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There hasn’t been a day in the past few months where crypto isn’t in the headlines in some shape or form; whether its Elon Musk’s random (and frankly irresponsible) tweets or its incessant volatility. “Should I invest in crypto?” has become 2021’s most popular question. And rightfully so, considering the amount of attention its been getting. But is attention really a good reason to invest into something?
The purpose of this piece isn’t to explain what a cryptocurrency is or its intended application. There’s plenty of material out there that does a fabulous job of that. The purpose is to decipher how to go about thinking before investing in it. I believe a good starting point is to understand that asset classes can broadly be divided into two of the following categories –
Performance is driven by an underlying asset – A great example of this is an equity share, the underlying asset of which is a business. It is highly improbable that a failing business’s stock makes money for an investor consistently. The price of a stock usually moves in line with earnings growth over a long enough term. Another example is real estate. The price of agricultural land will be driven by its location, soil quality, topology, etc. Though the prices of these assets may stray from the underlying’s true value temporarily, fundamentally they’ll always be driven by it.
Performance is purely driven by demand and supply – These assets are speculative by nature. Prices rise simply because the next person is willing to pay a higher price for them. Gold is a good example here; it has little industrial application apart from jewelry and prices usually rise during economic uncertainty. Collective fear and greed are largely responsible for its ups and downs.
Its fair to say that cryptocurrencies belong to the 2nd category. Although they’re intended replace the current system of centralized fiat currency, when that’ll happen (if ever at all) is anyone’s guess. As you can imagine, asking governments and central authorities to give up monetary sovereignty isn’t exactly a piece of cake. Even if they do, communities and societies must attach collective value to crypto for it to work as a real currency. In other words, we need to be able to trust it, just like we trust the dollar or rupee. Without trust, it’s just another piece of paper (remember demonetization?). Of course trust isn’t easy to come by. And how will it? Crypto-currencies are more volatile than the price of stuff you want to buy with them! It’s a vicious cycle. Imagine going to your favorite restaurant and by the time you get there, you meal costs three times as much! No wonder Tesla reversed its decision to accept Bitcoin as payment!
Cryptocurrencies at best can be seen as a store of value; an asset that provides diversification from the traditional asset classes. So if you must have it in the portfolio, it’s important to ask – what is a sensible allocation to assets that are speculative in nature? While the answer probably differs from individual to individual depending on their constraints etc., it surely can’t be too large right? How will you justify its ups and downs to yourself? At BlueFort, we find it difficult to wrap around heads around cryptocurrencies as an investment. Not because we’re certain that money can’t be made in it. But because we’re certain that there’s a far better way of consistently creating wealth a with much higher probability (and lower stress levels). Granted it might take more time, but if history has taught us anything; it is that quick money is unsustainable. Many of you may have read about the Dutch Tulipmania in the 1600s, one of the most famous asset bubbles and crashes of all time. It occurred in Holland where speculation drove the value of tulip bulbs to such extremes, that each one was trading in the vicinity of $50k-$150k in today’s terms. Goes to show that when herd mentality and liquidity are involved, anything can become a bubble, even flowers!
Whether crypto currencies are a bubble or not is anyone’s guess. However if you have invested in it, we’d recommend that you follow a core and satellite approach. Keep 80%-90% of your portfolio in traditional assets that give you consistent compounding. This makes the core. With the rest you can create satellites that hold bitcoin, paintings, or whatever you prefer. Keep rebalancing. Be smart.