I have a confession to make. I’ve been a longtime skeptic of cryptocurrencies, Bitcoin in particular. I had no idea what it was, and I did not want to be bothered to dig deeper. I told myself that I would follow Warren Buffett’s approach – I will not invest in what I don’t understand.
But lately, I have realized that Bitcoin and blockchain technology it’s built on is part of a more significant disruptive trend. It is not going away. And we all need to pay attention.
Do I think that a +$1 trillion asset is speculatively inflated? Possibly. But I will no longer ignore it. In fact, I bought some Bitcoin this week…for the first time.
If you’re wondering what Bitcoin is and if you should own it, you’re not alone. Keep reading to learn why adding Bitcoin allocation to your portfolio might make sense and what are the risks of investing in crypto.
What is Bitcoin
Bitcoin is a digital currency that is “mined” from a digital storage depot and pumped into circulation through a decentralized computer network called “blockchain.” Hard to grasp, I know.
Bitcoin is a technology, a currency, an inflation hedge, a noncorrelated asset, an environmental threat, and the North Star of a new crypto universe that will probably change our lives far more than we can ever imagine.
Arguments in favor of investing in Bitcoin
Digital assets are rapidly entering the mainstream
Investors who jumped on a Bitcoin bandwagon early on see it as a bet on an emerging technology that will transform the way we pay for things and transfer money internationally. Think of it as buying a startup Visa or PayPal.
The World Bank, for example, points out that the strong demand for cryptocurrencies is fueled by several long-term trends, such as investors’ search for yield, demographic shifts, and new technology.
The main feature of Bitcoin is its decentralization. No person or authority controls the blockchain. Transactions are recorded only after all computer nodes, operating independently, prove their validity—enhancing security over ledgers overseen by humans.
Bitcoin is not controlled by any government or central bank. This point is getting more weight now because the U.S. government is printing trillions of dollars to stimulate the economy.
How do you protect your money from being devalued by the policy of the central bank? Some investors think that owning an independent currency such as Bitcoin is the answer.
Bitcoin’s scarcity is a crucial driver for its growth. According to the system’s design, the global supply can never exceed 21 million Bitcoins. About 18.6 million (89%) Bitcoins have been mined so far. Going forward, the number of new Bitcoins issued is supposed to decrease by 50% every four years. That will get us to the total capacity by 2140.
In contrast, Ethereum – another cryptocurrency – does not have a limit on how many coins can be created. Lack of cap on supply makes it hard to view Ethereum as a tool for storing value.
Some investors view Bitcoin as “digital gold” – an alternative asset for storing value that provides a better hedge against inflation than gold.
According to J.P. Morgan, one could value Bitcoin in relation to the total gold held by the private sector, which is about $2.5 trillion. In that case, the bank argues, Bitcoin should be priced at $146,000.
Uncorrelated asset class
How do you value Bitcoin? Without cash flows or other fundamentals to determine value, it’s hard to pinpoint an intrinsic value of this asset.
Many investors think that the price of Bitcoin is not correlated to the prices of stocks, bonds, or commodities. In other words, the price of Bitcoin is not affected by the moves in stocks, bonds, or commodities.
This feature makes Bitcoin a great asset to add to a portfolio’s allocation to increase diversification and reduce overall risk.
I am not sure that I fully support this view. Time will tell. To me, the market has two modes – risk-on or risk-off. When the risk is on, stocks and crypto should do well; when the risk is off, stocks and crypto should sell off, and bonds and commodities should do well.
Obstacles and risks of investing in Bitcoin
Mining Bitcoin is a potential environmental disaster. The global Bitcoin network emits 60 million tons of carbon dioxide every year. That’s equivalent to countries like Greece!
Bank of America estimates that if the price of Bitcoin were to reach $1 million, Bitcoin would become the world’s fifth-largest carbon emitter, passing Japan!
BofA also projects that every $1 billion of inflow into Bitcoin is equivalent to putting additional 1.2 million cars on the road. And I’m not talking about Teslas.
On top of that, Bitcoin’s annual energy consumption has double over the past year to 135 terawatt-hours. Countries like Sweden or Ukraine consume less electricity than that!
