If you accept – as I do – that blockchain is an important and transformative technological development, then it makes sense for investors to ask if they should get exposure to this through owning cryptocurrency.
You don’t have to be a crypto maximalist to take this position. For all the sceptics and initiates: regardless of the value of the tech, crypto as a trading asset is here to stay. There is too much volume, value and usefulness for cryptocurrency in world markets for it to go away (despite arguably the recent best efforts of the SEC in the USA who continue to base their approach on a court ruling from 1946).
But don’t take my word for it: For some good background reading to understand the macro tailwinds for blockchain technology, refer to both The Network State by Balaji Srinivasan and the amazingly prescient The Sovereign Individual by James Davidson and William Rees-Mogg. At the very least, you will get an insight into some of the broader societal changes that support this technology.
However, I am not talking to the traders here – I am looking at the role, if any, crypto should play for investors. That is, those that build and invest wealth through classic Modern Portfolio Theory portfolios. Those folk who remember that diversification is the only free lunch the market offers.
It’s in this area that there is some fascinating research. Analysts have shown that adding cryptocurrencies to a portfolio has the effect of both increasing returns and decreasing volatility. Interestingly, this effect plays out whether it is a conservative or aggressive portfolio.
How Much Cryptocurrency Should You Have in Your Portfolio?
Cryptocurrency in portfolios is like salt in cooking – too little and you still have a healthy, if not somewhat bland, meal – but too much and it can become inedible. Many articles you will find quote experts that settle on a figure of 5%, but this seems to me like a compromise with little science behind it (which is ok, just be honest about it).
Andrianto (2017) suggests that an optimum allocation of crypto should be between 5% and 20% depending on your risk tolerance. Other studies suggest even broader ranges, but these are very academic in nature and assume certain technical aspects of portfolio constructions that rarely translate into the real world (see the Geek Corner for more detail).
In my experience, unless you are living and breathing crypto as a trader, even the most aggressive investor (remember, investor, not trader) 20% is a level that will cause you to miss sleep at night no matter how much you embrace volatility. Balancing this research with my own experience, I believe a range of between 1% and 5% of your total investable wealth is a more appropriate starting point.
Like other assets, depending on the quantum, your investment can be dollar-cost averaged into the market. In most situations, these investments should be seen as very long-term exposure to future technology trends. Of course, in future rebalancing, they can either be topped-up or profit taken depending on the performance within the time frame being reviewed.
Cryptocurrency in portfolios is like salt in cooking - too little and you still have a healthy, if not somewhat bland, meal - but too much and it can become inedible.
What Should I Buy?
The specific crypto purchases need to be determined by your adviser. But, just like the good old days in Australia when a diversified portfolio was BHP, Rio and the 4 banks; it is hard to go past Bitcoin and Ether:
- Their combined market capitalisation is nearly 3 times larger than the next ten cryptos combined
- They are the most liquid
- Continued technological advancements for both blockchains should act as a tailwind to their acceptance
Alternatively, look at what crypto ETFs are available in your jurisdiction (if any). These make life much easier but you need to keep an eye on the management fees.
As some final steps, consider what strategies, like ‘staking’ or liquidity pools, you may adopt to enhance your yield and also understand how your particular jurisdiction treats crypto from a tax perspective.
It’s true – the world of cryptocurrency can be both confusing and intimidating when first approached. The combination of jargon, technological minutiae and poor user interface can make it very easy to put in the ‘too-hard’ basket.
Don’t let these factors dissuade you. Do your research, talk to your adviser, and make a decision that is best for your own situation, having regard to your cash flow and need for future access to equity.
Like to know more about how I work with my international investor clients to achieve their goals? Contact me and tell me your story!
For all the academics in the room, here’s some further reading on some of the research mentioned in this blog:
Should Investors include Bitcoin in their portfolio? A Portfolio theory approach. A very interesting summary of a 2020 paper.
The Value of Bitcoin in Enhancing the Efficiency of an Investor’s Portfolio – looks only at BTC but also includes some helpful background for new investors.
Investing with cryptocurrencies – evaluating the potential of portfolio allocation strategies A paper from 2018
The Effect of Cryptocurrency on Investment Portfolio Effectiveness Andrianto and Diputra’s paper referred to above. It is also back in the distant past of 2018, an eon in crypto terms but interesting reading.