Should You Allocate Part of Your Portfolio to Cryptocurrencies?
During the last decade, cryptocurrencies, namely bitcoin, have captured the world by a storm. The initial idea behind cryptocurrency investing might’ve been seen as a sort of ‘anti-establishment’ movement, as in – early ‘investors’ saw the opportunity to stick it to the age-old banking industry across the globe and promptly took it without much hesitation. However, slowly and deliberately, investing in crypto has taken over the world and looks like it’s here to stay.
Overall, the popularity of crypto investing owes everything to the modern rags-to-riches stories that have intertwined themselves with the rapid rise of bitcoin and other popular cryptocurrencies. And, much like with every other facet of our lives – it is human nature after all – we tend to believe and take account of the success stories much more often and freely than, well, the unsuccessful ones. This tendency, in turn, prompts us to inquire and look for such opportunities ourselves.
How does crypto investing work exactly?
While it would be preferable to understand how blockchains work and cryptos even exist in the first place, our primary goal is to understand the overall investment methods.
Similar to fiat currencies (Government issued currency that isn’t backed by a commodity, e.g. gold. Most currencies around the globe are fiat currencies), cryptocurrencies aren’t backed by a commodity and their value stems from the relationship between supply and demand.
Therefore, investing in cryptocurrencies in essence is similar to investing in the conventional currencies, where you buy and sell a currency in order to make profit from the difference.
Those of you who have followed cryptocurrencies for some time now will recognize, however, that cryptocurrencies tend to be much more volatile than the more conventional currencies. Sure, it could mean much higher rises, but it certainly means much lower dips in value, too.
The reason for this arises from the fact that cryptocurrencies are exponentially more prone to the ‘unknown’ – there are no uniform regulations or laws that regulate cryptos internationally, and they aren’t backed by any government like a national currency would be, thus making them increasingly vulnerable to any given occurrence (For example, a single tweet from an influential CEO of a tech company).
It’s possible to try and counter volatility, however. You can achieve this by diversifying your investment portfolio, for example. This holds true for cryptocurrencies as well as any other means of investment. By dividing your investment among multiple cryptos, you would perhaps put yourself at far less risk than gambling with just one.
Recently, more and more industry titans are looking to expand towards cryptocurrencies. For example, S&P Dow Jones rolled out 5 new cryptocurrency index products in the Summer of 2021 in addition to the 3 in May 2021. This is significant as it allows an investor to diversify their cryptocurrency portfolio without having to purchase separate coins, similar as with regular indices. There are now index funds and ETFs following cryptocurrencies, that allows you for much more affordable diversity and therefore – lower risk. And, when talking about investing of any kind, lowering your risk is utterly important.
Additionally, you can invest in companies that are either blockchain-related or accept any type of cryptocurrency in their day-to-day business as payment or investment. As cryptocurrencies grow in value, so do such companies.
How much of your portfolio should be in cryptos, then?
As with any type of investment, it all boils down to your personal risk tolerance. Considering the volatility of cryptocurrencies, investing any significant amount of your portfolio could either set you back a few years or let you retire earlier in life.
Hence, various professionals suggest that the amount allocated to cryptos should be no more than 1-5% of your portfolio’s total, with 1% being the most typical and welcome amount.
While a 1% of your portfolio might not seem like the amount that will set you up for life in case the investment blows up in value – it is also small enough to not set you back in the case of a value crash. Whether you bolster the amount up to 5% or more is entirely up to you. It’s the ‘due diligence’ in your research of cryptocurrencies, your risk tolerance, even your age. The younger you are, the more room for error you potentially still have, which rings true for investing, too. Subsequently, the older you are, the less room for error and less risky investments you can afford. If at all.
And cryptocurrencies are risky.
No matter how much research and time you put in choosing the coin(s) you want to invest in, cryptocurrencies are still much more prone to volatility for obscure reasons than the more conventional investment types. You can call it unsystematic risk, if you will. And with unsystematic risk, there really isn’t any way to protect your investment from it.
Unlike conventional currencies, cryptocurrencies are yet to be recognized in most parts of the world as legal tender. In turn, most governments do not yet have laws and regulations in place for cryptocurrencies, even if the use of cryptocurrencies itself is not prohibited.
While the lack of legislation and regulations can make crypto transactions more attractive to a certain type of person, it also deprives the investors of certain protections they enjoy when investing in other, more legally-sound assets.
For example, in the UK the FCA (Financial Conduct Authority) does not regulate cryptocurrencies and crypto-transactions, which means that the FSCS (Financial Services Compensation Scheme) will not help you in case of asset loss.
Similarly, across Europe and the rest of the world any type of regulation usually concerns the use of cryptocurrency for money laundering or other criminal activities, but does not protect investors and other law-abiding citizens that want to use cryptocurrencies.
Some governments take a more totalitarian stance and ban cryptocurrencies and corresponding transactions as a whole. China, Bangladesh, Qatar, Oman, Iraq, Egypt, Tunisia, Algeria and Morocco have all banned cryptocurrencies. These actions against cryptocurrencies send heavy ripples around the globe, adding to the price volatility of cryptos as well as uncertainty to the future of cryptocurrencies.
How to go about it?
Look, there’s no saying how much you should or shouldn’t allocate to cryptocurrencies when concerning your portfolio’s total amount. As previously stated, you and only you can decide what risk you’d be comfortable with. And, while the possible earnings from trading cryptocurrencies can be very enticing, the reality can often be disappointing.
Considering how little protection nationally or internationally you can count on, treading lightly is your best option. Investing from 1% up to 5% from your portfolio in cryptocurrencies can both help you avoid too much risk and destruction, while at the same time making sure you don’t entirely miss out on the ride cryptocurrencies can prove to be.
All in all, especially concerning all the aforementioned reasons, it’s best to consider any crypto investment as a mid-to-long-term gamble rather than a safe bet. And, while knowing when to get in on it is extremely important, even more so is knowing when to get out.