When global warming is a real threat and investors, businesses, and consumers try to make environmentally conscious decisions, I struggle with the idea of investing in the asset that destroys our planet.
Some analysts argue that a lot of Bitcoin is mined using clean energy such as wind and solar. But this data is hard to verify because most of the mining (65%) happens in China.
Bitcoin is a very volatile investment. Be ready for it. Swings of 10% to 20% in a matter of a week are hardly uncommon.
One way to take advantage of volatility is to rebalance more often. However, taxes and fees are going to add up if you trade frequently.
Bitcoin’s high volatility is one of the reasons why many financial advisors suggest allocating not more than 1%-3% of your assets to this asset.
IRS classifies Bitcoin as property and not currency. So, selling Bitcoin is a taxable event. Keep that in mind when rebalancing your portfolio or when paying for something with Bitcoin.
Government policy risk
Throughout history, governments have consistently squashed anything that poses a risk to their currencies and monetary policies.
Bitcoin is a threat to the U.S. dollar, not to mention that it could be used for all sorts of illegal activities because it’s very tough to monitor.
China, for example, has already cracked down on Bitcoin. The same might happen in other countries, so there is a significant regulatory risk in investing in Bitcoin.
Even though Bitcoin is a $1.2 trillion-dollar asset, it acts more like an illiquid stock than a liquid blue-chip company. Most of the Bitcoin is owned by long-term holders who don’t trade it; therefore, the price of a Bitcoin might be affected by large purchases.
Growing adoption by corporate America
Corporate America and most prominent financial institutions are warming up to the idea of using Bitcoin.
Tesla bought $1.5 bn of Bitcoin for its Treasury, so did MassMutual. Hedge fund icons Stanley Druckenmiller and Paul Tudor Jones revealed they have allocations to Bitcoin.
Fidelity and Morgan Stanley have recently made Bitcoin funds available to certain wealth management clients.
Bank of New York Mellon said it would soon offer custody of Bitcoin and other crypto-assets for its clients.
PayPal offers a digital wallet where one could use Bitcoin to pay for purchases.
Bitcoin debit cards are coming from Visa and Coinbase Global.
Fidelity and VanEck are trying to convince the regulators to approve a Bitcoin-based exchange-traded fund.
In total, more than two dozen publicly traded companies have some type of cryptocurrency on their balance sheets, according to Barron’s.
However, the adoption of Bitcoin by professional investors remains slow. Only about 9% of financial advisors have any allocation to crypto in their clients’ portfolio due to the risks and uncertainties related to it.
How to Invest in Bitcoin
If you are ready to dip your toes into Bitcoin, I suggest you start small and proceed with caution.
Due to Bitcoin’s volatility, an asset allocation of 1%-3% is appropriate for many investors. That way you still have upside potential, but your downside is limited.
For example, I put 1% of my money in Bitcoin, and I am okay with sustaining possible losses on this position because it won’t ruin me.
My preferred method of investing is through low-cost index funds, but a pure Bitcoin play like that does not exist yet.
So, how can you invest in Bitcoin?
First, take a look at Grayscale Bitcoin Trust (ticker: GBTC). It is the largest Bitcoin fund ($45bn in assets under management). It was created in 2013, so there is some trading history. GBTC is the most popular option. The expense ratio is whooping 2%, though. Share of BGTC are traded on the exchange and can be easily purchased through your brokerage account.
Second, if you want exposure to several cryptocurrencies, not just Bitcoin, then do your research on Bitwise 10 Crypto Index fund (ticker: BITW). It tracks the 10 largest digital coins and has a 2.5% expense ratio.
Third, you could bet on the growth of crypto through purchasing Coinbase (ticker: COIN) – a cryptocurrency exchange that makes it easy to buy, sell and store cryptocurrencies like Bitcoin, Ethereum, and more.
Finally, if you want to buy Bitcoin directly, some investment apps like Robinhood give you a chance to do that.
The bigger picture
Cryptocurrencies and digital assets are here to stay. An intelligent investor should not ignore it but rather educate herself about it.
There are lots of reasons to invest in Bitcoin, and there are lots of reasons not to. If you’re going to dip your toes into the world of crypto, take small steps and understand all the risks involved.