Key takeaways
Cryptocurrencies and other digital assets continue to attract investor attention.
Digital assets have a limited and volatile performance record.
A key challenge for investors is that cryptocurrencies such as Bitcoin do not fit neatly into a traditional asset allocation mix.
Cryptocurrencies including Bitcoin, tokens, altcoins and other digital assets continue to draw interest, even though some consider its investment benefits vague, inconsistent and ill-defined.
The most visible cryptocurrency, Bitcoin, garners frequent headlines owed to rapid price changes. When the price of Bitcoin soars, investor interest rises. While investors will always consider an asset’s price appreciation potential, it’s notable that price upswings often follow periods of weak performance.
In 2009, Bitcoin, cryptocurrency’s initial asset, first appeared on the scene. It remains the crypto asset benchmark, representing close to 60% of the entire asset class. Dozens of other cryptocurrencies have since emerged, along with other forms of digital assets such as tokens and coins.
For perspective, while publicly traded equity and fixed income securities total close to $200 trillion worldwide,1 assets in the crypto marketplace represent just a fraction of that. Even after a rapid growth period, crypto assets total less than $3 trillion.2
What is the crypto investment case for individuals? How can investors realistically capture digital assets’ unique return opportunities in a way that’s consistent with their risk tolerance? These are increasingly relevant and challenging questions to consider.
Before assessing crypto’s investment characteristics, it’s helpful to understand the underlying ecosystem. It sets cryptocurrency apart from traditional financial assets. Crypto trading and values are driven by a system known as a blockchain. A blockchain is a decentralized electronic public ledger that records transactions in a way that prevents alteration of those records. As crypto transactions occur, they are recorded and stored on the blockchain, with transaction information broadly accessible.
This contrasts with traditional finance, which relies on the banking system to serve as the clearinghouse for financial transactions. Crypto transactions don’t rely on a central resource (i.e. Federal Reserve Bank, commercial bank) to serve this purpose.
A cryptocurrency, token or altcoin will have its own blockchain or be attached to an existing blockchain.
Cryptocurrency’s role as a financial or investment asset varies. Six key themes are most relevant. Not all are mutually exclusive, and not all of these themes apply to specific crypto asset. The most relevant crypto investment themes include:
Bitcoin emerged as an alternative to government-issued “fiat” currency, that is currency not backed by a physical commodity such as gold. Given Bitcoin’s limited supply and the decentralized blockchain ecosystem driving it, investors hope that higher cryptocurrency prices result from growing Bitcoin demand. “In some less stable countries, that nation’s currency may not seem reliable,” says Eric Freedman, chief investment officer for U.S. Bank Asset Management. “In those cases, an option like bitcoin may appear to provide greater stability than a nation’s fiat currency.” However, initial enthusiasm that cryptocurrencies like Bitcoin could eventually replace the dollar and other major global currencies have proven exaggerated.
Some blockchains experience network growth and enhanced usage while others have experienced the opposite. Just as with financial assets like stocks and bonds, investors buy, sell and short crypto assets consistent with their views about the asset’s value.
A fundamental value can be created in select crypto assets such as Ether, by allowing investors to control a crypto application’s asset. By “staking” or pledging to help secure the blockchain, investors can earn additional crypto (such as Ether). Other crypto assets offer investors cash flow the application generates. In either approach, investors seek to capitalize on more than the asset’s price appreciation, uncovering potential fundamental value not unlike stock and bond investments.
An investor’s stock and bond trades can at times be driven by macroeconomic or market expectations. For example, in a strong growth environment, investors may anticipate greater opportunity in technology or consumer discretionary stocks. Crypto investors may also base decisions on macro views. Some may anticipate that crypto assets will fare well in a growth environment marked by increased flow to risk assets. Because of their limited track record, it’s challenging to attribute specific performance and risk characteristics to crypto assets relative to underlying economic conditions.
Blockchain technology critical to digital assets requires tangible assets such as data centers, computer chips and other specialized hardware. That creates potential investment opportunity in pick-and-shovel investment that seeks to leverage, through more tangible investments, cryptocurrency’s rising popularity.
