Cryptocurrency investments should be made cautiously, and only as part of a much larger diversified portfolio of stocks and bonds. For investors with a long time horizon, traditional asset allocation remains an effective strategy.
Bitcoin is back in the news. For many investors, the combination of dramatic price appreciation - Bitcoin is up 50% in 2024 alone - and the regulatory approval of several high-profile ETFs has prompted the question, "do Bitcoin and other cryptocurrencies have a place in portfolio construction?" To answer this question, it is important to understand the associated risks and opportunities.
Bitcoin is the quintessential cryptocurrency, accounting for 52% of total cryptocurrency market capitalization. Its primary value is its inherent scarcity: the maximum number of bitcoin possible in circulation is fixed at 21 million. For this reason, Bitcoin is meant to function as an alternative to fiat currencies, like the U.S. dollar. However, significant limitations exist.
Currencies are supposed to be both effective mediums of exchange and effective stores of value. Bitcoin satisfies neither of these requirements, as evidenced by recent price swings and the minimal adoption in real-world commerce. Instead, Bitcoin is better described as an asset, although unlike a stock or bond, Bitcoin has no associated income stream (a dividend or coupon); and unlike a commodity, it has no physical application. As a result, for most investors, Bitcoin is a purely speculative asset.
For other investors, the technology that underpins Bitcoin - the "blockchain" - is alluring. At a high level, a blockchain is a public database, with data structured into “blocks” that are “chained” together. These “blocks” contain transaction data in addition to security measures that make them impossible to alter or duplicate. Today, blockchains are primarily used to store cryptocurrency transactions.
Potential use cases, however, extend beyond Bitcoin and into any industry where data security and transferability are important. For example, a purpose-built blockchain - with its own crypto "token" - could standardize health care record keeping or replace physical ledgers in supply chains. In some ways, therefore, purchasing a specific token is akin to taking an equity-like stake in its underlying infrastructure. It should be noted, though, that with very few barriers to entry, purpose-built blockchains are constantly becoming obsolete as better ones are created, making concentrated positions in any particular token unwise.
Ultimately, the limitations of cryptocurrency should be acknowledged and its risks appreciated. Still, even skeptics should recognize that the asset is likely here to stay. As a result, cryptocurrency investments should be made cautiously, and only as part of a much larger diversified portfolio of stocks and bonds. For investors with a long time horizon, traditional asset allocation remains an effective strategy.