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After a -50%+ decline in the price of bitcoin, is it time for you to consider adding a position in the cryptocurrency? After capturing so much mindshare of financial news media lately, bitcoin has become difficult to ignore. Everybody is talking about it, and bitcoin millionaires have cropped up everywhere. In fact, nearly half of millennial millionaires have at least 25% of their wealth in cryptocurrencies, as the crypto boom continues to create wealth for young, early adopters, according to the CNBC Millionaire Survey. In response to this adoption, major companies, such as Microsoft, PayPal, Overstock, Starbucks, and Whole Foods, now accept Bitcoin as a valid form of payment.
After being pronounced dead 425 times, perhaps it’s time to admit that this new asset class is here to stay. And if it’s here to stay, shouldn’t we consider a crypto allocation? Or better phrased, is it irresponsible NOT to add cryptocurrencies to your portfolio?
Of course, the future of Bitcoin and other cryptocurrencies is unknown. In my opinion, it will either continue to explode in value (and adoption), or it will go to zero. There is no middle ground. Its future depends upon government regulation, increased efficiency, and a secure ecosystem.
HISTORY
Bitcoin (BTC) was introduced in 2009 by an individual or group of individuals using the pseudonym Satoshi Nakamoto. Over the years, several attempts have been made to reveal Nakamoto’s true identity, but none have been able to prove it decisively.
In developing Bitcoin, Nakamoto also created the world’s first blockchain database. Until 2010, Nakamoto was involved in developing Bitcoin, but after that, he disappeared.
Bitcoin is revolutionary as it is the first cryptocurrency, a type of digital cash, that eliminates the need for a middleman when making financial transactions. Unlike fiat money, such as the US dollar, bitcoin transactions involve no banks or governments. Most fiat money worldwide is backed and regulated by governments, whereas Bitcoin operates differently. The currency is backed by cryptographic computer code through open-source, peer-to-peer technology.
How Does Bitcoin Work?
Each bitcoin (BTC) is a packet of code mined by computers that solve complicated algorithms. These blocks are added to the blockchain record, and miners are paid in Bitcoin. The blockchain is a string of information blocks arranged chronologically. Bitcoin is used today as both a store of value and a payment system.
Bitcoin and other digital currencies are made by a process called mining. But this process isn’t like typical gold or metal mining. Computers perform digital currency mining, requiring enormous amounts of energy. So it’s impractical for most individuals to mine digital currency. While estimates of the energy required to mine Bitcoin vary, it is generally agreed that the amount is very high. The BBC claims that Bitcoin consumes more electricity than the entire country of Argentina. Further, Technology Networks estimates that bitcoin mining consumes 1% of the global energy used.
Once mined, Bitcoin is stored in a wallet that includes a public and a private key. The two keys enable the owner to make transactions and provide proof of ownership.
Bitcoin vs Cryptocurrency
According to CoinMarketCap, there are nearly 8,000 cryptocurrencies. Bitcoin is, of course, the earliest and most popular coin. As I currently write this, Bitcoin has a market cap of $634B, a staggering number at first glance. However, it breached the $1T figure earlier this year before pulling back.
Bitcoin, in theory, is in direct competition with the US dollar (along with other currencies). A market cap of $634B compared to the US dollar market cap of $27T is almost laughable. Though an idea as big as Bitcoin probably deserves a much larger market cap.
Whether you should invest in Bitcoin or other coins depends on your risk tolerance. Bitcoin is the most widely used, and despite its volatility, well-known institutions are buying it. This adds to its credibility and staying power, though there is undoubtedly a way to go before Bitcoin is fully mature.
Investing in any cryptocurrency requires extensive research and a willingness to speculate. Although second-tier coins like Ethereum, Tether, Cardano, Polkadot, Bitcoin Cash, and others are popular and easy to trade, they are typically more volatile than Bitcoin because they are generally less liquid and more speculative.
Is it too Late to invest in Bitcoin?
With a price increase from $6,800 in April 2020 to $64,800 in April 2021, and a subsequent drop to ~$32,500 today, investors might fear they are in for a roller-coaster ride. They’re not wrong. It takes nerves of steel to hold onto an asset class like this.
To help decide whether or not it’s too late to invest in Bitcoin, it’s helpful to understand what influences Bitcoin’s price and why this digital currency could increase in value.
Bitcoin’s pricing, like all other assets, is determined by supply and demand. Many investors ask: Will companies accept bitcoin as payment in the future? If inflation picks up here in the US, will the USD depreciate relative to other currencies? And will that make cryptocurrencies more attractive? Other important factors that also contribute to its price movements:
- The cost of mining Bitcoin
- How much do Bitcoin miners earn for verifying transactions
- Regulations and internal governance (big one)
- The number of competing currencies
When considering whether to invest in Bitcoin, I compare it to an awkward teenager. It had advanced from its infancy in 2012 and out of childhood in 2017. The cryptocurrency still has room to grow and has yet to reach adulthood. Right now, it is mature enough to be trusted in some situations, but it still needs to grow up a bit before it can be considered a viable currency. For it to be truly mature, transaction costs need to fall substantially, and it needs to be more easily accepted as payment. More importantly, though, people need to trust Bitcoin as a viable medium of exchange. In my opinion, there is still a lot of room for improvement.
