Bitcoin shot up to a record high today approaching the $6,400 level after derivatives marketplace operator CME Group announced it would launch a futures contract in the fourth quarter.
While everyone is getting all giggly and bubbly over Bitcoin, it is important to understand whether you are holding Bitcoin as a speculator, gambler, or an investor. If you are holding Bitcoin to speculate or gamble on the price, this article is not for you.
If you are an investor who believes in the disruptive blockchain theme at the macro level, you want to continue building on an existing diversified portfolio of stocks, bonds, gold, and alternatives.
The first rule of investing is risk management. The second rule is asset allocation.
If you are a Bitcoin tech geek and can’t imagine Bitcoin being used in an asset allocation strategy, stop reading, this article is not for you.
Although cryptocurrencies can be considered protocols or a store of value by others, I am talking about crypto as an investable asset class and as part of a sophisticated asset allocation strategy for small and large investors.
Here is the definition of an asset, according to Investopedia:
An asset is a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. Assets are reported on a company’s balance sheet, and they are bought or created to increase the value of a firm or benefit the firm’s operations. An asset can be thought of as something that in the future can generate cash flow, reduce expenses, improve sales, regardless of whether it’s a company’s manufacturing equipment or a patent on a particular technology.
If you are a big believer in diversification and making sure your general investment portfolio has a sufficient level of non-correlated assets, this is how your investment allocation to the blockchain theme could look:
Here are a few reasons you don’t want to be holding just one crypto asset — Bitcoin.
1. Bitcoin is unlikely to be the crypto winner long term. It is very rare for the first-mover advantage to be sustained in a leadership position for the long term, successfully fighting out disruptive innovators over time. Consider Netscape, AOL and Yahoo, for example. Sure, Bitcoin is not a tech company but the first-mover advantage lesson applies to the broader crypto space. The first cryptocurrency out the gate won’t necessarily win over the long term.
2. Ether has outperformed Bitcoin over the last 12 months and may end up being the winner in the space.
Ethereum is up almost 2700 percent over last 12 months while Bitcoin is up nearly 700 percent. Ethereum has a market cap of $29 billion and many analysts believe Ethereum could be the operating system of tomorrow’s blockchain. Many analysts believe Ethereum not only has a more unified community but the technology is more flexible for engineers and businesses alike. I would have at least the same amount of Ether as Bitcoin in my diversified crypto portfolio.
3. Security risks
There are meaningful security risks with Bitcoin. If it goes down, there could be a risk you lose some or all of your investment. There may not be a security risk with holding bonds or stocks but with this asset class, security risk and a large-scale hack are things you have to consider. Risk factors also include the various wallets and brokers where you are holding your Bitcoin. One thing you want to check is whether your broker or wallet has insurance that could cover you if your coins are stolen in the event of a hack. With Bitcoin being the most popular crypto asset, hackers could focus on BTC specifically but everything in your wallet could be at risk. If you are investing in size, $100,000 in the sector, I would recommend even having multiple wallets.
4. Regulatory risk
Bitcoin could be targeted specifically by regulators while other blockchain/crypto investments are given the green light. The space is so new that we don’t know how regulation could impact some cryptos and not others. This regulatory uncertainty should be guiding you to spread your risk out.
5. Reduce risk in your portfolio
If you buy shares of private tech companies such as Chain, focusing on the blockchain or ICOs such as Ripple or STORJ, this could potentially reduce the risk of your crypto portfolio. Correlation data is not easy to find in the crypto space but some diversification is better than none. There is a potential of a crash where all Blockchain-related assets and companies crash together but I would still recommend diversification at this stage of the crypto market.
Remember, you are an investor, not a gambler. All you have to do is get the big theme right and spread your bets and you have a good shot at being massively successful as an early crypto investor.
In terms of the blockchain investment theme, I want to invest in the horse track rather than a specific horse. We don’t know who will win the race. The horse that starts off in the lead may not finish that way. You don’t want to be that investor who loses out in the event Bitcoin crashes and collapses but Blockchain and other assets perform well over the next decade.
This is how the crypto asset class could fit into a general investment portfolio:
With its massive volatility and no track record, you should expect the crypto asset class to be the riskiest piece of your portfolio.
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