According to a recent GOBankingRates survey, about one-quarter of people invest in digital currencies. This alone makes cryptocurrencies worthy of investigation, as that represents a lot of money flowing into the asset class.
Of course, it’s hard to avoid hearing about cryptocurrencies in the financial news these days, as Bitcoin prices are typically quoted continually throughout the day. Big winners, like Shiba Inu’s astonishing return in 2021, also garner headlines.
But should digital currencies really make up a part of your investment portfolio? Here are the reasons some experts believe so.
The basic purpose behind investment diversification is to limit risk. As cryptocurrencies are extremely volatile, it pays to diversify that risk with more traditional investments like stocks and bonds. But the opposite is true as well.
According to Michael Kelly, CFA with Switchback Financial, “I view (cryptocurrency) as a valid asset class in a portfolio due to its lack of correlation with the traditional investments of stocks and bonds.” Kelly sees crypto as a potential opportunity, but he still limits client exposure to a 1-2% allocation.
Ark Investment Management CEO Cathie Wood goes even further when it comes to the potential diversification benefits of cryptocurrency, telling CNBC that it is “the Holy Grail of diversification.” According to Wood, “Institutional managers have to look at new asset classes that are evolving and that have low correlations.”
Anjali Jariwala, founder of FIT Advisors, suggests that you should further diversify even within your crypto allocation. According to Jariwala, the real benefit of diversification in cryptocurrency is to limit extreme outcomes. If one cryptocurrency fails and your investment goes all the way to zero, other crypto investments may still do well. Ideally, Jariwala says, your whole crypto portfolio won’t be wiped out because of one coin.
In addition to avoiding a total loss on your portfolio, diversifying your portfolio with crypto can help your overall upside. Although the ride has been extremely rocky, Ethereum, for example, has returned over 30,000% since its inception in 2015. A small allocation of your portfolio to cryptocurrency will not only smooth out the ups and downs in the volatile asset class but also potentially juice your total returns.
As most cryptos have been hammered in price as of mid-year 2022, this could represent a buying opportunity for risk-averse, long-term investors. If you properly diversify your portfolio by not being too overexposed to crypto, even a significant loss won’t take more than a few percentage points off your total portfolio return.
Cryptocurrency bulls see the sky as the limit for crypto. As Wood told CNBC, “The move by institutional investors into Bitcoin could add $500,000 to its price, if they ultimately give it a 5 percent allocation.”
There’s no denying that the potential for cryptocurrency to change the very nature of financial systems in the future is exciting. However, as this asset class was essentially created out of thin air and remains a very new way to invest, it also carries immense risks. Here are just a few of those risks:
Crypto Is Still a Speculation
The bottom line is that for all of the excitement that crypto brings to the investing world, it’s primarily backed by the hopes and dreams of its investors. While some cryptos do have real-world functionality, they aren’t backed by revenues or earnings like stocks are. Rather, investors back currencies that they either think will evolve into something bigger or that will simply be pushed higher by crowds of speculators.
To help reduce this risk, stick to the big names in the space. According to Anastasiya Belyaeva, head of growth at PieDAO, a platform that offers investors a range of crypto portfolios, “If you’re a newcoming investor, betting on coins and projects that have been around for a bit of time and have proven that they are at least not a scam is a good idea,” Belyaeva said. “Investing in something that’s been around for a couple of weeks is probably on the risky end for newcoming investors.”
Crypto Is Highly Volatile
Even if some cryptos turn out to be “the next big thing,” as an overall asset class, they are extremely volatile. In early May 2022, for example, stablecoin Terra, which was supposed to maintain an equivalent value of $1, fell off a cliff and dropped to just 9 cents per coin. This sent a huge ripple throughout the entire crypto world, wiping $200 billion in value off the world’s cryptocurrencies in a single day, according to CNBC.
When so-called “stable” coins can collapse by 91% — and former big winners like Shiba Inu can plummet 87% from their all-time highs — you have to be prepared to handle huge swings in your portfolio. For many investors, this is simply too much to stomach.
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