Bitcoin investment is far too risky for most portfolios

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Many cryp­to enthu­si­asts believe bit­coin is “dig­i­tal gold,” an impor­tant new asset class pro­vid­ing attrac­tive expect­ed returns, a durable store of val­ue, and diversification.

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

From an all-time peak of $68,990 (U.S.) in Novem­ber, it fell to a low of $17,630 in June. It has since recov­ered a small por­tion of lost ground, trad­ing at around $21,700 last Fri­day, accord­ing to investing.com.

This poor per­for­mance comes as it was start­ing to make inroads in the main­stream invest­ing world. A few major invest­ment firms like Fideli­ty Invest­ments have start­ed to include small allo­ca­tions of bit­coin in con­ven­tion­al port­fo­lios along­side stocks and bonds. 

But in my view, bit­coin isn’t ready for aver­age investor port­fo­lios. Its recent price behav­iour shows it’s still far too risky for most aver­age investors who are typ­i­cal­ly invest­ing with their retire­ment sav­ings on the line.

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

Unteth­ered to fun­da­men­tals, it might do real­ly well, or real­ly bad­ly, 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 favourable invest­ment attrib­ut­es often asso­ci­at­ed with gold, but with impor­tant added benefits.

For one thing, its sup­ply is lim­it­ed more tight­ly than gold, with an ulti­mate cap of 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 may encour­age even more usage by each exist­ing user, as well as attract­ing addi­tion­al new users, thus poten­tial­ly dri­ving expo­nen­tial growth.

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

Bit­coin believ­ers range from young peo­ple with small sums to invest, to promi­nent tech bil­lion­aires such as Elon Musk (of Tes­la Inc.), Michael Say­lor (of MicroS­trat­e­gy Inc.), and Jack Dorsey (of Block Inc.), who use ample per­son­al and com­pa­ny 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. Pri­or to the pan­dem­ic, cor­re­la­tions between prices and major stock indices were very low, sim­i­lar to gold. That fuelled the expec­ta­tion that bit­coin would help diver­si­fy con­ven­tion­al stock and bond portfolios.

Pro­po­nents also start­ed to view bit­coin as a trust­wor­thy store of val­ue, a means of retain­ing pur­chas­ing pow­er for future use. Of course, its prices have his­tor­i­cal­ly been far more volatile than cash (the store of val­ue bench­mark), or gold (an estab­lished alter­na­tive). But it could eas­i­ly be sold if nec­es­sary and its pro­po­nents expect­ed it to enjoy strong price gains over time.

Also, sim­i­lar to gold but unlike cash, the cryptocurrency’s sup­ply is inde­pen­dent of cen­tral banks and there­fore pro­po­nents expect­ed it to pro­vide a good hedge against infla­tion. Promi­nent hold­ers like Tes­la, MicroS­trat­e­gy, and Block have accu­mu­lat­ed bil­lions of dol­lars worth of it on their bal­ance sheets.

While its prices pros­pered along­side tech stocks in the ear­ly stages of the pan­dem­ic, bit­coin start­ed declin­ing from its Novem­ber peak, with a sharp plunge in the sec­ond quar­ter of 2022.

It was part­ly dri­ven by cryp­to indus­try busi­ness fail­ures which includ­ed: cryp­to lender Cel­sius Net­work LLC; cryp­to bro­ker Voy­ager Dig­i­tal Ltd.; linked cryp­tocur­ren­cies Ter­raUSD and Luna; and hedge fund Three Arrows Cap­i­tal Ltd.

These busi­ness fail­ures sapped investor con­fi­dence in bit­coin along­side the rest of the cryp­to indus­try. In addi­tion, ram­pag­ing infla­tion, ris­ing inter­est rates, and slow­ing eco­nom­ic growth 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 unload riski­er assets, and now that includ­ed bit­coin. Some tech enter­pris­es sold the cryp­tocur­ren­cy to reduce debt and raise cash as exter­nal financ­ing dried up. Most promi­nent­ly, Tes­la sold more than $900-mil­lion U.S. worth dur­ing the sec­ond quarter.

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

In the sec­ond quar­ter, the tech-heavy NASDAQ 100 Index fell 22 per cent, while bit­coin prices dropped 58 per cent, act­ing like just anoth­er risky asset.

The cur­rent envi­ron­ment war­rants cau­tion for aver­age investors. Cen­tral banks haven’t fin­ished rais­ing rates and no one knows reli­ably how much the econ­o­my will slow.

There is a real­is­tic pos­si­bil­i­ty the econ­o­my could end up in deep reces­sion, in which case riski­er invest­ments would like­ly get ham­mered some more. Giv­en its recent price behav­iour, that sce­nario would like­ly hurt bit­coin severely.

Of course, believ­ers have seen big sell-offs before. Many view cur­rent prices as a buy­ing oppor­tu­ni­ty for those who can be patient. Even if prices drop fur­ther, there’s still a strong chance they’ll recov­er at some point and reach new heights down the road.

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

David Aston, a free­lance con­tribut­ing colum­nist for the Star, is a per­son­al finance and invest­ment jour­nal­ist. He has a Char­tered Finan­cial Ana­lyst des­ig­na­tion and is a Char­tered Pro­fes­sion­al Accoun­tant. Reach him via email: davidastonstar@gmail.com



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