Over the past year or so, digital currencies have become one of the hottest investing crazes since the dot-com boom of the late 1990s. The value of Bitcoin, one of the most recognized digital currencies, has skyrocketed since early 2017, leading many investors to wonder if they’re missing out on big returns if they aren’t investing in digital currencies.
Should these investments be a part of your portfolio? Before answering this question, let’s first explain the concept behind digital currencies so you have a better understanding of what’s going on.
What Are Cryptocurrencies?
Also referred to as cryptocurrency, digital currency is a form of electronic payment that can be exchanged for goods and services that are bought and sold online. Businesses issue cryptocurrencies, also sometimes called tokens, that are used specifically for trading their products and services.
Cryptocurrencies are kind of like casino chips or arcade tokens. To obtain a product or service, you’ll exchange real currency for a company’s cryptocurrency. Cryptography is used to secure and verify transactions, while blockchain technology ensures that double-spending of cryptocurrencies doesn’t occur.
A growing number of online and offline businesses now accept cryptocurrency for payment. These include Overstock, Expedia, Dish, Microsoft and Apple, as well as many local shops and merchants.
Approximately 1,400 different cryptocurrencies are now being exchanged with a total value of about $708 billion, according to Coin Market Cap. Bitcoin is by far the most popular cryptocurrency — it’s worth about $280 billion alone. Ethereum, Ripple and Litecoin are other cryptocurrencies that are gaining traction.
High Volatility, High Risk
Many cryptocurrecies have skyrocketed in value over the past year. For example, the value of Bitcoin soared from around $800 early last year to nearly $20,000 by the end of the year. It has since fallen to around $10,000.
This illustrates one of the biggest risks of investing in cryptocurrencies: their extreme volatility. If you bought Bitcoin early last year and sold it at the December peak, you’d have realized a handsome profit. But if you bought it at the peak, your investment would be down nearly 50 percent now.
Another risk is the fact that cryptocurrencies are largely unregulated and aren’t recognized as having legal tender status by the U.S. government (though they aren’t illegal). Unlike the U.S. dollar, which is backed by the full faith and credit of the United States, cryptocurrencies have no backing in hard assets.
Also, cryptocurrencies are not businesses that make products, deliver services or earn profits. They are simply a form of currency like coins, cash or paper checks. Cryptocurrencies only increase in value if the next investor is willing to pay more than the last investor did. This is why some market analysts believe that cryptocurrencies, like dot-com stocks two decades ago, are just the latest investment bubble.
So Should You Invest?
Does all of this mean you should never invest in cryptocurrencies? Not necessarily. If you have an appetite for a high-risk, highly volatile investment and can afford to lose the money you invest, it might make sense to consider a cryptocurrency investment.
One way to purchase cryptocurrency as an investment is to invest in a cryptocurrency ETF like the Ark Web x.0 ETF (ARKW) or the Ark Innovation ETF (ARKK). Based on Frontier’s research, these Bitcoin ETFs were two of the top-performing ETFs of 2017 — both were up about 85 percent for the year. Other ETFs offering exposure to cryptocurrencies are Grayscale’s Bitcoin Investment Trust, Ethereum Classic Investment Trust and Zcash Investment Trust. There are also a few cryptocurrency hedge funds, such as Polychain Capital, MetaStable Capital and the Galaxy Digital Assets Fund.
Cryptocurrency may also play a role as non-correlated alternative asset in an investment portfolio, similar to real estate investment trusts (REITs) and hedge funds. The idea here is that as other asset classes fall in value, cryptocurrencies may help offset this by rising in value.
In an article published in December on TheBalance.com, one top-rated financial advisor said he believes investors should be paying close attention to Bitcoin, though he’s not yet ready to recommend this to his clients as an investment just yet. But he does see long-term potential in companies that use blockchain technology, which he believes could be one of the major technologies of the future.
Early Stage Technology
Not unlike the Internet two decades ago, cryptocurrency is a new technology that’s still in its very early stages. This makes it especially risky — but also potentially very rewarding.
Please contact us if you have more questions about whether cryptocurrency would be a wise investment for you.