INTRODUCTION TO CRYPTOCURRENCIES INVESTING
NOTE: this eclectic text incorporates several external sources of information and data (notable those of Grayscale, Bankrate, Edelman and Deloitte).
Cryptocurrencies are undoubtedly one of the most fascinating creations of the 21st century — entirely electronic currencies, its use and monetary supply governed by computer code.
Unlike traditional fiat currencies, which are controlled by central banks and governmental bodies, most major cryptocurrencies networks (such f.e. as Bitcoin and Ethereum) are decentralized and maintained by thousands of independent computers on the Internet.
For investors cryptocurrencies have many unique qualities that may make it look like a safe haven or hedge. Its blend some features of commodities and currencies, while also displaying distinct characteristics that don’t have an analog in mainstream finance.
Let's take a look at some of cryptocurrencies' characteristics that may make it an attractive investment.
Stocks and bonds may always be staple investments, but investing in digital currencies (like Bitcoin, Ethereum, EOS, Zcash etc.) may provide further diversification (with higher returns per unit of risk) as investors seek to build more resilient portfolios.
Although during 2020 market crash cryptocurrencies closely followed major stock indexes (same did the gold) in their downward spiral, cryptocurrencies had historically performed as an uncorrelated asset. As a result, they may provide benefits to an investment portfolio that other assets may not be able to match.
By properly sizing a cryptocurrencies allocation as part of a traditional investment portfolio (e.g., a 1-5% allocation), the risks of investing in cryptocurrencies can be mitigated relative to potential gains.
The Next Generation of Investors
With an estimated $68 trillion in wealth transferring from older to younger generations over the next 25 years, we may see more investment dollars make their way into uncorrelated assets like cryptocurrencies.
One survey showed millennials are much more likely to buy, hold, and use cryptocurrencies – the majority of which have not yet hit their prime earning years. Despite the fact that most financial advisors don’t currently allocate their clients' portfolios to cryptocurrency, 76% of advisors received questions about cryptocurrency in 2019, signaling major interest in the asset class.
As a new generation is evaluating where and how to invest their money, cryptocurrencies may become an increasing part of the mix.
Infrastructure is Strong
While use cases are still emerging, most popular cryptocurrencies' global transaction networks enable its to be sent securely anywhere, across borders, in any amount, at low costs, as seamlessly as a text message, and without the need for trusted third-parties.
While we are still in the early days of the technology’s development, the implications of this capability are massive. Removing the need for trusted third-parties enables billions of people to transact without the need for robust government enforcement systems, making international commerce, trade, and finance more accessible than ever before.
Safe Haven Investment
Some of cryptocurrencies, such as, most famously, Bitcoin, are scarce assets (for example, there will only ever be a total of 21 million Bitcoin created).
With that cryptocurrencies have demonstrated many of the same traits as traditional safe haven investments like gold. It has been shown to perform well in both normal and volatile times.
For example, during past market shocks, including Brexit, Grexit, and heightened trade tensions between the U.S. and China, most popular cryptocurrencies (such f.e. as Bitcoin and Ethereum) outperformed traditional equity and bond markets, sometimes by a significant margin.
Cryptocurrencies' indifference toward broader market conditions has made them an attractive investments for those dealing with runaway inflation at home. Monetary policies that devalue local currencies have traditionally led to an influx of investment in cryptocurrencies by residents of those countries. During a time where the U.S. is seeing unprecedented fiscal stimulus, the idea of a currency that is disconnected from geopolitical developments has made cryptocurrencies an attractive prospect to many investors.
It's Still Early
Cryptocurrencies have the potential to capture value from a spectrum of large and diverse markets. Their value today is only a tiny fraction of the markets it stands to disrupt, which reaches well into the trillions of dollars.
What if cryptocurrencies takes even a quarter of the store-of-value market held by gold? What if it becomes the currency of choice for a few of the more unstable nations whose currencies are plagued by hyperinflation? These are just a few examples of markets that cryptocurrencies have the potential to disrupt, and in doing so, gain from in value.
Cryptocurrences' unique properties and digitally-native identity may make it a compelling investment prospect for investors of all types. With the right allocation, cryptocurrencies may offer upside potential and have demonstrated superior risk-adjusted returns compared to other asset classes over the last decade.