Crypto assets are noted for having zero intrinsic, fungible or practical value. In this way, they may be like baseball cards. While most baseball cards have little practical value, certain sought-out cards may be more marketable. Similar characteristics apply to crypto assets. In certain cases, the potential redeemable value for crypto requires another investor who will “foolishly” pay an asset’s price exceeding that paid by the current crypto asset holder.
As with any investment, the phrase “price is what you pay, value is what you get” is particularly applicable to the crypto marketplace. “One of the emerging questions for investors is ‘what am I getting for whatever I’m transacting?’,” says Freedman. It is one of the questions he suggests investors consider as they assess crypto assets within their portfolio mix.
While results are, at best, mixed, cryptocurrency as an investment is one that some investors choose to explore. It’s important for interested investors to gauge the inherent risks as they explore ways of investing in digital assets.
“It may be most appropriate for those who recognize the inherent risk involved and can endure extreme volatility,” says Eric Freedman, chief investment officer for U.S. Bank Asset Management. “People should be willing to risk the full amount of their investment to participate in this marketplace as they seek to capitalize on favorable investment potential.”
Digital assets can be divided into different major investment components:
A cryptocurrency is a digital asset “native” to a given blockchain. These are decentralized assets built on a blockchain or other Distributed Ledger Technology that uses cryptography to secure the currency’s underlying structure and network system. Cryptocurrency’s primary function is to facilitate payments through the blockchain ecosystem.
Bitcoin is by far the most popular cryptocurrency. Other notable cryptocurrencies include Ether, Dogecoin and BinanceCoin. Based on their limited trading history, Rob Haworth, senior investment strategy director with U.S. Bank Asset Management, notes the highly volatile nature of cryptocurrency values. “Part of this is they trade on a 24-hour-a-day, 7-day-a-week basis,” he says. “While there are some capital market regulatory features that can cap trading volatility for traditional assets like stocks, these don’t exist in the digital asset universe.” The price of the industry’s recognized benchmark asset, Bitcoin, has repeatedly experienced dramatic swings. Even in just the last few years, Bitcoin’s price volatility far exceeds the S&P 500’s. Investors who typically consider stocks the most volatile asset in their portfolio, must recognize that cryptocurrency volatility is typically far more pronounced. This is illustrated in the following chart showing 12-month rolling returns (price-based) in Bitcoin versus the S&P 500 Index.
“As history shows, cryptocurrencies like Bitcoin periodically experience tremendous upside potential,” notes Haworth. “But price volatility is significantly higher than we’ve seen in even the most volatile equity market segments.”
Tokens are developed by blockchain-based organizations on top of existing blockchain networks but are separate from cryptocurrencies. Tokens can be used to raise funds for projects and are usually available through an initial coin offering. Thousands of different tokens have been created, most with distinct characteristics. Tokens demonstrate even greater intraday price volatility and drawdown characteristics than their cryptocurrency peers. Trading volumes are often thin due to a smaller ownership base, contributing to greater price volatility. In some cases, tokens can represent a stake in a company with the value determined through regular transactions.
This is a way to invest in the digital asset space through hedge funds, private market managers and other investors who focus on crypto universe subcomponents. This can include a focus on suppliers like power companies and technology firms. Storage components, a major consideration in the crypto marketplace, is another. Investments are also possible in public or private companies involved in the crypto space, such as crypto exchanges.
Among the growing crypto investment universe are crypto-centered exchange-traded products or ETPs (similar to traditional exchange-traded funds or ETFs). ETPs are a group of securities tracking the value of one or more underlying crypto asset. For example, an ETP may own a variety of crypto assets such as Bitcoin and Ethereum, giving investors exposure to the marketplace through a more familiar investment vehicle.
Investors can also trade futures contracts in crypto. These allow investors to speculate on a cryptocurrency’s future price without purchasing the digital asset or alternatively to hedge or offset a future sale or purchase of a cryptocurrency.
Crypto’s emergence and growing popularity indicate digital assets’ staying power, according to Freedman. But he cautions, “There’s a lot of excess and many of the assets can best be described as speculative.” While the crypto market gains more institutional acceptance on Wall Street and globally, it remains a relatively new investment asset.
