Key Takeaways
Did we learn anything from the meltdowns and extreme volatility of 2022?
Crypto is not well-regulated and hasn’t proven reliable as a hedge against the stock, bond, or real estate risk.
If you want to explore this asset class, make sure all other obligations are satisfied and don’t allocate more than 1% to 5% of your portfolio. The level of risk inherent in crypto is equivalent to sports gambling, casino gambling, and investing in penny stocks.
People often ask me if now is the time to start investing in cryptocurrency—or if it’s safe to get back in. For most of you reading this post, the answer is “no.” As 2022 provided, crypto is extremely volatile, so it’s not in the best interests of most of our clients.
As with most asset classes, 2022 was a tough year, but crypto plummeted about 65%, three to four times the painful decline seen in stocks, bonds, and real estate. The collapse of FTX, Terra Luna, and other exchanges didn’t help investor confidence, especially since this asset class is very lightly regulated. I bring this up now because some investors sense an opportunity as crypto seems to be turning the corner. As recently as November 2021, Bitcoin was trading at nearly $69,000, but by late 2022, its value had plummeted to about $16,500. But over the past month, it seems to have stabilized, having gained about 40% so far in 2023 to $23,000. Talk about volatility! Also, if there’s a silver lining to the FTX debacle that burned so many investors last year, it’s that Congress is taking notice and will be pushing hard for regulation to make sure people don’t get swindled again. I’m all for reasonable regulation, but that’s not likely to change the highly volatile nature of crypto. I’m not a prognosticator. I don’t know if this recent rally in crypto values will last. Just know that if you’re going to dabble in crypto, it’s hard to know where to incorporate it into a balanced portfolio since cryptocurrencies are highly correlated with the stock market. That means it doesn’t provide much in the way of diversification from stock and bond market shifts. In other words, it goes up when the stock and bond market goes up, but goes (way) down, when those markets go down. Control What You Can Control The common theme throughout all of our planning for clients is that you want to control the things that you can control. Crypto doesn’t make it easy. The large daily swings in the value of crypto are well outside the risk tolerance of most of our clients. It’s especially troublesome for clients at or near retirement age, unless they understand crypto is 100% speculative and they could lose it all in a moment’s notice as with sports betting, casino gambling, or investing in restaurants, nightclubs, and penny stocks.
Crypto Market Cycles
When Bitcoin reduces its rewards, it’s on a cycle. After a certain amount is mined, the reward you would receive becomes half. When that happens, we typically see a run-up shortly thereafter and eventually an epic collapse six to twelve months later. Again, we don’t find this type of speculative asset class useful for our clients in terms of portfolio construction. The risk level is simply too high for the majority of our clients who are retired or within 10 years of retiring. I know some self-directed retirement accounts allow savers to allocate a small portion of their savings to crypto, but I don’t recommend it.
Could we see another FTX-like meltdown?
I don’t think it’s a question of if, but when. The history of crypto has been marked with meltdowns since its inception. The first meltdown I can recall was the hacking and subsequent bankruptcy of Mt. Gox in 2014. At the time Mt. Gox was the largest exchange processing about 70% of all Bitcoin trades. But shortly after they got hacked, they determined the exchange was insolvent. A few days later, they closed their doors and anyone with assets held on the exchange lost 100% of their tokens. There were several others preceding FTX.
Regulation
On the plus side, the collapse of FTX has caught the attention of regulators. For years, governments have considered crypto a danger, but not an established asset worth regulating. But since FTX was so widespread and impacted so many people, regulators are starting to pay more attention to crypto. Senator Elizabeth Warren is leading the charge stating that “rogue nations, oligarchs, drug lords, and human traffickers are using digital assets to launder billions in stolen funds, evade sanctions, and finance terrorism.” If Warren has her way, cryptocurrencies will be required to follow the same rules that banks and brokers do; it could bring more legitimacy to the crypto space.
Conclusion As 2022 showed us, you need to have the stomach for 65% annual swings in your investment’s value to be even a casual crypto player. If you or someone close to you is thinking about investing in crypto don’t hesitate to reach out. We’ve helped many clients like you in similar situations.
RYAN A. DUNN, CFP®, is a Wealth Manager at Novi Wealth