In 2022, we watched the former FTX CEO Sam Bankman-Fried and his FTX cryptocurrency exchange collapse. With investors’ concerns it may result in another Bear Stearns moment, that collapse dealt a catastrophic blow to cryptos reputation and the plans and aspirations of many in this unique industry. The question now is, is this the end of cryptocurrency? Early in my career, when everyone in our office shared a computer with two floppy discs and CompuServe was our email resource, I was asked by a client to purchase a new start-up stock offering called Google. He shared that this company was on the forefront of technological advances. Recently, as my doctor walked into the examination room after I had waited for over an hour in the waiting area, he greeted me and quickly said, “So what type of work do you do?” I shared that I am a financial planner who advises our clients on retirement planning. Not surprisingly, the next question he asked was, “So what do you think about investing in crypto?”
As I thought about the start-up Google and now crypto, I questioned if there were any differences between these two investment opportunities. Were both created as an idea to make life better?
Before I answer these questions, let me first begin by sharing my limited knowledge of cryptocurrencies. The cryptocurrency was invented in 2008 and provided digital virtual means of facilitating online peer-to-peer transactions. The currency is not a commodity, an asset class, or a currency, but shares some characteristics with them. Individuals can use cryptocurrencies to buy goods and services; however, the technology is still developing. Blockchain is the technology behind cryptocurrency. It is a database, a ledger distributed across a peer-to-peer network that supports all types of transactions. Often the question is, where is “crypto” stored? Is it a bank? Do they store it with the Federal Reserve? Well, no, cryptocurrencies are stored in a digital wallet that no one else has access. Cryptocurrency can be bought and sold directly on crypto exchanges, crypto brokerage platforms, and what some refer to as a crypto kiosk.
How are cryptocurrencies compared to everyday money like the dollar? They are not universally accepted medium exchanges, which is important to note. This is why many advocates are trying to encourage a digital currency that can be easily transferred for goods and services. The problem some believe is the lack of a central authority to manage the currency which became apparent with the recent FTX debacle.
So, what is the difference between owning shares of a start-up like Google and owning cryptocurrency?
When you purchase stock in a company like Google, now known as Alphabet, you own shares in that company. If the company becomes profitable and earns income beyond its expenses, the share price reflects that. On the other hand, most people do not really understand digital currency. Therefore, they do not understand what they own. I have been leaning more toward viewing cryptocurrency as a collectible. A collectible refers to an item worth far more than it was initially sold for because of its rarity and/or popularity. The price for a particular collectible usually depends on how many of the same items are available and its overall condition. Bitcoin’s supply limit is set at 21 million.
Our friends at Vanguard have put together some good materials when it comes to investing in crypto. They share how their company has benefited from the technology when receiving index data from a major provider. They find that it is efficient, reduces risk, and operationally attractive when receiving the data. When it comes to our banking relationships, there is a large amount of infrastructure required to maintain trust between a bank and its depositors. This is expensive and is often captured by insiders who profit. On the other hand, public blockchains are built on a network of computers, making their transactions transparent and in theory trustworthy. Who knows today where technology will lead us. Individuals should be free to devote time and money to inventions that may or may not benefit society in the future. Because we live in a capitalist society, investors are free to speculate and take these risks with the full understanding that they will incur losses on some of these ventures. However, when it comes to investing, the price volatility makes it impractical for many investors to allocate funds to cryptocurrency, this is especially true for those in their retirement years. In time, we will learn more about this technology, but for now, let venture capitalist and speculative hedge funds speculate on this technology.
In summary, for the average investor, the volatility, the unknown, and the lack of central authority require prudent investors to avoid allocating funds to cryptocurrency. Focus on these investing principles that have been proven over time and you will avoid many of the pitfalls that result when they are not followed:
- Set clear, attainable, and written investment goals.
- Invest regularly: it is time in the market not timing the market that matters most.
- Know your “sleep level”: Recognize your tolerance for volatility and diversify accordingly
- Minimize fees and pay attention to net performance. Markets are uncertain; fees are certain.
- Rebalance your portfolio regularly. Not all asset classes are alike.
- Engage a Certified Financial Planner™ professional to advise you.
Cryptonite – Neuberger/Berman CIO Weekly Perspectives 12/05/2022