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.
What is Bitcoin and Blockchain Technology?
Unlike traditional money, cryptocurrencies such as bitcoin, don’t have paper notes or metal coins. There is no central bank issuing the cryptocurrencies, and no regulator or nation supporting it. Instead, cryptocurrencies are a form of code made by computers and stored in a digital wallet. Transactions are recorded on a public ledger called blockchain. People can earn bitcoins in several ways, including buying them using traditional currencies or by ‘mining’ them- through the use of powerful computers to compile recent transactions into new blocks of the transaction chain by solving highly complex mathematical puzzles.1
The price of a cryptocurrency theoretically should be tied to the economic principles of supply and demand. For example, although the supply of bitcoins is slowly rising, it may reach an upper limit, which might imply limited future supply. However, new cryptocurrencies are developed almost daily, and with future innovations in technology making cryptocurrencies close substitutes to one another, the quantity of future supply might be unlimited.
Should We Expect the Value of Cryptocurrencies to Appreciate?
Similar to traditional currencies, there is no reliable way to predict by how much and when that appreciation will occur. We know that a holder of bitcoin today should not expect to receive more bitcoins in the future. Unlike owning bonds or stocks, a bitcoin today doesn’t entitle the holder to an expected stream of future bitcoins.
None of the above is meant to deny the exciting potential of the underlying blockchain technology that enables the trading of cryptocurrencies. As an open, distributed ledger that can record transactions efficiently, verifiably and permanently, blockchain technology will have significant implications for banking and other industries across the globe.
Should You Own Cryptocurrencies in Your Portfolio?
Unlike stocks or corporate bonds, it is not clear that cryptocurrencies offer investors future positive returns. Unlike government bonds, cryptocurrencies don’t provide any level of clarity about future wealth. Unlike holding cash in fiat currencies, cryptocurrencies don’t provide the means to plan for a wide range of near-term known expenditures.
When evaluating any investment, you must consider what percentage of all eligible investments the value of the proposed investment represents. In the example of bitcoin, when compared to global stocks, bonds, and traditional currency, its market value is minuscule. Therefore, if an investor concludes they are missing out on bitcoin-mania and must buy a cryptocurrency, we believe its weight in a well-diversified portfolio should generally be minuscule as well.
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