Bitcoin and other cryptocurrencies are receiving significant media coverage, with articles being written about ‘crypto-millionaires’ and a whole heap of noise around its growth potential. It is somewhat difficult to comprehend what this all means, however, it is prompting many investors to wonder whether this new type of electronic money deserves a place in their portfolios.
Although there are other crypto-currencies, bitcoin is by far the most widely traded. My blog therefore focuses on bitcoin and gives an opinion as to whether it should be considered within a diversified portfolio. However, a good place to begin is to explain what it is.
Some background
Bitcoin has emerged only in the last 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.
Bitcoins are transferable digital tokens made by computers and stored in a digital wallet. There is a finite supply of 21 million bitcoins, of which more than 18.5 million are in circulation. Transactions are recorded on a public ledger called blockchain and can be purchased through dedicated exchanges. Bitcoin could be described as ‘internet money!’
For much of the past decade bitcoin has been the preserve of digital enthusiasts and for people who believe the age of traditional currencies is coming to an end. However, the price of bitcoin has surged over the last few months prompting intense media attention, in part fuelled by large companies such as Tesla, Mastercard and JPMorgan purchasing the digital currency. Furthermore, Tesla has recently announced that it will accept bitcoin as a form of payment for its products in the future.
So what are investors to make of all this media attention? What place, if any, should bitcoin play in a diversified portfolio? Why does bitcoin have any value at all if it is not backed by any physical commodity (such as gold), nor guaranteed by any government or company?
The arguments for bitcoin
Proponents of bitcoin state that it is free from centralised interference (unlike the money supply) and is a store of value, like gold. It has also been argued that it acts as a hedge against the price movement of other investments i.e. that the price of bitcoin can move in the opposite direction. Also, because it has a finite supply many have reason to believe that the longer term price trajectory of bitcoin will continue to surge upwards.
The arguments against bitcoin
The key arguments against owning Bitcoin is that it can only be used to pay for a small number of goods and services and so it has limited intrinsic value. Furthermore, it is criticised as being ‘unsuitable money’ because its price has been too volatile in its short existence to be a suitable substitute for cash. There is also the risk of the threat of a legal clampdown if governments were to intervene and were to make it, for example, illegal to own. Owning bitcoin is not like having money in the bank and there is no financial protection if something were to go wrong.
My opinion
Firstly, I think it is important not to be drawn in by the media noise and instead to look at the big picture and focus on your personal goals, situation and risk tolerance.
Although the value of bitcoin may continue to appreciate there is no reliable way to predict by how much and when that will occur. When designing a portfolio the default position is to have exposure to the whole market through a low cost highly diversified portfolio and let time and compounding do the heavy lifting work for you. Investing is a life long journey, not a fad, and although the path won’t always be a smooth one it is essential that a plan is in place that you can stick with during both good times and bad.
It is essential to understand and weigh up the risks before considering investing in bitcoin. However, for some the potential thrill of owning bitcoin and being part of the evolving blockchain technology may be too hard to resist.
So if it is decided that bitcoin does fit in within a plan, as part of a well diversified portfolio, I believe its weighting should generally be very small perhaps no more than the total value of bitcoin currently in circulation as a percentage of the aggregate value of global equities and fixed interest securities. This is currently less than 1%.
Finally, always keep in mind that a goals based approach using equities and fixed interest securities has helped investors achieve their lifestyle goals for decades and it is best to sleep easy at night!