Does Crypto Belong in Your Retirement Portfolio?

Life changing money. That’s what happened to John Ratcliff. In 2013 the software developer from Colorado purchased 150 Bitcoin. Today, his $15,000 bet is worth millions as the price of cryptocurrencies (crypto) skyrocketed. Another individual who also came into life-changing money this year is Vitalik Buterin. The 27-year-old college dropout and co-founder of Ethereum is now the world’s youngest crypto billionaire as Ether went from $130 in 2020 to over $4,000 in 2021.

Stories like Ratcliff’s and Buterin’s have led to a crush of demand for the popular new asset class. To be sure, rapid price appreciation in crypto over the past year has prompted heightened media attention and arguably is fueling frenzied behavior among some market participants in tokens like Bitcoin, Ethereum, and even Dogecoin for fear of missing out.

But what exactly are cryptocurrencies? And more importantly, do they belong in a retirement portfolio?

What is crypto?

Merriam-Webster defines crypto as “any form of currency that only exists digitally, that usually has no central issuing or regulating authority but instead uses a decentralized system to record transactions and manage the issuance of new units, and that relies on cryptography to prevent counterfeiting and fraudulent transactions.” In other words, crypto is created by a collection of independent actors rather than a central government.

So, where does crypto come from? Well, in many cases, these virtual currencies are produced out of thin air by computers that solve cryptographic puzzles. This activity called is called mining. As more puzzles are solved, the more crypto an individual or collective earns as payment for their mining efforts on various blockchain networks.

Another essential point to understand about crypto is that they’re unregulated and don’t flow through traditional financial channels like the euro, yen, or U.S. dollar. Rather than being stored in a bank, these virtual assets are stored in digital wallets, currently limiting their use in the broader economy.

Is crypto just a lot of hype?

For many disciplined investors, it’s hard not to see what’s happening in the crypto space and ask whether another Tulip Mania, South Sea Bubble, Dot-Com Frenzy, or Housing Bubble is in the works. Even so, various indicators suggest this technology is more than a passing fad as blockchain technologies are increasingly seeing mainstream adoption in both public and private sector applications.

For example, the Federal Reserve announced in May that the central bank will publish a paper exploring the potential for its own Central Bank Digital Currency (CBDC). Meanwhile, the People’s Bank of China is already testing a digital Yuan.

From the private sector perspective, Visa, Mastercard, Paypal, and Apple have recently expressed their intent to actively participate in the virtual currency space. So, it’s safe to say that crypto, for the time being, may be more than simply a flash in the pan.

What’s the outlook for cryptocurrencies?

While blockchain networks have been around for over a decade, the technology remains in its infancy. Even so, a key potential use for blockchain technology and crypto is in Decentralized Finance (DeFi). More specifically, crypto could be used to transform the way large transactions are settled between institutions and private individuals.

For example, a traditional high-dollar international wire can take several days to complete. Blockchain technologies supporting digital currency transfers, however, could offer a means to settle large transactions in minutes instead of days and at a substantially lower cost. For payment processors, this is big news and a key reason why Visa and Mastercard have entered the space.

To be sure, blockchain adoption might also find its way into widespread merchant payment processing services. Whereas banks and other intermediaries often charge around 2% to settle merchant card transactions, blockchain technologies might promote greater payment processing competition, leading to lower fees and higher profits for small and large businesses alike.

Does crypto belong in your retirement portfolio?

There’s a case to be made for the blockchain technology but does crypto belong in your retirement portfolio? While rapidly appreciating tokens have led to life changing money for some individuals, we believe that disciplined investors should view crypto as a long-term speculative investment that could go to zero for two key reasons.

First, the jury is still out on long-term token adoption. While Bitcoin remains the largest network, Ethereum is gaining mainstream popularity. That’s because Ethereum’s network is about to dramatically lower its energy usage, increase processing capacity and potentially end Bitcoin’s blockchain dominance. Either way, leadership in the space is likely to change a number of times in the coming years, making it that much harder to pick a winning cryptocurrency in the short-term.

Regulatory risk is another reason we view crypto as speculative near-term investments. Recently, the Chinese government enacted measures to curb bitcoin mining. This is important because the country accounts for 65% of the world’s Bitcoin mining hashrate. Similarly in May, U.S. policymakers hinted at the need for more crypto regulation. What’s more, central banks globally are in the process of developing their own digital currencies.

To be sure, crypto token investor should be comfortable with the idea of their investments going to zero. Nevertheless, blockchain likely will play a transformative role in finance, presenting a long-term thematic investment opportunity. From this perspective, we view a diversified allocation to traditional companies that facilitate blockchain adoption as an attractive component of a retirement portfolio.

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