Investing aspects pertaining to cryptocurrencies


A retail investor who is getting increasingly familiarised with cryptocurrencies has many questions on the investing approach to adopt for this asset class. The below insight by QuietGrowth helps in introducing various aspects to ponder as the retail investor tackles many fundamental questions in his mind.

Cryptocurrencies as an asset class

Cryptocurrencies are fast emerging as an asset class for many investors. Cryptocurrencies are now a reality in the world of investments. Irrespective of divergence in perspectives of many regarding the value of these assets, and the investing risks associated with these assets, it is now widely acknowledged that certain cryptocurrencies can be termed as assets. So, it will be inappropriate to crudely suggest to investors to ignore this asset class. It is now expected of a financial adviser and a portfolio manager, who is tasked with constructing a diversified portfolio for an individual, to attempt to understand this asset class in a proper manner.

Pricing of cryptocurrencies

We believe that the value of every cryptocurrency is the price, irrespective of the volatility of that price. The price that is decided by the market for that asset. It is not appropriate to assert that the inherent value of all cryptocurrencies is zero, and to draw a conclusion that they are not assets with a value. The inherent value of any cryptocurrency, though each of them is not backed by any tangible asset or a promise by a credible institution, is the trust and belief placed in it by its distributed investors.

Even assets that do not generate income, at present or in future, on their own, can be perceived to be valuable. After all, the market-determined pricing, at any point of time, is a function of demand and supply. Whether the current pricing of various cryptocurrencies is speculative or not, can be just a subjective opinion of someone. That said, it is believed that the prices of a certain cryptocurrencies have been manipulated or have been subject to intense speculation.

Inclusion of cryptocurrencies in the portfolio of an individual

We opine that it is too early in the evolution of this space, to make prudent suggestions on which cryptocurrency to invest in, how much risk to assign to such an investment, and how much proportion of an individual's portfolio should be allotted to this asset class. In short, we believe that it is not possible to derive optimised long-term risk-return derivations for any asset in this asset class. We believe that, as of now, investing in cryptocurrencies is a venture bet, and one should invest in this asset class only from the optional 'discretionary fund' that one might have set aside. Someone should not invest in this asset class if she is not comfortable with the realistic possibility of losing all her investment in it.

For clarification, we refer to the 'discretionary fund’ as part of your personal savings and it can be of a size that you are comfortable with, if you have the financial strength and appetite to easily withstand the loss of that entire amount in the worst-case scenario. The amount in this discretionary fund can go towards investing in risky opportunities in which you personally believe and understand, such as a specific stock, a personal loan for a relatively-higher interest to a friend, or a business venture of your friend.

Usage of existing research to assess cryptocurrencies

The existing research material is not adequate to assess the future influence and relevance of various cryptocurrencies. We opine that prior research of the emergence of new asset classes cannot be applied to the cryptocurrency asset class, because many of the fundamental characteristics of the cryptocurrency asset class are unique because of the power of the underlying technologies. Many new use cases are getting discovered as the underlying technology itself is evolving at a quick pace.

For example, we think that Efficient Market Hypothesis does not hold good for the market value of cryptocurrencies, as of now. This is because the underlying technologies of cryptocurrencies are new, fast evolving, complex and esoteric. No detailed investment research material is available to sizable section of the investors. This translates that an investment bet on this asset class is a bet on the concept of future, and that it is a venture bet.

Emergence of new cryptocurrencies

There are many cryptocurrencies, and each of them have their own characteristics such as the underlying technology, utility, efficacy, trustfulness and acceptability/adoption. The prominent examples now are bitcoin, ethereum and ripple. Many new improved cryptocurrencies will be created, and some of them might have completely innovative underlying technologies, resulting in them replacing the existing, prominent cryptocurrencies.

We believe in looking out constantly for new alternatives to the existing cryptocurrencies, because at any point of time, the value of the investor’s exposure to a particular cryptocurrency can be severely eroded with the emergence of a better alternative. This is a reason asset managers and hedge-fund managers who focus completely on investing in cryptocurrencies will emerge. A retail investor can avail the services of a financial adviser who in turn will depend on these asset managers and hedge-fund managers. This is because a retail investor might not be having the time nor the skill to perform this task.

Utility of cryptocurrencies

We respect the viewpoint that the cryptocurrency asset class can be your backup-wealth that cannot be destroyed by a war or societal chaos, nor can be appropriated or de-recognised by a Government or an authoritative institution. An exposure to certain cryptocurrencies can be your ticket to avoid financial dead-end when any unexpected disaster happens to you or to the society that you live in.

There is a possibility that all it takes is a major, difficult, damaging, long war involving a developed nation, and then certain cryptocurrencies will be more widely used for storing part of assets, as people would become a warier of the fiat money they own.

Investors should recognize the possibility that the price of any cryptocurrency can suddenly decrease substantially for reasons that almost anyone might not be able to decipher. There are far too many moving parts at play, and most probably everyone, have not understood most of these moving parts at play, in order to identify the exact reason for any fall in the price of that asset. Hence, the primary reason for investing in a cryptocurrency should not be the prospect of any price appreciation. Rather, for a retail investor, if there is a reason to invest in this asset class, then it is to attempt to have a backup-wealth at an unfortunate moment in the lifetime of the investor.

Investing in a basket of cryptocurrencies

Investing in a broad collection of cryptocurrencies is one of the approaches to gain exposure to this asset class. However, it should be noted that each of the cryptocurrencies can be fundamentally different and might have an entirely different future trajectory. Some cryptocurrencies can be shams, the underlying technologies can be obsolete or ineffective, the teams behind them can be ineffective, or the communities around them can lack vibrancy. Only a domain expert can state with a higher probability of certitude whether a cryptocurrency can act as a store of value of part of the investor’s wealth for few years. So, it is prudent to understand the characteristics, to a large extent, of every single cryptocurrency before taking an exposure in that specific cryptocurrency.

Holding cryptocurrencies for the long term

There is no guarantee that holding a specific cryptocurrency or a diversified basket of cryptocurrencies for many years would result in price appreciation. If an investor still holds cryptocurrencies for a long term with an expectation of price appreciation, while ignoring the daily price volatility throughout, then it is still a venture bet on the manner the investor visualizes how our societies transform into.