Cryptocurrency has gained modest headway as an acceptable form of payment, but adoption to this point is limited. “Ultimately, there needs to be some utility or use case, some broader metrics that drive people to adopt and increase network transactions,” says Freedman.
Crypto does not currently have a place in a traditional asset allocation mix. Much of this is attributable to crypto’s limited historical track record. That makes it difficult to determine a specific role for crypto in a well-diversified portfolio.
“Portfolio building begins with past properties and considerations based on an asset’s return history, particularly in relation to economic or market conditions,” says Freedman. “The challenge is cryptocurrency’s very limited history. That makes it difficult for any asset allocator to rely on past data.” Freedman notes this is in sharp contrast to more traditional equity and fixed income assets, where long established track records can help investors better project expected outcomes. “What crypto’s track record shows to date is that these assets have as much or more price volatility than individual stocks.”
Freedman notes, for instance, that the most established crypto asset, Bitcoin, has an uneven track record relative to major asset classes such as S&P 500 stocks or gold. When seeking to diversify portfolio risk, investors typically focus on owning assets that will have a low or negative performance correlation to each other. For example, owning a mix of stocks and bonds seeks to capitalize on typical behaviors. When stocks decline, bonds often perform better. When stocks soar, bonds often underperform. In this way, a mix of the two asset classes provides a degree of balance and portfolio stability.
Crypto offers a much less definitive track record. Correlations between Bitcoin and the S&P 500 or gold demonstrate the difficulty in determining expected performance relative to other asset classes. “To this point, the crypto investment universe remains a more speculative venture rather than a core component of an individual’s asset allocation strategy,” says Haworth.
One discernible trend is that Bitcoin tends to perform best in an environment of improving liquidity. When the economy has excess money to put to work, cryptocurrencies are more likely to offer upside potential. However, it should be noted that this assumption, too, is based on a limited track record and these patterns could easily change.
|
Liquidity environment |
Bitcoin |
S&P 500 |
Gold |
|---|---|---|---|
|
Worsening (M2 < GDP YoY) |
7.98% |
2.61% |
2.10% |
|
Improving (M2 > GDP YoY) |
36.10% |
3.88% |
2.45% |
|
Period 10/31/14 – 9/30/24 |
|
|
|
|
Improving/worsening |
4.52% |
1.49% |
1.17% |
Liquidity environment
Worsening (M2 < GDP YoY)
Bitcoin
7.98%
S&P 500
2.61%
Gold
2.10%
Liquidity environment
Improving (M2 > GDP YoY)
Bitcoin
36.10%
S&P 500
3.88%
Gold
2.45%
Liquidity environment
Period 10/31/14 – 9/30/24
Bitcoin
S&P 500
Gold
Liquidity environment
Improving/worsening
Bitcoin
4.52%
S&P 500
1.49%
Gold
1.17%
Source: U.S. Bank Asset Management Group.
Does investing in cryptocurrency represent a reasonable opportunity? “It may be most appropriate for those who recognize the inherent risk involved and can endure extreme volatility,” says Freedman. “People should be willing to risk the full amount of their investment to participate in this marketplace as they seek to capitalize on favorable investment potential.”
Frequent price swings are a significant concern. Even the flagship asset within the crypto universe, Bitcoin, experiences more frequent and significant price fluctuation than what is typically found in traditional capital markets.
Bitcoin’s price moved significantly higher from its initial trading days, with a value of more than $85,000 in mid-March 2024. However, price fluctuations tend to be more extreme than investors experience in more established asset classes. “Crypto’s historical path is short and not clear,” says Haworth. “Potential investors must recognize that crypto assets are speculative in nature.” Haworth emphasizes that for investors with a sufficient risk appetite and a desire to pursue a different investment space, there may be a place for crypto investing.
The future path for cryptocurrencies is far from clear. Should cryptocurrencies gain greater acceptance as a scaled and secure medium of exchange, higher digital currency valuations may be justified. If roadblocks to wider adoption persist, current cryptocurrency prices may be overzealous.
Investors interested in the crypto assets’ potential should learn more about the marketplace and explore how it may fit into the larger scope of their investment strategy. Be sure to discuss this topic with your financial professional before making any investment decisions.
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