You may be considering jumping into bitcoin, this year’s most exciting—and controversial— investment. The price of bitcoin, by far the leading digital asset, jumped 325% over the past year, while a $1,000 investment at the beginning of 2021 in the obscure Dogecoin ballooned to more than $120,000.
Digital assets, also known as cryptocurrencies, have come a long way since 2018, when Warren Buffett quipped that they were “rat poison squared.” Bitcoin’s increasing acceptance on Wall Street makes it hard to dismiss as a fad. Still, consumers and investors are confused by its bubblelike gyrations in value… warnings from government regulators… and lack of clarity over what an asset that exists only online is good for in the long run. Bottom Line Personal spoke to Ric Edelman, founder of RIA Digital Assets Council, who answers questions to help you determine whether digital assets are right for you…and, on page four, crypto strategist Theresa Morrison, who explains how to get started investing…
Bitcoin was created as a digital currency for small online payments. Are we going to buy lattes and electric cars with bitcoin? That is very unlikely. As a currency, bitcoin’s wildly fluctuating value makes it unsuitable for everyday use. And there’s no FDIC insurance that protects the money you put in bitcoin if you fall victim to scams or theft.
Why all the excitement? Digital assets have enormous value for other reasons. First, the technology that underpins bitcoin, known as blockchain, is as transformative as the Internet itself. Blockchain is a processing and recording software program that runs across a network of computers around the world and facilitates near-instantaneous transactions. At the heart of the program is a virtually unhackable open ledger—anyone with an Internet connection can view it— of every transaction. Someone would have to take control of 51% of all the computers accessing the network, and that’s virtually impossible.
Blockchain has the potential to revolutionize international commerce—it is a way to transfer large sums of money around the world without an intermediary. Currently, it takes five days for corporations and individuals to transmit payments cross-border and the average fee is 6.38%, according to the World Bank. It’s a $4 trillion business worldwide. With bitcoin, payments can be done in 10 minutes and virtually for free.
Second, bitcoin is a new type of investment that can be useful in an investor’s portfolio. Only 21 million bitcoins will be made, and nearly 19 million are in circulation. No other asset class—not stocks, bonds or even gold—has such a rigid fixed supply. That makes bitcoin an effective hedge against inflation.
Bitcoin also has little to no correlation with other investments, meaning that its value doesn’t rise and fall when their values do. I’m very bullish that this new asset class will keep rising in price because it has achieved real scale and critical mass. Pension funds and Ivy League college endowments now invest in it. Major firms including Fidelity, Goldman Sachs and Morgan Stanley are letting their clients buy bitcoin. Bitcoin’s market capitalization of $700 billion is larger than that of such companies as Bank of America, Visa and Walmart.
If bitcoin has such a bright future, why is the price so volatile? It’s no more volatile than Microsoft, Apple or Amazon were in their early days. In 2020, 30% of the stocks in the S&P 500 were more volatile than bitcoin. Still, bitcoin does carry unique risks and is still evolving. This could diminish its appeal and value. China has banned bitcoin, and other countries could as well.
Another risk: Technological obsolescence. Newer, more useful cryptocurrencies may wind up supplanting bitcoin. Example: Ethereum is the second-most popular digital asset with a $300 billion market cap. It is better-suited than bitcoin for an array of commercial applications, and Ethereum allows you to attach conditions to a transaction before it’s completed, such as the delivery of goods at a certain time or location.
How much exposure to bitcoin should a small investor have? Follow the rules you use with any high-risk investment. Don’t own bitcoin if it will put you on an emotional roller-coaster. Invest only money you can afford to lose. And limit exposure to 1% of your portfolio. Bitcoin has such explosive potential that 1% is enough to have a meaningful impact. And if bitcoin’s value fell to zero, losing 1% wouldn’t cause irreparable harm.
Should I invest in other digital assets? There are more than 10,000 digital assets available. By comparison, there are only about 3,500 publicly traded stocks to choose from in the US. Bitcoin’s value makes up about 45% of the entire digital- assets market…Ethereum, another 20%. So, exposure to one or both allows you to capture most of the market.
Important: Avoid Dogecoin. Support from billionaire Elon Musk has helped boost its price, which carries a $44 billion market capitalization. That’s nuts given that Dogecoin was created by IBM and Adobe software engineers as a spoof—it offers none of bitcoin’s and Ethereum’s commercial applications. There are 130 billion Dogecoins in existence, and millions more are created every day.
When is the right time to get into the digital-assets market? That’s the biggest challenge for investors because digital assets don’t generate cash flow, earnings or dividends that allow you to analyze current valuations. One starting point: Supply and demand are the dominant drivers of prices for digital assets. When factors arise that could threaten or restrict demand, the price is likely to fall fast and create a buying opportunity. Example: Bitcoin prices dropped 30% in just a few hours in March. Or consider dollar-cost averaging—decide how much you want to invest, then automatically spread out your purchases in equal amounts each month over the next year.