The cryptocurrency market is a rapidly growing segment of the financial markets.  From its beginning 13 years ago with the invention of Bitcoin, it has grown to over $2.5 trillion dollars in market cap and over 6,700 cryptocurrencies.  While maybe even a couple of years ago it could be written off as a fad, as we’ve seen the space evolve it is difficult to ignore today.

Back in 2018, comedian John Oliver stated on his show Last Week Tonight that cryptocurrency was “everything you don’t understand about money combined with everything you don’t understand about computers”.  As funny as that is, there was probably a bit of truth to it three and a half years ago.  At the time of that show’s airing, the total market cap was around $300 billion.  So, maybe there’s a lot more understanding about the asset now.  However, it still splits opinion, among investment professionals and individual investors alike.

Renowned investors Warren Buffett, Chairman of the Board of Berkshire Hathaway, and Ray Dalio, Chairman of Bridgewater Associates, differ in their opinions of the asset (Buffett thinks it has no value, while Dalio believes it is a portfolio diversifier) as do many other well-known CEOs, portfolio managers, regulators, and central bank heads around the world.

Talking about cryptocurrencies can feel as charged as talking about politics nowadays.  A lot of people have very strong views of the asset and are usually more than willing to tell you why you’re wrong if your view differs from theirs.  However, as a firm, we’ve always prided ourselves on removing our emotions from the equation when executing our investment process on behalf of our clients.  In that spirit, we’d like to communicate RTD’s current thinking on the asset by answering a few questions.

Are cryptocurrencies a currency? If we’re talking about most of the big “coins” like Bitcoin, Ethereum, Binance Coin and Cardano, then the answer is “no”.  There are three criteria for currencies and these types of cryptocurrencies meet none of them.

  1. First, because of their high volatility, they cannot be used to price current transactions.  Therefore, they are not a reliable unit of account.
  2. Second, these cryptocurrencies are not used as a medium of exchange because transactions costs can be expensive, especially for some of the original Layer-1 Technology coins (As with any product, efficiency improves and cost declines as the underlying technology develops).
  3. Finally, these cryptocurrencies are currently not good stores of value.  To be a good store of value an asset must be able to be saved, retrieved, and exchanged at a later time, and be predictably useful when retrieved.  The volatility of these cryptocurrency prices prevents this from taking place.

However, there is a subset of cryptocurrencies known as Stablecoins where the answer would be “yes”.  Stablecoins, as their name denotes, attempt to offer price stability by pegging their value to an external reference.  Usually, these digital tokens are backed by reserves of U.S. dollars and Treasury bills but can also be linked to a commodity such as gold.  The largest Stablecoins in circulation are Tether and USD Coin, both in the top ten of all cryptocurrencies.

As an investment, how should cryptocurrencies be viewed?  Non-Stablecoin cryptocurrencies should be treated like the highly speculative assets they are.  The smaller the market capitalization of the coin, the more they are like penny stocks as they are currently ripe for malfeasance (“pump and dump schemes”) and loosely regulated.  The larger the market capitalization of the coin, the more similar they could be compared to a highly volatile tech or biotech stock with a promising, yet unproven product.

Or think of them as an alternative asset such as art or wine (we’ll talk about digital art in the form of Non-Fungible Tokens, NFTs, in a future communication).  If a person buys, say, one Bitcoin, she will own one Bitcoin in the future.  What that one Bitcoin will be worth in U.S. dollars is anyone’s guess.  Remember, the difference between investors and speculators is the amount of risk involved.  Investors aim to generate a satisfactory rate of return by taking on an average or below-average amount of risk.  Speculators seek abnormally high returns by putting money into financial endeavors with a high probability of loss.

Will RTD be adding cryptocurrency exposure to my portfolio any time soon?  We do not believe that will happen any time soon.  Cryptocurrencies are too speculative, volatile, and largely unregulated currently.  We are strategic, long-term investors and we don’t believe speculative investments should be a part of our core managed portfolios that are designed to minimize risk in helping our clients meet their financial and non-financial goals.  We reserve the right to change this stance when/if cryptocurrencies mature past their speculation phase.  This would mean there are diversified, cost effective investment options, meaningful regulatory oversight, and a clear legal and tax framework around cryptocurrencies.

If I’m interested, how should I approach investing in cryptocurrencies?  Our guidance would be the same as when clients want to buy shares of an individual stock.  FOMO, fear of missing out, should not be your sole investment thesis.  You should understand the risks associated with cryptocurrencies and only invest an amount (1) you are comfortable completely losing and (2) that won’t have a material impact on your overall, long-term financial plan.

Anything else I need to know?  One of the upsides of cryptocurrencies is the underlying blockchain technology they are built on.  This technology has so many different potential use cases, from protecting artists from counterfeiting, and ensuring fair and verifiable election results worldwide, to removing intermediaries from financial transactions such as title insurance, which should result in more efficient and less expensive data processing.  Outside of the financial sector, Walmart and other companies are using Blockchain technology to increase supply chain transparency by giving them access to real-time data.  And grocery stores are using the technology to improve food safety as it allows them to track down issues with greater precision.

As noted above, there is much more to the digital asset space than just cryptocurrencies.  While we briefly mentioned Stablecoins and NFTs, the space also encompasses Central Bank Digital Currencies (CBDCs), Decentralized Finance (DeFi), Interest Bearing Cryptos, Governance Tokens, and even baseball cards!  Over the coming year, we intend to keep you informed of developments in this area so you can make informed decisions about whether they are appropriate assets for you to own.