Does Bitcoin Have a Place in Your Investment Strategy?

In 2013 I bought my first Bitcoin. I was a financial advisor at a not-to-be named wirehouse in Clayton, Missouri and a friend tried to explain to me what blockchain was. At the time, Bitcoin was around $50 per coin.

 

In 2013 I sold my first Bitcoin.

 

After all, how high could this “currency” actually go?  There was no useful application, few people understood what blockchain was and you can forget about cash flows, tangible assets or even an easy way for those who were interested to buy it…and I was up over 100%!

 

Oops.

 

But this isn’t an article about my investment successes and failures, nor is it going to teach you everything you ever wanted to know about Bitcoin.  My hope in this article is to highlight some of the reasons investors are excited about Bitcoin and yes, how it may play a part in your portfolio.

 

In the Beginning…

 

The idea of Bitcoin was first introduced in a paper by Satoshi Nakamoto in 2008, and began it’s useful (if one can call it this) application in 2009.  No one knows who Nakamoto is and to this day it remains a mystery as to whether it’s an individual, group of individuals, government agency or someone else.

 

A Bitcoin is created or generated by a process known as mining.  Similarly, a Bitcoin miner receives bitcoin for completing “blocks” of verified transactions which are then added to the blockchain.

 

Supply and Demand

 

One of the distinguishing factors cited by Bitcoin bulls is its finite supply.  Written into the code of Bitcoin is a limit as to the number of Bitcoins that can be created – about 21Million.  Currently there are about 18.5MM in circulation and for a number of reasons beyond the scope of this article, the final Bitcoin won’t be mined until about the year 2140.

 

Due to the finite supply, investors concerned about inflation (devaluation of a currency) may be interested in holding Bitcoin.  In an economic downturn, central banks have a tendency to stimulate the economy by printing more money and injecting more liquidity into markets.  This has the effect of supporting the markets and their participants, but may devalue the currency (remember supply’s impact on price from Econ 101?).  With Bitcoin, there is no central bank that can print (or mine) new Bitcoin in the event of an economic downturn.

 

Comparisons to Gold

 

Given its properties as an inflation hedge, many have likened Bitcoin to gold, another (perceived) inflation hedge, and some refer to it as digital gold.  Gold however, is of course a real, tangible asset (with real miners).  While there isn’t exactly a finite supply – people are still mining it – it’s a real asset that can’t be inflated away very easily.

 

For decades, people have used gold as a hedge against rampant inflation, and it’s performed well in the handful of years since 1980 when inflation exceeded 5% – an average return of over 14% in those years.  Many investors – retail and institutional in nature – hold gold as a small portion of their portfolio in hopes that it outperforms when other assets are underperforming.  As a result, gold as an asset class is valued at somewhere between $10T and $11T.  For reference, as of this writing, all of the Bitcoin in circulation is valued at slightly under $1T.

 

Buyer Beware

 

Bitcoin is volatile.  It’s prone to 10 and even 20% swings – up and down – over the course of days and even hours.  Investing in Bitcoin means accepting that this whole experiment may not work in the end.  After all, Bitcoin isn’t a company that holds tangible assets (real estate, furniture, computers, etc.) or has cash flow from its operations.  It’s more of a currency, though currently much harder to use than most currencies.  While it’s easier to purchase today than it was a year (or 10) ago, it’s still relatively difficult to spend on goods and services.

 

As with most currencies, its value is fundamentally based on whether people perceive it to have value – and have confidence that they can purchase goods, services and/or convert it back to fiat (non-digital, government) currencies.  There is no guarantee that scarcity and relative undervaluation (to gold) is sufficient to support the value of Bitcoin or any other digital currency.  In the end, it may just not work.

 

What do I REALLY Think About Bitcoin?

 

I began discussing Bitcoin in early 2020 with a study group I’m a part of.  This is a fantastic group of five Registered Investment Advisor (RIA) owners, all of whom are CFPs and a few CPAs and other impressive letters after their names.  Needless to say, bringing up Bitcoin to a group of tried and true asset allocators (read: non-stock pickers) and fiduciaries met with significant skepticism.

 

Importantly, all members – including me – decided that while it may be a good long-term investment, it’s almost impossible for a full-time fiduciary a.k.a a fee-only advisor (all of us met this criterion) to recommend or place into an account.  At this point, it’s simply too risky to recommend.  Sure, I believe each investor should have a small allocation of 1-5% in speculative high-risk, high-reward investments.  This number is unique to each investor and is based on risk tolerance, but also total net worth, time horizon, and overall financial picture.  As mentioned above, someone investing in any digital currency needs to accept that they may lose all of their invested capital.  However, if an investor can accept the risks – and there are many – there’s also a possibility that they may find a pot of (digital) gold in the end.