The Crippling of Crypto
Is crypto currency (crypto) a chimera or a true investment? Per Merriam-Webster’s dictionary, one definition of a “chimera” is “an illusion or fabrication of the mind, especially: an unrealizable dream.” Webster also defines investment as “the outlay of money usually for income or profit.” Crypto may be both a chimera and an investment. But how wise an investment is crypto?
Crypto is not traditional money which is issued by a national government or central bank, for example, the American dollar. You can carry physical denominations of U.S. dollar currency or fractional coins in your wallet or coin purse. Crypto currency resides in cyberspace. It exists digitally or virtually and is not issued by government entities. The two leading forms of crypto currency measured by market capitalization are bitcoin and ethereum. Bitcoin, the first crypto creation, is the most well-known. Crypto does not pay interest or dividends. But like a traditional investment, you buy it with hope that ultimately you’ll be able to sell it for a profit.
Like some things new and unregulated, crypto has been hyped in a manner that would make the “wild, wild west” seem relatively tame. The 1881 gunfight at the O.K. Corral in
Per The Wall Street Journal, FTX, a leading crypto exchange, had $16 billion in funds that customers had placed with the firm for trading purposes. Without the knowledge of investors, FTX lent roughly $8 billion of that to an affiliated firm,
As a financial advisor with a penchant for eschewing speculators as clients in favor of working with true investors who seek long-term growth of capital while understanding the dynamics of risk, reward, and diversification as a risk management tool, bitcoin and other digital assets hold little appeal. It’s true that bitcoin soared to an all-time high of over $68,000 for a single coin in November, 2021, after starting the year at just under $30,000. That kicked off a buying frenzy as even small investors seeking quick returns flooded in. This situation was akin to the recent “meme stock mania” involving names like GameStop, Bed Bath and Beyond, and AMC, whose prices were driven to unrealistic heights by armies of speculators who grouped together on social media platforms. Speculative fever didn’t go well for most who jumped aboard late in either game.
The Journal noted that prior to the FTX debacle, crypto markets lost roughly $2 trillion in market value over the last year. On November 13, 2022, one bitcoin traded at $16,546, facing pressures from rising interest rates as the “Federal Reserve has removed liquidity and markets re-priced financial assets.” So much for crypto “inflation hedge” theories. But the siren song of “quick riches” still lives on the internet. Trading platform Robinhood urges, “There’s no need to buy a whole coin─start with as little as $1.” You may buy crypto with a debit card or credit card. Using borrowed money to speculate is overly risky and aggressive.
Firms like FTX are not governed relative to the safety of client assets like well-known independent custodians such as Pershing, Fidelity, Schwab, T.D. Ameritrade, etc. For example, Pershing, a division of Bank of New York/Mellon, protects securities in a customer’s account up to $500,000 through Securities Investor Protection Corporation (SIPC). Plus Pershing carries extensive added insurance on client assets through underwriters such as Lloyds of London. Custodians such as those noted and others offer SIPC protection and excess coverage similar to Pershing. Note that insurance does not protect you from the rise and fall in the value of securities due to market volatility. Protection only guards against insolvency or the bankruptcy of the custodian entity. Such safeguards do not exist in cryptoworld.
Independent financial advisors should use independent custodians to house client cash and assets and execute trades. Make sure that account statements come from recognized custodians, not from the advisor directly. Some of the greatest frauds, Madoff included, came from fake statements generated in-house by the fraudster. Understand what safeguards are in place.
Long-term investment strategies involve diversification. With inflation concerns paramount, “loanership,” a portfolio of cash and bonds, is less likely to provide real long-term returns in excess of inflation and taxation. Nevertheless, such asset classes are germane to liquidity needs and wealth preservation efforts during turbulent periods. Cash is a source of bargain hunting capital when opportunities arise.
For value-oriented conservative investors, a long-run growth-oriented portfolio should encompass equities and real assets with the potential to generate interest, dividends, and/or growth, i.e., “real returns in excess of inflation and taxation over time. “Ownership” of growing companies and assets such as dividend paying real estate or other alternative investments form the core of long-term wealth-building and wealth-preservation strategies. Because any individual asset or asset class can underperform expectations at any given time, diversification counts.
Crypto as a prudent investment? The jury is still out.
All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost. Asset allocation is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.