As more retail trading and brokerage platforms add cryptocurrencies and crypto-products to their lineups, an increasing number of investors are joining the fray. According to a late 2020 survey, an estimated 21 million U.S. investors aged 18-65 owned cryptocurrencies – broad appeal for a young asset class – with a further 19 million planning to invest in crypto over the following 12 months.
Crypto’s emergence also creates a conundrum for everyday investors with no exposure yet: invest despite the potential unknowns, or suffer the regret at each turn when friends, family, analysts or the media discuss the acceptance of crypto for a growing set of uses.
Ultimately, investing in crypto depends on individual risk tolerance and one’s own general investing behavior. If you’ve been on the fence about whether to invest, you may also be asking yourself if it’s too late to invest at all.
Prices for the most popular cryptocurrencies like Bitcoin have been volatile over the last year, recording monthly double digit gains and losses, while Ethereum (ETH) recorded gains of 15% during the calendar fourth quarter of 2021 alone. So why are fairly novice and seasoned investors alike bullish on crypto? Investors with a long-term strategy and risk tolerance believe they may potentially stand to benefit from returns as the currencies gain broader adoption – many point to bitcoin and its limited supply as a fundamental reason why it must appreciate over time as incrementally more individuals and corporations begin to own the asset.
The market value for cryptocurrencies exploded since the end of 2018, with the total value of coins in circulation (known as market capitalization) now valued at more than $2.2 trillion as of January 2022. The largest and most well-known cryptocurrencies, Bitcoin (BTC) and Ethereum (ETH), saw their prices hit all time highs in 2021 (BTC hit $68,492 on November 10 and ETH hit $4,843 on the same day).
According to the chart below, Bitcoin outperformed other asset classes over the past few years. For example, in 2020, BTC returned 318%, while gold returned 28%, and equities returned 15%. 2021 was slightly different, but Bitcoin and Ethereum returns still exceeded those of equities, gold and oil. According to Bloomberg, top Wall Street analysts and strategists remain bullish on BTC with forecasts anticipating the price reaching $100,000; meanwhile a Nasdaq report points to research that forecasts Ethereum reaching $7,500 in 2022 after closing 2021 above $3,700.
Source: JP Morgan, Messari
Despite the outperformance, it’s important to acknowledge wild price swings can occur among cryptocurrencies for a number of reasons, including geopolitical events, news reports, actions by governments and companies, and outspoken opinions from influential business leaders.
For example, in the span of a year beginning in January 2020, BTC soared from $7,300 to more than $32,000, only to further double from there by March 2021. It halved to $31,500 by July that same year. ETH saw similar volatility, rising from $775 in January 2021 to $3,900 in May, then halving to $1,825 at the end of June. By November, ETH had more than doubled to exceed $4,600. While seasoned crypto investors may accept that such volatility is to be expected, this variability may exceed some investors’ risk tolerance.
For perspective, see the comparison of Bitcoin’s recent performance over a 5-year time horizon against other risk assets based on a $1,000 investment.
Looking beyond the U.S. and surveys of intent, the data points to more people adding crypto to their investment portfolios. According to Blockchain.com data, the number of Bitcoin wallets has grown exponentially since 2016, rising from around five million to 80 million wallets, up 16x.
According to a Q4 Eaglebrook Advisors study, “Bitcoin has moved from weak hands into those looking to hold for the long term.” Cryptocurrency investors have even earned themselves the moniker “HODLers,” with the acronym HODL signifying the phrase “Hold On for Dear Life.” It’s a term derived from the misspelling of the word “hold,” that refers to buying (not selling) and holding Bitcoin or other cryptocurrencies.
Since 2011, the number of HODLers has risen to 35% of the supply. Additionally, more than half a million addresses are buying and not selling Bitcoin.
Cryptocurrency adoption is not just growing with everyday investors. Now, corporations and even countries are increasingly investing in cryptocurrencies. For example, in September 2021, El Salvador adopted Bitcoin as legal tender. Companies such as Microstrategy, Tesla, and Square have also bought Bitcoin to include in their balance sheets.
In October of 2021, hedge fund manager Paul Tudor Jones said that Bitcoin, just like gold, is a great way to protect wealth over the long run. “I like Bitcoin as a portfolio diversifier,” Jones explained on CNBC’s “Squawk Box.” “Over time, it’s a great diversifier. Again, I look at Bitcoin as a store of wealth.” Those comments came after he had many numerous public comments about his ownership of Bitcoin and how he had allocated a small percentage of assets to the cryptocurrency.
As cryptocurrency goes mainstream, newer investors shouldn’t fear that they are late to the party. According to the data below, the S curve implies cryptocurrencies may have yet a long way to run in this current cycle. As corporations continue to buy and hold large quantities of cryptocurrencies, like Bitcoin, there is also speculation that this will take a percentage of the total available BTC supply of 21 million coins out of circulation, 90% of which have been mined. With less availability as institutions hold, prices could continue to rise as each incremental buyer enters the segment.
Before allocating Bitcoin or Ethereum to any investment portfolio, understand that while there is an opportunity for returns, losses and market corrections are still possible. Conventional wisdom dictates that before investors commit to an investment, they should have fully funded an emergency fund, and only invest with money they can afford to lose.
While risk-averse investors may choose to allocate only a small percentage of their portfolio to cryptocurrencies, such as Bitcoin, more risk-tolerant investors may opt to invest more, which may result in a higher possibility of volatility.
Traditionally, a diversified portfolio consists of a mix – of risk assets , like stocks, and fixed income, like bonds – depending on one’s risk tolerance. Generally speaking, advisors typically recommend younger investors allocate more heavily to risk assets that may come with a higher rate of return and volatility. Older investors nearer or in retirement are typically recommended to allocate more heavily to fixed income as they may be less tolerant of downturns and require more consistent, albeit lower, returns over time.
Cryptocurrencies, as an asset class, are still being understood, and, given their record of performance, are being considered as part of a balanced portfolio.
Aside from the Bitcoin, retail investors are buying alternative coins or “altcoins,” which refer to Cardano (ADA), Polkadot (DOT), Solana (SOL), and Dogecoin (DOGE), to name a few.
These altcoins are younger development projects, and are tempting investors to get involved given their potential as rivals to the more established currencies like Bitcoin and Ethereum.
They are often pitched as improvements to Bitcoin, which is often critiqued for the perceived lack of scalability and inefficiency in processing mass transactions. For example, Bitcoin uses “proof of work” (PoW) as the consensus mechanism to create blocks in the blockchain, which has been labeled as energy intensive. Some altcoins, on the other hand, use the “proof of stake” (PoS) consensus method to reduce energy usage and the time it takes to generate new blocks.
Besides the volatility of cryptocurrencies, there are some other risks to consider:
Cryptocurrency exchanges may be vulnerable to attacks or hacks: While this is a concern, there are ways to protect against these risks. In addition to managing and keeping trading platform passwords secure, investors may also wish to keep cryptocurrencies stored away from centralized exchanges in offline wallets (known as cold storage).
Their future is unknown: Investors must perform their own research and due diligence when investing in alternative assets, like cryptocurrencies, as the future of these projects, impending regulations, and future market values are uncertain.
New and existing investors and their crypto investments are subject to tax by the IRS: Investors must understand the tax implications when investing in cryptocurrencies. Investors can consult the help of tax professionals when it comes to understanding the proper tax treatment of buying, holding, spending and selling crypto, including rules on capital gains taxes on any returns or profits from crypto sales.
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