Recently, we’ve received several calls on the crypto mania occupying headlines and winning over investors with the potential of becoming the next great investing frontier.  With further adoption taking place, many investors are asking this question:  Is the hype for crypto assets real and should I participate?  Below are some of our thoughts and considerations regarding crypto assets.

What are Crypto Assets?

Crypto assets were first introduced in 2008 via Bitcoin.  Bitcoin was designed as a digital vehicle to store and easily transfer value without the baggage of an intermediary (i.e., a bank) facilitating the transaction.  Asset transfers take time to process (ever had to wait three days for a check to settle?) and are restricted to banking hours.  The goal was to create a secure and anonymous means for transferring value; accessible 24 hours a day, 7 days a week and processed within minutes.

So how would this be done?  Well, Bitcoin established a new, independent method for facilitating transactions called Blockchain.  This process acts as a digital ledger managed by a public peer-to-peer network.  This peer-to-peer network is incentivized to process transactions by earning shares of Bitcoin.

This new ledger created a remarkable technological advancement.  Not only does it decentralize the management of transactions, but it also significantly increases both the speed and accuracy in which transactions can be processed.  Fast forward to today, there are over 6,000 different crypto assets serving different industries, applications, and locations; all using some form of Blockchain as their fundamental cornerstone.

Why are people excited about it?

Crypto assets were initially dreamt up to serve as a new, anonymous payment system (like Venmo or PayPal), but as time went on, a higher purpose took flight.  Investors started to understand the power of the technology behind crypto assets and began to consider its ability to replace larger stores of value such as gold or currencies all together.

As investors bank on the idea of crypto assets becoming a 21st century currency, these assets have built additional steam with greater distrust in financial institutions and heightened concerns over a devalued dollar due to overindulgent fiscal policy.  As demand increased, these assets earned a spot on the trading platforms of major investment houses and created new avenues for buying and selling through crypto-only exchanges.

Should you invest in it?

As hard as it is to ignore the hype driven by celebrities such as Elon Musk on SNL and Guy Fieri on Twitter (Welcome to Flavor Town!), there are several things to consider before jumping on the bandwagon.

A large concern is what must take place for crypto assets to replace present currencies.  Currencies work because they are trusted, easy to use and are widely adopted by all parties within a given economy.  For crypto assets to be widely used, they must be widely adopted.

So, what would entice one to buy a crypto asset to garner this needed adoption?  Is it the price appreciation potential?  Is it the perceived value or the purpose the asset might serve that attracts participants?  This is where we run into the issue of perceived value vs. intrinsic value.

The major asset classes most recommended to investors each have their own form of intrinsic value.  Stocks represent real ownership in real companies (see George’s recent blog entitled “Real Companies, Real People”), which have a profit incentive and often pay a regular dividend.  Bonds represent a fixed source of income via debt instruments from governments or private companies.  Even gold serves as both a currency and a commodity, creating trust from its limited supply and global demand.  Some might argue that gold does not hold any intrinsic value.  Even if it does not, the trust and adoption of gold as a store of value has already been established.

When you bet on a perceived value, you lose a foundational benefit that underpins the price of an asset and become subject to the mercy of buyers and sellers.  In addition to the fundamental risk mentioned, there are others worth considering as well:


Competition Risk
– There are 6,000 different crypto assets currently.  Which one will stand at the top of the hill and how do you pick?

Technological Risk – How might crypto assets technology change over time?  What if there are flaws in the technology?

Taxation Risk – How will crypto assets be taxed?  If there are capital gains taxes, how can a crypto asset serve as an effective and simple transfer of value if taxes are involved with every transaction?

Regulatory Risk – If crypto assets were to become the central currency, how would regulation change their purpose?  How disruptive would this be to anonymity?

Government Risk – What if the government did not like the idea of a decentralized currency?  What if they government thought it was more of a threat than a solution to the financial system?

 

Now What?

While our concerns for investing in crypto assets are obvious, we do understand and respect the technological ingenuity within.  The internet, which was widely adopted in the early 1990s, is still providing technological and economic benefits today.  Blockchain has the potential to generate this same magnificent, inconceivable value to producers and consumers in many shapes and forms.

But how do you invest in it?  To answer this question, look back to the internet boom.  While you could certainly take your pick of any number of internet sensations that didn’t live up to the hype (anyone remember Pets.com?) there’s no denying that every company that currently makes up the S&P 500 has taken advantage of the technology of the internet to boost the value and profitability of their business, regardless of whether they are “internet” companies – or even technology companies, for that matter.

Looking forward, there is no doubt that Blockchain appears to provide a game-changing process that can be applicable across many industries.  While this technology originated in a crypto asset, do not lose sight of the component of the currency that is driving the demand.  Only time will tell if Bitcoin, or any other digital asset, will prove to be a merited asset class worthy of the hard-earned dollars of long-term, goal-oriented investors.

In the intermediate, focus on companies that provide inherent value and will undoubtedly capture the technology of the Blockchain evolution.  Win-Win situation!

 

Editorial Update (5/19/2021): Bitcoin is now down 40% from its recent peak.  The “Tesla” surge has now vanished.