Should you invest in cryptocurrency?

Do you know what you're investing in?

Bitcoin is just one of many cryptocurrencies, with new ones popping up on a seemingly daily basis. These ‘currencies’ don’t yet have the stability that many would associate with an asset to be used as a medium of exchange. Their highly volatile nature is persisting and is largely driven by speculation; fuelled by waves of media attention, reported uses, company endorsements, political attention and the occasional celebrity tweet.

Similarities to the dot-com bubble of the late 1990s cannot be ignored. FOMO (fear of missing out) in the early days of the internet led the Nasdaq stock index to rise by over 400% from the start of 1995 to March 2000, only to fall by 78% in the subsequent two years (October 2002), losing all the value gained alongside many companies ceasing to exist. 

We've already seen a large number of cryptocurrencies fail and the correlation that many have with each other is further evidence that it's still a largely speculative market with the differences between some of them and their chances of long term, widespread adoption not seeming to feed through to valuations. This, along with the technical complexities of the blockchain technology that underpins cryptocurrencies, may point to a more fundamental fact. Some retail investors getting caught up in the hype of cryptocurrencies may be falling foul of the old adage, often attributed to Warren Buffet in relation to investing in businesses - that you shouldn’t invest in something that you don’t understand.

The myths and the regulation

While there's generally a certain level of anonymity to transactions in cryptocurrencies and even reports of nations using them to avoid international sanctions, it is wrong to then assume that they are a method to evade scrutiny and avoid taxation. In the UK, platforms share data with HMRC and gains are subject to capital gains tax. In the US, the President’s plan to almost double the rate of tax on investment gains resulted in the recent sharp falls in cryptocurrency valuations.

The way in which governments and central banks try to implement regulations has been, and will continue to be, a challenge. Many have taken the ‘if you can’t beat them, join them’ approach with 36 central banks across the world now developing their own digital currencies. This includes the Bank of England who, with the Treasury, are exploring the possibility of a Central Bank Digital Currency (CBDC). These digital currencies may speed up payments and improve security but they lack some of the fundamentals that make cryptocurrencies so appealing to their advocates such as decentralisation and the perception that they are free from the manipulation of governments or other institutions.

Are cryptocurrencies here to stay?

Despite being almost 13 years since cryptocurrencies first came to light, it's still very early days. In our view, a number of challenges remain before cryptocurrencies become mainstream. Among other factors, achieving price stability is critical. The supply of cryptocurrencies is potentially key to this, having supply adjustable based on price via some metric like a traditional currency would seem logical, however, this goes against the original concept of decentralisation and no linkage to monetary policy. It's impossible to predict how long it will take for some cryptocurrencies to evolve into stable alternatives to traditional currencies.

There are of course other challenges that may inhibit their success that range from the lack of understanding of the complex technology, future regulatory impact to the sustainability of ‘mining’ cryptocurrencies. The mining of some (but not all) cryptocurrencies is resource intensive with almost 1% of the world’s energy consumption currently being used to mine cryptocurrencies. As consumers become increasingly aware of the impact of their spending and demands on the planet, it's unlikely that this will continue to be acceptable. This is highlighted as we write with Tesla’s announcement that they will no longer accept Bitcoin as a method of payment only months after permitting this, citing their concerns of the environmental impact of Bitcoin mining and transactions, resulting in an almost instantaneous 10% drop in Bitcoin price.

Do they have a place in portfolios?

Like any currency exposure, if and when cryptocurrencies values start to behave and are more widely used like traditional currencies, they may well have a purpose for some as part of a diversified portfolio.

It would take a brave person to bet against the increased use of blockchain technology over their lifetime. However, on the cryptocurrency side, while we watch markets develop with interest, at the current point in the market we view Bitcoin and other cryptocurrencies as speculation rather than a long-term investment.

These views are seemingly mirrored by the FCA, deeming cryptocurrencies to be ill-suited to retail consumers, citing many of the issues highlighted above as a reason to ban the sale, marketing and distribution of any derivative referencing cryptoassets in the UK. 

Our reason to include an alternative ‘asset’ like this within a well-diversified portfolio would normally be to achieve either inflation protection, negative correlation or reduced downside risk. Unfortunately, Bitcoin has demonstrated none of these attributes to date. This, along with the unregulated nature of the asset, means we will remain on the sideline for now when considering how to produce well-diversified returns for our clients.

You might also be interested in: Cryptocurrency. The need to knows.

If you would like to speak to one of our investment specialists, please contact Matthew Hodge or Seth Dowley in Buzzacott’s Financial Planning team. Alternatively, fill out the form below and we'll be in touch shortly.