Love it or hate it, cryptocurrency is enjoying another moment at this time. Fortunes have been made and lost on crypto already and it continues to edge its way into the mainstream more each day, especially now that we have what appears to be a more crypto-friendly administration in the White House.
And while it can be risky and speculative, at the same time, I hear from plenty of serious investors who have crypto in their portfolio, and I’m ok with that, as long as they’re cognizant of the volatility and the risks.
I am a true believer in the advantages and savings that blockchain technology will bring to our economy and society in the coming years. My views on cryptocurrencies, which have blockchain underpinnings, however, are more muted. I don’t think it’s all a sham, but it has clearly attracted some shady characters, so there is reason to be cautious.
Even in the best-case scenario, when backed by diligent founders, cryptocurrency has a level of volatility that is not appropriate for all investors.
But, rather than a knee-jerk dismissal, let’s consider the appropriate place for crypto in an investment portfolio, if any. The first thing investors should be aware of is there are different categories of cryptocurrencies.
The primary group of cryptocurrencies are those with a fundamental financial or technological utility. These include:
1) Payment cryptos like Bitcoin, Dogecoin, Litecoin and others generally have a finite number of coins. In theory, and increasingly in reality, such coins can be used as a way to pay for any kind of goods, services or other financial obligations.
2) Utility tokens (also sometimes called Infrastructure tokens) include most notably Ethereum. These have a specific function for which they are created and do not have a finite number of coins. So, like a governmental currency when a lot more gets printed, these will tend to be inflationary over time.
3) Stablecoins have their value tied to a traditional currency (sometimes referred to as fiat currencies because governments can increase or decrease the supply at their fiat), typically the U.S. dollar or the Euro. Tether is the best-known and biggest stablecoin. These avoid the drastic and sudden swings in valuation that we hear about so often with payment cryptos. But, these still aren’t guaranteed. TerraUSD was a stablecoin that collapsed because the holdings backing it up were in risky assets.
One form of stablecoin is Central Bank Digital Currencies (CBDC) which are issued by a country and tied to the value of their currency. These are in the very early stages, but expect to hear more in the coming years as there are advantages in terms of stability and traceability.
The second group, which has been back in the news recently, is called Meme Coins because they are typically tied to some cultural fad (or meme). Unlike the group above, these do not have any underlying intrinsic value. Many of these are started on a whim, or as a joke.
In effect, these are collectibles that are purchased from the issuing party, who immediately makes money. Everyone else beware. As long as interest and demand stay high, you MAY be able to resell them for more than you purchased them.
But don’t count on it.
At some point, the music will stop and someone will be left holding these coins that no longer have a market. If this is your idea of entertainment or if you want to support a cause of the issuing party, then buy them. Just don’t think of them as an investment.
The next thing to think about with crypto is that it generally aligns with bull markets. When the stock market is running strong, crypto tends to do well. When the market turns down, crypto does too, sometimes quite hard.
5 Rules to Manage Risk While Investing in Crypto
1) Do NOT invest in Meme Coins. These aren’t investments. I’m not saying don’t buy them (although I won’t), just that you should not consider these to be part of your investment portfolio.
2) Do your due diligence before buying any crypto. Is it solid? What is the value based on? What is the underlying thesis?
3) Buy early in bull markets. Wait until the trend has been clearly established. Once you’ve bought, watch closely. Be prepared to sell much, or even all, of the position, upon a sharp rise. Take your profits and move on. And put a pause on your buying when the market turns bearish.
4) Don’t get greedy. Investors often hate to sell only to see an asset continue to rise in value, but it’s better to sell before a peak and lock in profits than leave the party too late, having watched the value fall off a cliff. I see this all the time with equities and it’s an even bigger risk with crypto because of the greater volatility.
5) Consider buying and holding. If you think crypto is destined to gradually ratchet up in value in the long run, you can buy early in a bull run or on any substantial dip. If that’s your strategy, don’t check the value every day. You’ll drive yourself crazy as you see sometimes massive fluctuations up and down (ouch!). If this is your strategy, I recommend buying quality – Bitcoin or Ethereum would be at the top of my list.
If you are following a buy-and-hold strategy, that can be an exception to buying only in bull markets. As with any buy-and-hold strategy, a dollar-cost-averaging approach where you buy a set amount each month can be appropriate here.
At the end of the day, only you know how much risk you’re willing to take in crypto, but hopefully these rules can help you manage that risk appropriately.
