Investing in bitcoin, other cryptocurrencies and NFTs
Should you invest in bitcoin, other cryptocurrencies or NFTs (Non-Fungible Tokens)? The below insight by QuietGrowth helps you to tackle many fundamental questions in your 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
What determines the "store of value" of a cryptocurrency?
For any cryptocurrency that is considered as a credible "store of value" by the market, we believe that value is its 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. We consider investing in bitcoins as speculation. We do not agree with the view that everyone should have at least a small part of their portfolio, say 2% to 5%, in bitcoin or other cryptocurrencies.
One should invest in this asset class only from the play money 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.
Inclusion of NFTs in the portfolio of an individual
We believe that you need to understand the value of the underlying objects such as art, music, photos, videos and in-game items before you consider investing in the NFT that represents any of these objects.
Inclusion of digital assets of a metaverse in the portfolio of an individual
We believe that you need to understand the dynamics and value of a metaverse and specific digital assets in that metaverse before you consider investing in those digital assets of the metaverse.
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.
Stablecoins need not be stable
We observe that the prices of many cryptocurrencies referred to as stablecoins are not necessarily stable! We believe that you need to gain considerable expertise by researching to understand the dynamics of a stablecoin so that you can assess the risk involved in investing in that coin.
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. However, we have not yet observed, in a convincing manner, that bitcoin has proven itself to be a dependable store of value as its attribute.
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.
Bitcoin is an energy guzzler
Bitcoin consumes a lot of energy. If you care for the environment and are exploring to invest in bitcoin, then you should become aware of the extent of energy consumption by bitcoin. If the price of bitcoin increases, then there is a higher incentive for bitcoin miners to consume more energy to mine more bitcoins. Also, the per-transaction energy consumption of bitcoin is high.
This drawback of bitcoin is a serious concern for us at QuietGrowth. It is one of the reasons for us not to include bitcoin in our QuietGrowth portfolios.
We base our assertion on various technical studies and observations made by multiple cryptocurrency experts, and their work is publicly available.
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.
Efficient market hypothesis and cryptocurrencies
We believe that Efficient Market Hypothesis (EMH) does not hold good for any of the cryptocurrencies, as of now. The underlying technologies of cryptocurrencies are fast evolving and esoteric. The utility of some cryptocurrencies, especially bitcoin, deriving from their positioning as a store of value is yet to pass the test of time. The utility of each of the cryptocurrencies is a bet on its "concept of the future".
Investing in cryptocurrencies using superannuation or pension
We are against the idea of investing in cryptocurrencies using the money from your superannuation or pension. Your superannuation wealth is critical to your quality of life post-retirement, and hence it is not prudent to expose your superannuation wealth to these venture bets.
Refer to our Investment Methodology page for more information.
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