But waiting for this improvement to occur before investing could be a fallacy. Like any other form of investing, the perfect conditions will never exist. If one waits until everything lines up perfectly (E.g., most retailers now accept crypto payments), it will likely be too late. Like stocks, prices are forward-looking indicators, always trying to price in future developments.
The good news is that because there is still an opportunity for crypto to improve, ‘investing’ in Bitcoin, especially after the 50% price drop we’ve just seen, may make sense.
Although no one knows the future, here are five reasons to consider before adding a bitcoin allocation to your portfolio.
Reasons to Invest in Bitcoin
The Bitcoin source code stipulates that there must be a finite supply of 21 million Bitcoin. At present, only 18.5 million bitcoins have been mined, but due to complicated mining procedures, it will likely take decades to mine the remaining 2.5 million coins. Once the supply threshold is reached, no more bitcoins will be produced. Given the rules of supply and demand, if the public values bitcoin and the supply is fixed, the price will continue to rise.
Remember that Bitcoin is young, only 12 years old. In scouring the internet for market cap predictions, the professionals on bitcoinprice.com project extremely high valuations (biased opinions, of course). Andy Edstrom, wealth manager and bitcoin investor, projects an $8 trillion market cap by 2031, putting the price at $400,000 per coin. While Mike Novogratz, former hedge fund manager and bitcoin investor, pegs the value in 2029 at $7.5 trillion.
Keep in mind that most former price and market cap predictions have fallen short of the current value. So take all of these with a healthy amount of skepticism.
Diversification
Bitcoin has the potential to diversify a typical stock-and-bond investment portfolio. Since its inception in 2009, bitcoin’s price hasn’t shown a significant correlation with other asset classes such as commodities, equities, or fixed income, according to research on Binance.com. In addition to its diversification benefits, investors need to be aware of the asset’s volatility. So, even if you appreciate its diversification benefits, you need to tolerate the price swings.
Bitcoin is a potential hedge against future uncertainties like inflation and political instability. A recent Coindesk.com article by Noelle Archon suggests that we are in “crazy” economic and political times, and bitcoin can provide a hedge against the unknown. Some believe BTC will survive any economic or infrastructure collapse and compare it to gold. I’m not sure if I ultimately buy the idea that Bitcoin will hedge against inflation, but we shall soon find out.
Another point to consider is Mark Cuban’s viewpoint. He believes that if the socio-political climate worsens, countries will protect their currencies and their ability to tax.
Does Bitcoin Thrive During Uncertainty?
Bitcoin might be seen as a form of insurance against an uncertain future, especially when investors believe fiat currency is being debased.
Many view BTC as the new gold and a store of value. Money managers are replacing their gold allocation with BTC. JPMorgan Chase went from deriding cryptocurrency to projecting a $146,000 price, flipping its stance on the currency. Going one step further, the largest banking conglomerate is planning to issue debt linked to cryptocurrency-focused companies.
A common belief among BTC enthusiasts is that it is an ideal store of value, and broader adoption will only solidify that position. Ultimately, whether Bitcoin lives or dies depends on its widespread acceptance and adoption.
What is the point of bitcoin halving?
The Bitcoin halving reduces Bitcoin mining rewards by 50%. This occurs after each set of 210,000 blocks is mined. Bitcoin halving ensures that the number of bitcoins won’t increase too quickly, putting additional upward pressure on its price. There are only 21 million bitcoins that can be mined. The reward will continue to halve every four years until the final bitcoin has been mined. This is likely to occur in 2140.
As bitcoin halves, its inflation rate drops. In 2011, Bitcoin’s inflation rate was 50%. After halving in 2012, it dropped to 12%. Its current inflation rate is 1.76%. For those who are very skeptical and frustrated with global central banks and their policies, bitcoin and its predictable inflation rate are quite an attractive feature.
What’s the Best Crypto Portfolio Allocation?
Those who are ready (and suitable) to add bitcoin to their portfolios need to decide: “How much bitcoin should I invest in?” Although there are many cryptocurrencies to choose from, sticking with Bitcoin for now seems the most sensible approach.
Clearly, Bitcoin is speculative due to its uncertain future and extreme volatility. Those factors advise against a significant allocation to the cryptocurrency. Again, BTC can undoubtedly go to zero, so always keep this in mind. A relatively small amount seems more reasonable. If it does explode in value, it doesn’t take a large allocation to benefit from this.
Because of its volatility, I believe a 0% to 4% allocation makes sense, depending on your risk tolerance and time horizon.
Investors who select an allocation near 4% might be more aggressive, wealthier, and have a longer time horizon. More conservative investors tend to have a shorter time horizon and lean towards a smaller to no allocation. Note that this is only my opinion and not advice to pursue an allocation like this. Of course, please consult with a financial professional first.
