Create an asymmetrical risk vs reward system
Cryptocurrencies have become one of the hottest, most interesting, and most misunderstood topics in personal finance. Many in this community have been immersed in the space for years, are bitcoin maximalists, conduct extensive research in altcoins, and may even hold upwards of 50% of their assets in digital currencies. I can confirm that I fit none of those profiles, but can also accept that the momentum and network effects of adopting digital currencies are far too great to ignore.
As more of a traditional investor in stocks, bonds, and real estate, I have only recently begun investing in crypto. I suspect that many readers are cut from the same cloth and looking for affirmation for how and why they should get in now. Below are my thoughts on how you can start, along with how I am giving my own portfolio the exposure to digital currencies that I feel provide the right balance of risk and reward.
What do the optimists and pessimists think about crypto, and why?
In order to have any level of confidence in being a first-time crypto investor, it is important to understand the sentiment from both the optimists and the pessimists. There are two opposing schools of thought on the outlook of crypto. In a nutshell, they are as follows:
The arguments against…
Limited underlying value
The main argument against crypto is that the actual underlying value of these currencies is minimal at this point in time. The thought is that you would primarily only be acquiring crypto in order to try and sell it at a more favorable price down the line. People in this camp believe that using it as an actual medium of exchange is not going to happen any time soon, and may also be limited to more conducive environments like gaming and collectibles.
A second argument against crypto is in regards to regulation. Crackdowns from China have created some pause in the recent bull run of cryptocurrencies, particularly bitcoin. Even as a decentralized currency, governments can still maintain some control over how digital currencies are mined, taxed, and accepted as legal tender (which is gaining support in Latin America but remains an unknown).
Another concern brought up by many key influencers in the space has been around energy inefficiencies in the mining process. The computational power required in mining bitcoin requires supercomputers that currently create a massive carbon footprint. Elon Musk remarked that Tesla would suspend bitcoin payments until “there’s confirmation of reasonable (~50%) clean energy usage by miners with positive future trend.”
These are reasonable criticisms that understandably give new investors some pause in taking the leap. Now let’s look at the counterpoints to understand the other side:
The arguments for…
Finite supply acts as digital gold
This argument is predominantly tied to bitcoin rather than crypto as a whole, but it is still important given bitcoin’s dominant share of the crypto market. The reward for mining bitcoin halves with every 210,000 blocks on the blockchain, limiting the lifetime supply of bitcoin to 21 million coins.
Finite supply provides a tremendous hedge against inflation of the US dollar and other fiat currencies since bitcoin cannot simply be “printed” in perpetuity. This is similar to the value of gold, and even similar to real estate since there is a finite amount of land from which to build. However, the growth potential of cryptocurrency is considerably higher if it is in fact utilized as a mass adopted medium of exchange globally. 21 million coins is a relatively small number when you consider the global population is nearly 8 billion and climbing.
Network effects trump government intervention
Bitcoin and other cryptocurrencies across various blockchains become stronger the more that people use them. Additionally, the more that individual investors actually own their own keys (more on that later), the more control and protection they have on intrusive action from local governments.
Additionally, if and when cryptocurrencies are used more as currency than just as an investment, they are likely to be protected from even the most aggressive tax policies. This is because the currency could be “used” instead of sold. This idea is similar to owning wads of cash — if the cash itself increased in value by 10,000 times, you could simply use less of it to acquire goods and there would be no tax implication.
China’s crackdown is actually a positive
While China’s aggressive policies to ban mining have resulted in a dip in crypto prices, the long term implications may actually be a positive. Currently, a massive portion of bitcoin mining takes place in China, which is not ideal for a decentralized currency. If the mining process becomes more globally diverse, that gives it added protection from being at the whims of any single regulatory body limiting its use.
What percentage of your portfolio should be crypto?
Even if you are convinced that the long term outlook for crypto has massive potential, most everyone agrees that the path to getting there will not be smooth. Therefore, if you are more of a traditional investor like I am, I would recommend no more than 10% of your portfolio being allocated to crypto.
The key point to discern for yourself is to risk no more than you are willing to lose, but also risk enough where a massive gain is actually meaningful. Investing $1k and seeing it triple to $3k is nice, but not life changing for most people reading this. However, investing $100k and seeing it triple to $300k is significant. Find the balance between impact and your personal risk profile to define your exact percentage.
Ok, I’ll dabble, but where should I start?
There are many ways to get started, all with their respective pros and cons, but I’ll outline a few. First, a mantra you will often hear and may be unfamiliar with if you are new to the space is “not your key, not your coin”. Cryptocurrencies are only “owned” if you have authority over the unique keys associated with them…
The clearest examples where investors may not own their keys is with popular crypto exchanges, like Robinhood. In that instance, Robinhood is the custodian of your coins and has access to the associated keys. They do not fully disclose how they store these keys, other than the fact that they use a combination of hot wallets and cold wallets. This is not to say that using exchanges is necessarily a bad thing, as they do allow for greater flexibility in trading. However, if you plan to hold a portion for the long haul (a decade or more), then you will need a crypto wallet to store and protect these keys.
At this stage, I would not recommend dumping 80% of your net worth into crypto, but I do believe there is no other asset class with the same upside. The only conventional stock that could conceivably mirror the upside of crypto would be an unproven small-cap stock on the verge of exponential growth (i.e. picking the next Amazon or Apple). Since crypto is an entire asset class, I would confidently argue that investing in crypto is actually far safer than trying to find the next Amazon. Even limiting your crypto investment to only bitcoin is effectively investing in the broader asset class since bitcoin represents roughly 60% of the total crypto market cap anyway.
As a lower risk approach to ease into or compliment your crypto investments, you can also get involved in crypto savings accounts which pay interest.
Lauren Como has an excellent piece offering more detail on this. Essentially you can own “stablecoins”, which are digital coins tracking fiat currency like the US dollar, in a crypto bank. These banks offer high interest rates because they lend your coins to other institutions at an even higher rate. While this may seem risky, you are likely (though not guaranteed) to at least maintain your principal investment. Therefore, if future rates drop due to volatile crypto market changes, you can simply withdraw your full principal with interest accrued up until that point and move it elsewhere.
My own crypto exposure
My crypto exposure currently makes up about 3% of my total assets. It is predominantly in bitcoin, followed by etherium, and finally a small amount in litecoin. Of this 3%, about 80% is in an exchange, and the other 20% is in a crypto bank earning interest, as I outlined above. Based on the points I have covered, this is a relatively small portion of my total. The reason for this is that I have only recently begun investing in crypto. As new cash flow enters my portfolio, I expect this percentage to only increase over time, especially if there is a short term crash on the horizon and I can acquire a larger chunk of the 21 million bitcoin global supply.
Contrary to what is often seen in financial and general media, investing in cryptocurrencies is not about overnight wealth. It is a long play that comes with volatility, and therefore the short-term fluctuations should not make your stomach turn.
Learn the basics and mechanics of the technology and research its potential. You don’t have to be an expert and you don’t have to wait for the price to come down. You simply have to understand the risks and reward and determine how much you are willing to put into this roller coaster.
This article is intended for informational purposes only and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.
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