If basic principles of responsible investing — diversification, investing for the long term, appropriate risk management — still hold true, it's clear that there is a home for cryptocurrencies in many portfolios.
Digital currencies aren’t just a new investment — they represent an entirely new asset class unlike any other. With about $300 billion market capitalization, digital money have the potential to revolutionize many aspects of our lives.
Just as the computer and the internet radically transformed the way people store, process, and exchange information, cryptocurrencies radically enhances the ways we can store, process, and exchange value.
Digital currencies share some of the same qualities as commodities and currencies. They are, however, generally uncorrelated to other asset classes and the broader market, meaning that there are many times when digital currencies don’t exhibit any of the characteristics we associate with traditional asset classes.
When it comes to cryptocurrencies, it’s helpful to think of it as both a store of value and a medium of exchange. Most importantly, investors will have an easier time understanding the role it can play in a portfolio if they understand its unique, underlying characteristics.
Cryptocurrencies possesses a superior composition of 'good money' qualities for a global digital economy: it is independent, scarce, verifiable, portable, and divisible. Many view cryptocurrencies as a new and improved “digital gold” that is better suited for our modern world. Understanding these aspects of cryptocurrencies is key to understanding it as an innovative financial product, one that should be seriously considered as a financial investment.
One critical difference between cryptocurrencies and other asset classes is that there is no central authority that governs cryptocurrencies’s monetary policy or global distribution. Changing political climates do not impact how much cryptocurrencies is created daily. The ability to send and receive cryptocurrencies cannot be controlled by a government. Nations and economies might rise and fall, but cryptocurrencies was designed to remain separate from those events.
In fact, many of cryptocurrencies' characteristics are hard-coded into the cryptocurrencies network and due to the decentralized nature of this network, its code cannot be arbitrarily changed. cryptocurrencies supporters and investors alike see this as beneficial to the digital currency, given its independence from governmental actors.
One of the most enduring qualities of cryptocurrencies is the network’s ability to prevent fraudulent transactions. Despite more than a decade of attempts, no entity has been able to alter the cryptocurrencies transaction log. No entity has been able to “counterfeit” cryptocurrenciess or fake that they had more cryptocurrencies than they really did. This is due to the cryptographic nature of the cryptocurrencies network and the blockchain technology it introduced to the world.
Cryptocurrencies also doesn’t need a central processor to be verified. That function instead is spread throughout the cryptocurrencies network through the use of blockchain technology, utilizing thousands of computers around the world that each maintain an identical record of transactions taking place on the network. cryptocurrencies’s blockchain allows transactions to be verified anywhere, anytime, from any connected device.
Because cryptocurrencies are a digital currency, it can be stored easily on any digital medium. Anybody can create cryptocurrencies wallet without going through the gatekeepers of financial institutions.
Cryptocurrencies can even be stored in a wallet that only the owner can access. What this means is that cryptocurrencies is both widely accessible and also incredibly secure. It can cross borders in an instant — an internet connection is all that is required to effect a transaction in cryptocurrencies to go to anyone, anywhere, at any time.
While a U.S. dollar can only be broken into 100 denominated parts (cents), a cryptocurrencies can be broken into millions identifiable pieces. As there is no need to own an entire cryptocurrency, many investors start by owning a small fraction of one, knowing they can always invest more over time. For investors who are curious, yet uncertain about the investment risks associated with cryptocurrencies, this quality offers nearly unlimited flexibility for cryptocurrencies investors to invest an exact dollar amount they want.
Taken as a whole, these individual characteristics begin to paint a portrait of a truly unique investment that displays significant practical uses in the real world while also retaining many attractive elements of financial instruments.
Cryptocurrencies' independence and uncorrelated nature to global markets make them a potential safe haven asset for investors looking to hedge against the shifting monetary policies that have downstream effects on many other financial assets.
The Next Generation of Investors
While digital currencies are an emerging asset class, there has been no shortage of surveys, reports, and data compiled to analyze investment trends in the digital currency space. And with the next Great Wealth Transfer right around the corner — with $68 trillion going to younger generations in the U.S. over the next 25 years — it’s important that we address the impact and appeal that digital currencies will have on wealth management for younger generations who are interested in digital currencies.
