Bitcoin remains the world’s largest digital currency by market capitalization and reached an all-time high of $63,558 in April. The second-largest digital asset by market cap is Ethereum. When Bitcoin fell below $50,000 on April 23, it also dragged down prices for Ethereum and other digital coins, resulting in a $200 billion loss in value of the cryptocurrency market in one day.
The lack of regulation and continued volatility makes investing in virtual assets risky, which is why the majority of institutional investors – such as hedge funds, pension funds and retirement companies – are reluctant to put money into them.
Bitcoin Can Help Diversify Your Portfolio
Some investors have turned to Bitcoin because its correlation to returns in the stock market remains low, says Jodie Gunzberg, chief institutional investment strategist at Morgan Stanley Wealth Management. “Bitcoin may provide diversification to a portfolio as it has had nearly zero three-year correlations with other assets, which is important given the rising and positive correlations that many asset classes have shown with mega-cap tech stocks,” she says. “A small allocation to Bitcoin in a traditional portfolio may improve returns and risk-adjusted returns without significantly increasing volatility or maximum drawdowns.”
There is a growing number of pension funds along with foundations and endowments that have added Bitcoin over the past two years to their portfolios, including the largest asset manager BlackRock and Massachusetts Mutual Life Insurance Co. Two pension funds in Fairfax, Virginia – the Fairfax County Employees’ Retirement System and Fairfax County Police Officers Retirement System – made their initial investments in blockchain technology and Bitcoin through investments in two Morgan Creek Digital funds in 2018 and 2019.
Various family offices, pension and hedge funds, asset managers, endowments and foundations hold Bitcoin through Boston-based Fidelity Digital Assets.
Retail investors should limit their holdings in Bitcoin to 1% to 3% of their portfolio since it could “lose a lot of its value in a short amount of time,” says Alex Chalekian, CEO of Lake Avenue Financial in Pasadena, California.
“One of the biggest reasons for adding Bitcoin to a portfolio is having exposure to a cryptocurrency which can be a non-correlated asset to the existing stocks and bonds in a traditional account,” he says.
Risks in Owning Cryptocurrencies
Investors can only speculate on the future price of Bitcoin since it has no intrinsic value, says Robert Johnson, a finance professor at Creighton University.
“I can think of absolutely no pros to adding BTC to a portfolio,” he says. “One cannot invest in BTC. Unlike a stock or a bond, it promises no cash flows to the holder. This is the biggest bubble I have witnessed.”
Billions of dollars of market cap have been lost in the cryptocurrency market due to ongoing massive volatility and hacking since it was launched in January 2009 in the aftermath of the Great Recession.
Investors need to view Bitcoin as a “very good vehicle for someone who is truly a speculator – either a bull or a bear,” Johnson says. BTC could rise exponentially in value before it collapses again.
“I have no idea when the bubble is going to pop and how far BTC will rise before the bubble pops, but I am convinced it will,” he says.
Bank of America echoes a similar sentiment. In a March 17 analyst report, the bank says there’s “no good reason to own BTC unless you see prices going up. It is not tied to inflation and remains exceptionally volatile, making it impractical as a store of wealth or payments mechanism.” The bank adds that the main argument for holding it is “sheer price appreciation.”
Hacking by cybercriminals into cryptocurrency accounts continues to rise since the act can be highly profitable. Tracking footprints is nearly impossible since their handiwork is eliminated digitally, and investors lack a legal recourse since the virtual assets are not regulated by a central bank or government.
“Tools have evolved to directly steal money from crypto wallets, and the criminals are brazen in their claims and advertisements on the dark web,” says Chris Morales, chief information security officer at Netenrich, a San Jose, California-based provider of information technology, cloud and cybersecurity operations and services.
“Anyone can do it,” he says. “With the dramatic hike in prices of all crypto, it is a good way to get rich compared to ransomware that is noisy.”
Hackers are also targeting the cryptocurrency exchanges, or the exchanges themselves are scams in the first place, Morales says. “With no regulation, crypto is, and will continue to be, the Wild West of the internet.”
How to Invest in Bitcoin
Some investors prefer to own Bitcoin directly, while others invest in blockchain funds.
“As of now, the best way to invest in Bitcoin is to own it directly,” Chalekian says. “There are a number of good platforms that allow you to purchase BTC.”
Digital payments companies like PayPal Holdings (ticker: PYPL) and a handful of brokerage companies such as Robinhood and Webull have entered the retail market and allow investors to buy Bitcoin, Ethereum, Litecoin and Bitcoin Cash.
Family offices and higher net worth investors might opt to invest in registered fund products as a starting point, Gunzberg says.
Investors should store their digital assets in a physical or offline wallet to avoid being hacked, or use cryptocurrency wallets, exchanges, brokerages and mobile apps that are reputable, says Austin Merritt, cyber threat intelligence analyst at Digital Shadows, a San Francisco-based provider of digital risk protection solutions.
Some investors see adding Bitcoin to a portfolio as similar to owning gold and operating as a “safe haven” when the value of currencies declines, Gunzberg says. Others view it as a new asset class that is not correlated to equities, while some investors treat it as a currency or commodity.
Investing in Bitcoin can be challenging because of the large fluctuations in its price. The volatility of Bitcoin is at least triple that of stocks, and 20% moves are common with four drops greater than 80% since 2011 and 16 drops greater than 30%, Gunzberg says.
“Bitcoin is still in its infancy so the reliability of information, data and how it is valued can be challenging,” she says.