Bitcoin and other cryptocurrencies are receiving intense media coverage, prompting many investors to wonder whether these new types of electronic money deserve a place in their portfolios.
Cryptocurrencies such as bitcoin emerged only in the past decade. Unlike traditional money, no paper notes or metal coins are involved. No central bank issues the currency, and no regulator or nation state stands behind it.
Instead, cryptocurrencies are a form of code made by computers and stored in a digital wallet. In the case of bitcoin, there is a finite supply of 21 million, of which more than 16 million are in circulation.
Transactions are recorded on a public ledger called blockchain. For much of the past decade, cryptocurrencies were the preserve of digital enthusiasts and people who believe the age of fiat currencies is coming to an end.
This niche appeal is reflected in their market value. For example, in late 2017 we saw a sharp increase to more than $27,000 per bitcoin, today the value has fallen to less than $12,000. At a market value of $12,000 the total value of bitcoin in circulation is less than one tenth of 1 per cent of the aggregate value of global stocks and bonds.
What are investors to make of all this media attention? What place, if any, should bitcoin play in a diversified portfolio? Recently, the value of bitcoin has risen sharply, but that is the past. What about its future value?
You can approach these questions in several ways. A good place to begin is by examining the roles that stocks, bonds, and cash play in your portfolio.
Unlike stocks or corporate bonds, it is not clear that bitcoins offer investors positive expected returns. Unlike government bonds, they don't provide clarity about future wealth. And, unlike holding cash in fiat currencies, they don't provide the means to plan for a wide range of near-term known expenditures.
Because bitcoin does not help achieve these investment goals, we believe that it does not warrant a place in a portfolio designed to meet one or more of such goals.
Future regulation adds to this uncertainty. While recent media attention has ensured bitcoin is more widely discussed today than in years past, it is still largely unused by most financial institutions. It has also been the subject of scrutiny by regulators.
For example, in a note to investors in 2014, the US Securities and Exchange Commission warned that any new investment appearing to be exciting and cutting-edge has the potential to give rise to fraud and false "guarantees" of high investment returns.
This week, a flood of complaints from customers unable to access deposits with Christchurch-based cryptocurrency exchange Cryptopia has led a law firm to look at the prospects for a class action.
Other entities around the world have issued similar warnings. It is unclear what impact future laws and regulations may have on bitcoin's future supply and demand (or even its existence).
The headwinds against bitcoin seems to be gathering strength and will make for a different environment in 2018.
We have seen only anecdotal evidence of local HB investment in bitcoin, to name but one of the hundreds of cryptocurrencies.
None of this is to deny the exciting potential of the underlying blockchain technology that enables the trading of bitcoins.
It is an open, distributed ledger that can record transactions efficiently and in a verifiable and permanent way. There are many sound opportunities for local businesses to use this technology as evidenced globally where this is gathering pace.
When it comes to designing a portfolio, a good place to begin is with one's goals.
This approach, combined with an understanding of the characteristics of each eligible security type, provides a good framework to decide which securities deserve a place in a portfolio.
When digesting the latest article on bitcoin, keep in mind that a goals-based approach based on stocks, bonds, and traditional currencies, as well as sensible and robust dimensions of expected returns, has been helping investors effectively pursue their goals for decades.
Crypto-currencies are an excluded asset class for Stewart Group along with other non-regulated and opaque assets. We don't offer investment advice on such assets. Also, as the holding of bitcoin is fraught with difficulty it falls outside the purview of financial advisers. It can't be held on one of the NZ custodial services and comingled with other assets such as stocks and bonds.
*Nick Stewart is the CEO and Authorised Financial Adviser at Stewart Financial Group. Stewart Group is a Hawke's Bay-owned and operated independent financial planning and advisory firm based in Hastings. The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed, or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any investment decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, stewartgroup.co.nz