returns with the least amount of risk, the addition of an asset class that serves that purpose is worth considering.
Some recent industry research found that small weightings of bitcoin have an outsized positive impact on risk-adjusted returns and diversification relative to other alternative assets. Additionally, the research concluded bitcoin’s lack of correlation to other assets make it a useful alternative asset that can actually help reduce exposure to economic cycles.
To that point, the RIA Digital Asset Council reports that when investors allocate 1% to a balanced portfolio, the returns increased with little to no impact on the volatility or maximum drawdowns when the market got dicey. Likewise, rebalancing a portfolio that includes 1% bitcoin each quarter increased the long-term return of a balanced portfolio, even though the volatility and maximum drawdowns for the same time frame barely budged.
Suffice it to say, having an open mind and using the risk-management tools already at our disposal makes a great deal of sense.
— By Ivory Johnson,founder of Delancey Wealth Management
In this video, I discuss whether Bitcoin is controlled by the rich and powerful. Contrary to popular opinion, holdings of Bitcoin are not as concentrated as widely believed: the addresses that hold hundreds of thousands of Bitcoin are mostly just the cold wallets of large crypto exchanges like Binance and Bitfinex. The collapse of the New York Agreement (where a bunch of Bitcoin miners and influential Bitcoin companies tried to push through a protocol change but failed) demonstrates that Bitcoin is controlled by the full nodes, rather than the rich and powerful. Finally, Bitcoin whales may be able to manipulate the short-term price of Bitcoin, but they are unable to affect its long-term value. Any crashes caused by Bitcoin whale manipulation are opportunities for hodlers to buy the dip. Bitcoin is the first instance in history of the retail investor entering an asset first, and getting in ahead of Wall Street. No matter how rich and powerful you are, you cannot change Bitcoin or make it bend to your will. Not investment advice! Consult a financial advisor.
You’re a Nobel prize-winning economist, or a tenured professor at a prestigious university. Maybe you run a deep value hedge fund. Perhaps you write a popular column on markets. You might be a central banker or a finance minister. You feel that your experience and your credentials grant you a thorough understanding of the world.
You wear dark suits (or, on a casual occasions, Patagonia vests), glide through airports with TSA pre, global entry, and lounge access, you wear round tortoiseshell spectacles, and you most likely live in a brownstone in Brooklyn. If you’re technologically-minded, you like the underlying blockchain technology, although you’re not entirely sure what that means. You have no trouble broadcasting your thoughts to the world — in fact, you are considered a trusted source of analysis on pressing issues of the day. You have opinions, and the masses ought — hell, they should be grateful — to hear them.
You’ve heard of Bitcoin. You do not like it. It’s rat poison, a ponzi scheme, and it’s boiling the oceans with its energy usage. It’s run by an uncouth federation of, presumably, alt-right-ers, or at the very least, ideological undesirables of some sort. It relies on curious, antiquated ideas like sound money, peer-to-peer networking, the abolition of seignorage, and censorship-resistance. It is profoundly distasteful.
You want to write a thinkpiece about Bitcoin.
You’re not sure where to start. You hunker down with a decaf soy latte and ponder the approach. Should it be the volatility? Currencies can’t be volatile, surely. Hyperinflation is a problem for the global south, not you. Maybe it should be the hacks. On NPR, you heard about the collapse of some Bitcoin exchange named after a Japanese… mountain? You reflect on the objectionable tone of those Bitcoiners on Twitter. Those trolls can be awfully rude.
Aha! You identify some core hypocrisy associated with the cyber coin. You read in the New Yorker that Bitcoin doesn’t actually support that many transactions. How could the damn thing be a world currency, at all? You vaguely remember some jargon about block sizes and TPS. You toy with the idea of looking up some usage stats. Better not. You have thinkpiecing to do.
Maybe you will target Bitcoin’s use for illegitimate purposes. You’re very comfortable with your financial life on SWIFT, ACH, and Paypal (if you’re feeling edgy). You couldn’t possibly conceive of a case in which you’d to transact outside of this regulated aegis. If you’ve got nothing to hide, why would you need privacy, after all, you muse to yourself. You recall reading a piece in the Guardian about Bitcoin usage in Venezuela due to hyperinflation. You dismiss the thought from your brain. Venezuela wasn’t real socialism, after all. You ask Alexa to pop on Maroon 5 and get back to your draft on google docs.