Numerous studies have documented that millennials show a greater optimism towards investing in digital currencies. For example, Bankrate found that millennials are five times more likely than older demographics to believe cryptocurrencies is the best place to put money they won’t need for 10 years or more. As our financial system continues to digitize, younger generations are consistently embracing digital solutions to analog counterparts.
This trend is illustrated in Edelman’s annual Millennials & The Future of Money Report, where it found that 12% of Gen Zs (ages 18-24) currently own cryptocurrencies, while 10% of millennials (ages 25-39) do, compared to 7% of Gen Xers (ages 40-53). Anecdotally, millennials are often seen as departing from their parents’ generation by emphasizing social causes, and certain aspects of digital currencies match some of those preferences. For those who dislike central bank control over fiat currencies, the idea of a decentralized, independent form of money may be incredibly enticing.
Digital currencies could potentially act as valuable tools to propel underserved populations, in turn advancing financial inclusion. For that reason, emerging markets, including areas in Latin America and sub-Saharan Africa, have seen some of the largest upticks in digital currency usage and could also have the greatest potential for utilizing central bank digital currencies.
The inextricable tie between digital currencies and their underlying blockchains is a critical component in allowing digital currencies to function properly without a central or governing authority. As you may already know, a blockchain is a digital ledger that maintains a record of each transaction taking place between participants on a network, such as the cryptocurrencies network, capturing important details including the sender, receiver, and amount transacted.
Each digital currency relies on a blockchain or ledger, but this powerful technology has use cases beyond capturing the details of digital currency transactions. Blockchain technology has attracted enormous attention and real investment from blue chip corporations and governments alike as they seek to recognize the real-world applications of the technology, ranging from supply chain management to voting in national elections. It’s still early, but these movements fuel optimism around practical applications of the asset class.
Private Sector Investments
A 2019 Deloitte report surveyed 1,000 companies across seven countries about when and how they would integrate blockchain technology into their operations. The report found that 34% of respondents already had a blockchain system in production, while another 41% anticipated blockchain development in 2020.
Additionally, two global banks — J.P. Morgan and Deutsche Bank — have both published their own respective reports that claim blockchain and digital currencies will be solidified in the mainstream within the next two to five years. And as for digital currencies themselves, the support doesn’t end there; according to data published by Fidelity, which surveyed 774 financial institutions, 36% of U.S. and European institutions currently hold digital currencies or associated derivative assets.
Financial institutions are demonstrating a particular interest in advancing this technology.Institutions including J.P. Morgan, The Royal Bank of Canada, American Express and Goldman Sachs have all made investments in developing proprietary blockchain projects and have funded digital currency-focused startups or are providing banking services to them. When it comes to technology firms, IBM has invested more than $200 million in research and development, making it one of the largest companies in the world to embrace blockchain technology.
Facebook has publicly set in motion plans to launch its own digital currency-based payment system named Novi (formerly Calibra) to support the digital currency Libra, sometime in 2020. Novi could continue to push awareness, if not acceptance, of digital currencies into the mainstream.
Public Sector Interest
Governments and public sector organizations have also expressed significant interest in the space. In the U.S., several governmental entities (e.g., USPS, U.S. Air Force, and the U.S. Department of Health) have invested millions of dollars in building new systems based on blockchain technology. In 2019, the IRS posted its first piece of digital currency tax guidance since 2014, marking a new milestone of acceptance amongst regulators.
Foreign governments across the globe have also placed significant financial backing behind digital currencies and blockchain technology. In 2018, 22 countries (Germany, France, and the UK, to name a few) signed a declaration to invest €300 million through 2020 into blockchain projects under the Horizon 2020 project.
And in April of 2020, China’s central bank rolled out a pilot of its digital Yuan currency in select municipalities. Companies such McDonald’s and Subway are among 19 companies accepting the digital currency as part of this trial run — a national experiment that other countries will closely watch.
What Does this Mean for Investors?
While interest from the private sector and public sector in blockchain technology may not feel directly related to investing in cryptocurrencies, it’s important to recognize that the adoption of blockchain technology lends greater legitimacy and credibility to this new digital ecosystem and its various use cases as a whole — cryptocurrencies included. The relationship between digital currencies and their underlying blockchain technology cannot be understated.
The same way that one could buy domain names but not own the internet, investing in digital currencies is the first and most liquid way for investors to own a piece of a network and gain exposure to this exciting new technology.
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