Cryptocurrency has captured the attention of many investors over the last decade.
Seeing large performance swings can excite a lottery mentality, tempting you to invest so you don’t miss out.
But as with all investments, it’s important to understand what it is, what drives returns, and what it would add to your current investment strategy.
What is Cryptocurrency?
Cryptocurrencies are digital forms of assets, which use an online ledger to maintain their transaction history, known as a blockchain database. The blockchain database is stored on many computer systems maintained by numerous third parties, and no one party is responsible for its integrity.
What Drives Returns for Cryptocurrency?
When investing in the market, there is a source of the return you expect. For stocks, this is the ownership of future profits and dividends of the company, of which you are a partial owner. For bonds, this is the promise of future interest payments.
What is it for cryptocurrency?
Currently, cryptocurrency does not offer future payments or access to profits. Instead, returns are driven by another individual willing to pay more than the last investor for the asset.
In addition, prices are pushed higher with the speculation that cryptocurrencies will have use cases in the future.
Volatility of Cryptocurrency
This asset class has a relatively short data history to estimate future returns, as the first cryptocurrency was created only 15 years ago in 2009.
Furthermore, our data suggests that investors must be willing to withstand periods of near-complete capital loss. For reference, in May of 2021, Bitcoin decreased 53%. In March of 2020, it decreased by 50%. In the year from December 2017- 2018, Bitcoin crashed by 84%. And these are only a few of the numerous crashes experienced in the cryptocurrency market.
An Unreliable Store of Value
At present, using cryptocurrencies in place of the dollar or another fiat currency is expensive and inefficient due to high transaction costs and market volatility. Furthermore, most goods and services cannot be paid for using cryptocurrencies. For those that can, an investor may incur capital gains to exchange the coins.
Cryptocurrency as Compared to the General Market
As of May 14, 2024, the global cryptocurrency market capitalization is $2.37 trillion. For Bitcoin and Ethereum, exclusively, the market capitalization is about $1.56 trillion. For comparison, the global stock market capitalization is around $106.0 trillion, and the bond market stands at about $133.0 trillion.
An investor should identify their purpose if seeking to diversify through investments outside of stocks and bonds. If sufficient reasoning is found, consider other options besides cryptocurrency.
Relative to real estate, stocks, bonds, commodities, art, collectibles, and more, cryptocurrencies are but a small portion of assets available in the general market, as shown in the table below.
| Asset | Market Capitalization (Global) |
|---|---|
| Real Estate | $320.00 trillion |
| Bonds | $133.00 trillion |
| Stocks | $106.00 trillion |
| Gold | $15.00 trillion |
| Private Equity | $5.50 trillion |
| Silver | $1.62 trillion |
| Bitcoin | $1.21 trillion |
| Art | $557.49 billion |
| Ethereum | $347.94 billion |
Before Investing, Ask Yourself
- Am I willing to risk severe or total loss of capital?
- Do I have the flexibility in my plan to allow for an allocation to cryptocurrency?
- Am I willing to endure the extreme volatility witnessed in this market?
- What are the expected outcomes for this investment, and what is the probability for each outcome?
- What investments must I forgo to provide an allocation to cryptocurrency?
- Do I understand what I am investing in?
- Does this investment align with a long-term, buy-and-hold strategy?
RESOURCES
- Barron’s: Will the Stock Market Keep Going up? What to Know as the S&P500 Hits New Highs – March 11, 2024 Magazine
- Dimensional: Does [Fill in the Blank] Belong in My Portfolio?, by Wes Crill
- Dimensional: Mining the Bitcoin ETF Buzz, by Kristi Higgins
- Forbes: Cryptocurrency Prices Today by Market Cap
- Infinite Market Cap: Over 18,000 Assets Ranked by Market Cap
- Investopedia: Cryptocurrency Explained with Pros and Cons for Investment, by The Investopedia Team
- Moonfare: Private Equity Market Size, by Pamela Espinosa
- SIFMA: 2024 Capital Markets Outlook
- The Business Research Company: Arts Global Market Report 2024
- Yahoo Finance: 7 of the Biggest Bitcoin Crashes in History, by Andrew Lisa
