Bitcoin investment is far too risky for most portfolios


Many cryptocurrency enthusiasts believe that bitcoin is “digital gold,” a major new asset class that provides attractive expected returns, a durable store of value, and diversification.

But since last fall, the cryptocurrency has failed to do any of that. Instead, its price has dropped like a digital stone, losing around two-thirds of its value.

From an all-time high of $68,990 (US) in November, it fell to a low of $17,630 in June. Since then, it has made up a small chunk of lost ground, trading at around $21,700 last Friday, according to investing.com.

This underperformance comes as it was beginning to make inroads into the world of conventional investing. Some major investment firms like Fidelity Investments have started to include small allocations of bitcoin in conventional portfolios alongside stocks and bonds.

But, in my opinion, Bitcoin is not ready for the portfolios of average investors. Its recent price action shows that it is still too risky for most average investors who normally invest with their retirement savings on the line.

At the root of its risk is the fact that it is a speculative asset whose value is determined by what investors believe it is worth, with no underlying “fundamental” value in the traditional sense. Unlike stocks, for example, you don’t own a share of a company’s profits, cash flows, and dividends.

Untethered to fundamentals, it could do very well, or very poorly, or anything in between. It all depends on investor sentiment, which can be fickle.

Of course, it still has true believers who think it has many of the favorable investment attributes often associated with gold, but with significant additional benefits.

For one thing, its supply is more limited than gold, capped at 21 million bitcoins.

On the demand side, it benefits from the network effect. As more people use bitcoin, it could become more valuable to each user. That, in turn, can further encourage usage by each existing user, as well as attract additional new users, potentially fueling exponential growth.

That potent potential combination leads enthusiasts to expect big price gains over time, albeit with plenty of volatility.

Bitcoin believers range from youngsters with small sums to invest to prominent tech billionaires like Elon Musk (of Tesla Inc.), Michael Saylor (of MicroStrategy Inc.), and Jack Dorsey (of Block Inc.), who use extensive personal resources. and the company’s wealth to support their beliefs.

For most of its history, bitcoin prices reflected the independent streak of its buyers, making it largely independent of stock market movements. Before the pandemic, the correlations between prices and major stock market indices were very low, similar to gold. That fueled the expectation that Bitcoin would help diversify conventional stock and bond portfolios.

Advocates also began to see bitcoin as a reliable store of value, a means of retaining purchasing power for future use. Of course, their prices have historically been much more volatile than cash (the store of value benchmark) or gold (an established alternative). But it could be easily sold if needed and its proponents hoped it would enjoy strong price gains over time.

Also, like gold but unlike cash, the supply of cryptocurrencies is independent of central banks, and thus advocates hoped it would provide a good hedge against inflation. Major holders like Tesla, MicroStrategy and Block have accumulated billions of dollars on their balance sheets.

While its prices prospered alongside tech stocks in the early stages of the pandemic, bitcoin began to decline from its November high, falling sharply in the second quarter of 2022.

It was fueled in part by cryptocurrency industry business failures, which included: cryptocurrency lender Celsius Network LLC; cryptocurrency broker Voyager Digital Ltd.; TerraUSD and Luna pegged cryptocurrencies; and hedge fund Three Arrows Capital Ltd.

These business failures undermined investor confidence in bitcoin along with the rest of the crypto industry. Additionally, rampant inflation, rising interest rates, and slowing economic growth have created a worsening climate for both investors and the tech industry. No one could be sure how bad it would get.

Institutional investors who had started to include bitcoin in portfolios were now looking to offload riskier assets, and now that included bitcoin. Some tech companies sold cryptocurrency to reduce debt and raise cash as outside funding dried up. The highlight is that Tesla sold more than 900 million US dollars during the second quarter.

All of that put selling pressure on the cryptocurrency and the price fell precipitously. This time, bitcoin and tech stocks were highly correlated and sold together, providing little to no benefit from diversification.

In the second quarter, the tech-heavy NASDAQ 100 index fell 22 percent, while bitcoin prices dropped 58 percent, acting as just another risky asset.

The current environment calls for caution from average investors. Central banks are not done raising rates and no one knows for sure how much the economy will slow.

There is a realistic chance that the economy could end up in a deep recession, in which case riskier investments would likely be hit a bit harder. Given its recent price action, that scenario would likely hurt Bitcoin badly.

Of course, believers have seen huge sell-offs before. Many see current prices as a buying opportunity for those who can be patient. Even if prices fall further, there is still a strong chance that they will recover at some point and reach new heights in the future.

The thing is, with speculative investments, the outcome is very uncertain. Based on the history of technology investments, there is also a significant risk that bitcoin owners will at some point move on to something new and let prices languish in the digital dust.

david aston, a freelance contributing columnist for Star, is an investment and personal finance journalist. He holds a Chartered Financial Analyst designation and is a Chartered Professional Accountant. Contact him by email: [email protected]

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