Best Way to Invest in Bitcoin
As bitcoin grows in popularity, so do the ways to invest in it. Aside from mining bitcoin directly (which is very costly), below are the most commonly accepted ways to invest in bitcoin.
Exchange or Brokerage
The most popular and most direct way to buy bitcoin or other cryptocurrencies is to use an exchange, such as Coinbase, Gemini, Binance, or Kraken. Robinhood, the popular mobile app broker, also offers cryptocurrency transactions.
Once you place your order, most, if not all, exchanges will place the crypto into a wallet for you. This is to ensure safe storage for your funds. Coinbase, for example, stores the vast majority of its customer funds offline (98%), meaning private keys are not on a server connected to the internet. If you wish to have more control over your keys, you can choose to keep them yourself and store them offline directly.
Exchange-Traded Products (ETPs)
If you don’t want to go through the hassle of opening a new account elsewhere or worry about handling currencies safely, having someone else do this for you should be considered.
Grayscale is the first investment firm to offer access to digital currency investing as a product. The largest digital currency asset manager has roughly $40 billion in managed assets and enables investors to invest in various digital currencies. The Grayscale Bitcoin Trust (BTC), launched in 2013, strives to provide returns in line with bitcoin.
Though know that GBTC is not an ETF (yet) but rather a closed-end fund, meaning its security can (and does) trade at a discount or premium to its underlying assets. It has historically traded at a significant premium but has since fallen dramatically and now trades at a discount. As I write this, GBTC is currently trading at a -10% discount. This can be good. A discount of this size means that if you purchase GBTC on the open market, you could be buying these assets at a discount. However, there is a risk in doing this, as this discount can continue to widen.
Ideally, GBTC will be converted into an ETF, allowing Grayscale to align its underlying assets with its trading price. In theory, this -10% discount would immediately disappear, and the trade would converge to its net asset value. Grayscale and many other asset managers have submitted applications to the SEC to either launch or convert funds to crypto ETFs. It is widely expected that regulators will soon approve these requests.
It’s expected that a US bitcoin ETF will launch soon. Fidelity and VanEck are requesting the okay from the SEC.
(Note – as of January 2024, the SEC approved spot bitcoin ETFs, giving investors a simple way to gain Bitcoin exposure through a traditional brokerage account. This was a major milestone for the asset class.)
Why You Might Need a Bitcoin Allocation
Given its growing adoption, increasing price, and limited supply, it’s riskier not to have a bitcoin allocation than to have one. After ten years of increasing acceptance, especially among traditional financial institutions, I believe that owning bitcoin now seems sensible for many risk-tolerant investors.
Despite its volatility, the reasons to add a bitcoin allocation continue to increase. Currently, only 14% of bitcoins are traded every day. This low float adds to its volatility but not its value. There is a correlation between a lower bitcoin float and a higher future price.
One of the largest investment brokerage firms, Morgan Stanley, is offering access to bitcoin through various funds for its wealthier, more aggressive clients.
Finally, some believe bitcoin may become a reserve currency in the future. Should this occur, there won’t be any question that bitcoin is essential.
Our client portfolios have a 0% to 4% allocation to bitcoin, depending upon risk tolerance. We are aware of the risks, but we believe that the upside potential makes it riskier not to invest in Bitcoin than to allocate a small percentage to the popular cryptocurrency.
Sources and Cryptocurrency Resources:
https://www.investopedia.com/news/how-bitcoin-works/
https://www.nerdwallet.com/article/investing/what-is-bitcoin
https://www.wallstreetmojo.com/bitcoin-vs-cryptocurrency/
https://www.forbes.com/advisor/investing/what-is-cryptocurrency/
https://www.bbc.com/news/technology-56012952
https://www.investopedia.com/tech/what-determines-value-1-bitcoin/
https://www.investopedia.com/tech/what-happens-bitcoin-after-21-million-mined/
https://research.binance.com/en/analysis/bitcoin-diversification-benefits
https://www.coindesk.com/bitcoin-hedge-inflation-crazy
https://www.coindesk.com/bitcoin-hedge-inflation-crazy
https://www.newsweek.com/will-bitcoin-become-new-gold-standard-1559385
https://www.coindesk.com/jpmorgan-to-launch-cryptocurrency-exposure-basket-of-bitcoin-proxy-stocks
https://cointelegraph.com/bitcoin-for-beginners/what-is-bitcoin-wallets
https://www.financialexpress.com/money/is-it-smart-to-invest-in-cryptocurrency-right-now/2218295/
https://corporatefinanceinstitute.com/resources/knowledge/other/bitcoin-halving/
https://advisor.morganstanley.com/the-mpz-group/documents/field/m/mp/mpz-group/bitcoin.pdf
https://www.purposeinvest.com/funds/purpose-bitcoin-etf?tab=knowledge-base
https://bravenewcoin.com/insights/5-reasons-to-still-buy-bitcoin-in-2019
https://www.purposeinvest.com/funds/purpose-bitcoin-etf?tab=knowledge-base
