Unless you have been living under a rock for the last few years, you have heard about the most recent craze to make money, cryptocurrency. Now there are tons of people talking about cryptocurrency, and like everything in life, be careful on whose advice you take. There are just starting to be a number of prosecutions of insider trading in the crypto space, and my guess is we’re going to see a lot more in the months ahead. With something so new and so hyped, it’s sad but not surprising that there are people out there lying or trying to scam others.
While acknowledging that there are many bad faith actors who support crypto, there are honest, decent, smart people who really do believe in cryptocurrency, the blockchain technology it brings, and think it’s smart to invest in this new technology.
One of the “good guys” in the financial services industry is Ric Edelman, the co-founder of Edelman Financial Engines, a firm that has billions in assets and serves thousands of clients. It’s a huge company that he started with his wife, and recently he moved on to focus his time and attention on educating advisors about crypto.
Now Ric thinks that you should incorporate crypto into your overall portfolio. So what I want to do is explain Ric’s strategy, define crypto and the blockchain, and then move on to some thoughts that I have about this strategy.
Ric’s advice on crypto is pretty straight forward. He says if you’re going to have a 60/40 portfolio, with 60% stocks and 40% bonds, he thinks you should instead consider 59% in stocks, 40% in bonds, and 1% in crypto. So instead of a 60/40 portfolio, a 59/40/1 portfolio.
Now it should be said, no one is advocating putting 10% or 20%, or 100% of your money in crypto. That’s crazy, please don’t do that.
Before we get into why Ric (and others) think you should put 1% of your investments into crypto, first I want to make sure we understand….What are cryptocurrencies and blockchain?
A crypto currency is a digital currency, that is able to be exchanged virtually, and isn’t issued by any central authority, like the government. The technology that allows these exchanges is something called the blockchain, which is a database that stores information and transactions.
To add some much needed context, the people who created Bitcoin (the most popular cryptocurrency) were extremely skeptical of government, and they had a major libertarian leaning. They were worried that the government didn’t respect people’s privacy, that they restrict people’s access to their own money, and that the government continually prints too much money thus devaluing their own form of currency, fiat money. So that’s where the inception of this movement came from, and if you want a really interesting book on the subject, check out “Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent Money”. I’m about halfway through and it’s well written and well researched.
With that context in mind, why does Ric recommend 1% in crypto? Let’s examine Ric’s rationale, as well as my own thoughts on each point.
First, Ric says that it’s not a valuation, it’s supply and demand. So there’s no inherent value. And people like Warren Buffett need to wrap their heads around the fact that you can’t put a valuation on Bitcoin the same way you can do with Apple, and the free cash flow that it generates from the MacBook Air that I’m typing on, or the iPhone right next to me, or the iPod that I have in my bedroom. So Ric says these are two completely different assets, and you simply can’t view them the same way.
While it’s undoubtedly true that you can’t measure Bitcoin in that way, that doesn’t make it any better of an investment in my mind. If I accept that Bitcoin, in and of itself, won’t do anything for me, then if I were to buy it, all I’m doing is buying it with the hopes that someone else will come along in the future and decide to pay a higher price. This is known as the Greater Fools theory. It’s the idea that prices will go up because people are able to sell to a “greater fool” regardless of the value or worth of the asset that you bought.
Now I should point out that there is an inherent scarcity to Bitcoin, in that only 21M of them are made, and there won’t be more made in the future. As we all know from psychology, when a product is scarce, it creates more buying interest. And that’s clearly in play with Bitcoin.
Even with the scarcity, though, when you buy Bitcoin, you aren’t going to be able to say if it’s overvalued or undervalued, because there’s no way to value it. So you simply will be wagering that someone in the future will pay more for it.
Second, that’s not the only reason why Ric is bullish on crypto. He thinks that there is real utility in this blockchain technology, and he has said that it’s the internet of sending money. In other words, do you remember the early days of the internet? And how Ebay, AOL, and Amazon were changing our lives? Ric thinks that’s what we’re experiencing with sending money, and the Blockchain technology is a key driver of this.
But don’t we already have PayPal, Venmo, Cashapp and Zelle to send money? And don’t all of those allow us to do it without a payment when we send money to friends and family? So sure, the Blockchain technology is interesting, but in terms of sending money, I already have a much easier to use, safer, and best of all, free way to do this.
Third, Ric says that crypto is a uncorrelated assets. In other words, it does not move in the same direction as stocks. In a well diversified portfolio, you typically don’t want everything moving at the same speed in the same direction. So having an uncorrelated asset is a good thing. However, as Ric acknowledged, so far in 2022, cryptocurrencies have trended right in line with technology growth stocks, which is the sector in the stock market that has been hit hardest so far this year.
So while cryptocurrency may have been uncorrelated in previous years, so far in 2022 it has been highly correlated with tech stocks, and the market overall. It also has never experienced a prolonged bear market, which frankly will be interesting to see if the correlation keeps up. If the correlation does keep up, and crypto goes in lock step with tech growth stocks, then frankly that’s not good for the bullish case for crypto.
The fourth reason to buy crypto is that it’s an inflation hedge. Or at least, that’s what people said in the past. But in the last 12 months with inflation rising rapidly, bitcoin and cryptos in general have fallen dramatically. Just like crypto being an uncorrelated asset, this rationale for crypto bullishness simply isn’t holding up.
Fifth, it’s an option for rebalancing your portfolio (since it’s not a correlated asset) and for tax loss harvesting, when appropriate. Now this one may actually be true! As of this writing, Bitcoin is down around 44% in the last year, and 58% year to date. So yes, if you had Bitcoin and you sold it, you could write off those losses on your taxes. While that is true, I certainly wouldn’t recommend you invest in something for the purpose of writing off a loss on your taxes. Now to be clear, in 2022 basically everything (minus energy) is down, so I’m not knocking Bitcoin simply because it’s down. My point is that being able to write off a loss on your taxes isn’t a good reason to buy Bitcoin, or anything else.
Alright folks, so there are five reasons why Ric thinks you should have 1% of your investments in crypto currency. As you can probably tell, I am not keen on that idea.
It’s not an investment that produces any type of service or product, like we see with Apple, Walmart, Home Depot, etc. It’s real world utility is quite small, especially in a place like the United States. Sure, there are people in other countries who don’t have the economic and political stability that we have, so many they need to get paid in more discreet ways that the governments can’t seize. But here in the US, unless you are blackmailing someone, or laundering money, or holding someone for random, I don’t see any utility.
However, if you could get crypto to be a stable store of value, something there the price didn’t fall 58% in a year, but the value stayed relatively stable and you used this to buy goods, I’d be much more bullish on this. And maybe it’ll go there in the future, but that’s not what it is right now.
Now that doesn’t mean that the price won’t go up! It certainly could. There’s a lot of crypto evangelists out there. But it could also go to zero, especially when we consider that the majority of crypto holders bought their first coins in 2021, and they are all holding their positions at a loss, if they haven’t sold their positions already. And if they’ve experienced a 40 to 50 to 70% decline in their crypto, what do you think are the odds that they’ll come back for more? My guess is that they’ll feel foolish for falling for it, and move on with their investing lives without going back to the crypto world.
So should you put 1% of your investments into crypto? Well, that’s your call, but I definitely won’t. Thanks for reading and talk to you next time!