There’s so much ground to cover. Where to start?
A solution
I suggest a method to simplify your punditry. No more wondering about which arguments to fit into your piece. No more fretting over Austrian economics. No more trying to recall what your econ 101 textbook said about deflation. Bitcoin has consumed enough of your mental energy already. You want it to go away, but you don’t want to think about it too hard either.
I humbly propose instead:
The Bitcoin spin device
These dice will make those Sunday afternoons spent toiling over Op-Eds so much easier. Just roll these twelve-sided dice several times and transcribe the answers. Simply regurgitate the talking points. You are essentially a random number generator for Bitcoin critiques, so why not outsource yourself entirely?
Do the 2018 thing. Reduce the task to its essence. Automate your punditry. I’ve carefully included the most popular and sophisticated objections to Bitcoin, completely saving you the trouble. These dice represent the platonic ideal of criticism — anything else is garnish.
Thought-free thinkpieces at your fingertips
I’ve included a handy guide so you can easily parse the various objections to Bitcoin.
21m cap: as you know, there will only ever be 21,000,000 Bitcoins minted. You skimmed a recap of some paper and you’re now very concerned about the long term viability of the Bitcoin security model as block rewards shift to a fee-subsidy model after the next halving.
Deflation: if Bitcoin were to become a dominant global currency, its capped supply might end up having deflationary effects. You know that your benevolent central bankers target two percent inflation to encourage people to spend and consume. You see no problem with that. You like spending and consuming.
Dev. incentives: ICOs (initial coin offerings) offered software developers the chance to write open source software and get handsomely paid for it, too. Bitcoin is disturbingly meritocratic, and doesn’t pay its developers anything. You don’t understand why anyone would work if they weren’t getting paid. Bitcoin devs wouldn’t just do it out of the goodness of their hearts, would they?
Energy waste: Bitcoin uses heaps of energy to secure the monetary system and retain the integrity of its ledger in a trust-minimized way. The US-driven fiat money regime relies on aircraft carriers and nuclear arsenals instead. You find the latter much more elegant. Its tangibility is comforting.
Small blocks: for a while, Bitcoin capped its block size at one megabyte (now it’s effectively 2.3 mb). You think the system should attempt to scale right away, rather than being built in a layered manner — consequences be damned.
Volatile: as an emerging virtual commodity, Bitcoin is extremely volatile. You think that risk in markets should be abolished, or at least suppressed through endless monetary expansion.
No Turing (completeness): Bitcoin isn’t capable of supporting arbitrary computation, unlike competitors like Ethereum. That makes Bitcoin more conservative and less expressive at the base layer. You think developers should be free to experiment with billions of stored wealth.
High fees: due to the capped throughput, Bitcoin has a market for block space. In times of congestion, users can pay a premium for higher-priority transactions. You dislike fees and would prefer immediate, global scaling — again, with no thought to the long term sustainability of the system.
Selfish mining: you may have heard about this potential edge case in Bitcoin mining, and have decided that the Proof-of-Work consensus system is a write-off, despite ten years of reliable functionality. If you really want to impress your friends, dredge up this exotic line of attack.
No KYC: Bitcoin is a permissionless system that anyone on earth can use to store or send their wealth. You don’t like the idea of free flow of money or untamperable wealth. You believe in capital controls and the USDA food pyramid. You prefer your steaks well done, and your money under the watchful gaze of the government.
Toxic fans: style is far more important than substance. Maintaining decorum in an argument matters far more than being right. Bitcoiners like to rudely call out ICO scammers and fiat-gorging central bankers alike. That’s not very nice. And nice makes right.
So there you have it. You are now free to launch somewhat erudite critiques of Bitcoin without learning about the system at all! If you want, you could even devise an encoding scheme for the dice, so you don’t even have to bother typing out the objections in full. Your next NYTimes column could simply read “4–11–5–6” and your readers will nod in understanding — Bitcoin will fail due to the energy waste, the toxic fans, the small blocks, and the volatility!
The dice are real. You can buy them today on Bitcoin’s lightning network at Quinsolo for 0.001 BTC (~$3). Cast those dice with confidence, fiat-inflationists.
