What are the risks and rewards of investing in cryptocurrency? A recent International Foundation webcast featuring Giles Anderson, director, sales and relationship management with Fidelity, and Philipp Meyer-Brauns, head of investment solutions analytics and vice president with Dimensional, explored some of the issues.
Understanding Cryptocurrency
You may already be familiar with Bitcoin or Dogecoin, but cryptocurrency is essentially a digital currency where transactions are verified and records are maintained by a decentralized system. It’s “distributed ledger technology” that can only exist on the blockchain, Anderson explained.
Cryptocurrency transactions have a number of common characteristics, he noted. They are:
- Immutable (meaning you can’t undo or cancel them like a banking transaction)
- Unanimous
- Anonymous
- Secure
- Programmable
- Transparent.
Transparency is a particularly important feature, Anderson added, as it helps achieve trust in the market.
Considerations for Investors
Globally, there are now more than 6,000 cryptocurrencies, but Bitcoin has the largest market share by far. “Many digital currencies were attempted before but have always failed . . . Bitcoin has managed to be resilient and stay around,” said Meyer-Brauns.
If you’re considering investing in cryptocurrency, what are the key considerations? It depends on your goal for including it in your portfolio, he explained. Meyer-Brauns reviewed the typical portfolio objectives and considered whether cryptocurrency is a fit.
- Providing positive expected return—Returns are driven by the prices that investors pay and the cash flows they expect to receive; however, Bitcoin does not provide a cash flow.
- Mitigating uncertainty—Given its volatility, Bitcoin doesn’t function well as a volatility mitigation tool.
- Supporting short-term liquidity—Liquidity requires general acceptedness of the asset class, and Bitcoin is not widely accepted today, he added.
Given that it is only a sliver of the investment opportunity set (when compared with stocks and bonds), there may not be a significant role for cryptocurrency when viewed through a traditional asset allocation lens, Meyer-Brauns noted. There is also still a lot of uncertainty around future demand and supply. He advised treating it with caution as an investment but added that it has great potential as a technology.
Looking Ahead
Today, adoption of cryptocurrency as a currency is varied, and the uptake is much higher in certain regions. For example, El Salvador has adopted Bitcoin as legal tender, and about a third of Nigerians use Bitcoin, said Anderson. He predicts it will be adopted as a payment network in other third-world countries—particularly those that don’t have their own currency or that use the U.S. dollar.
While the viability of Bitcoin and other cryptocurrencies as an investment remains to be seen, Anderson and Meyer-Brauns believe that cryptocurrency will radically alter payment operations going forward. “It’s not just an asset class that you can invest in . . . it’s a hugely transformative technology,” Anderson added.
Alyssa Hodder
Director, Education and Outreach – Canada
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