💥 Wild volatility: why crypto makes markets look calm
🪙 Digital coins vs. traditional investments
🎢 The psychology behind dramatic swings
📉 Lessons from past speculative bubbles
Executive Summary:
Cryptocurrency (“crypto”) is a complex and often confusing topic. Many retirees and pre-retirees wonder whether cryptocurrency should be part of their investment strategies. The following provides a basic overview of cryptocurrency; its potential risks and benefits; and crypto’s potential role in an investment portfolio.
Crypto Basics
At its core, cryptocurrency is digital cash that exists independently of the traditional financial system. It is not backed by physical reserves or government-controlled authority. Transactions are recorded and secured on a decentralized, distributed computer network. The name cryptocurrency comes from the cryptographic security that protects these transactions, which makes the network transparent while keeping individual user identities anonymous.
The original concept for cryptocurrency, specifically Bitcoin, emerged in 2008, during the financial crisis. The individual or group who created Bitcoin, who remain anonymous, sought to develop an alternative financial system that did not require centralized authorities acting as overseers and processors. They saw traditional financial institutions such as banks as flawed. This new system was designed to allow for direct, instantaneous, peer-to-peer transactions free of default risk.
Many early crypto enthusiasts were drawn to the promise of a monetary system resistant to government influence, particularly governments’ tendency to inflate their currencies’ values away over time. Bitcoin, for example, has a fixed supply.
Some believe a cryptocurrency such as Bitcoin could eventually replace traditional fiat currencies like the U.S. dollar. However, that view is not widely shared. The general consensus is that cryptocurrency will not replace traditional currencies for day-to-day transactions in the foreseeable future.
Over the last 15 years or so, the number and purpose of cryptocurrencies expanded significantly. Many of today’s cryptocurrencies have evolved beyond the original digital currency concept. Some even function similarly to stocks and bonds, albeit independently of the traditional financial system.
The Risks of Crypto Investing
For individuals seeking a stable, secure investment for retirement, cryptocurrency presents several significant risks. The first and most important is lack of regulatory oversight. Unlike traditional stocks and bonds, the crypto market operates with very little government or consumer protection. It is an area where regulations are still being debated and developed. There are currently few rules against insider trading or market manipulation, which can lead to rapid and unpredictable price swings. Crypto trading can be susceptible to manipulation.
The extreme volatility of cryptocurrencies is another major concern. Prices can swing massively over very short periods, creating potential for significant losses. Extreme volatility is typical of highly speculative assets.
Cybersecurity risks are also a threat. Scams, hacks, and even the simple loss of a digital key can lead to permanent investment losses. The complexity of converting between different crypto tokens and back into U.S. dollars can also present challenges. This typically involves the use of intermediary cryptocurrencies called “stablecoins,” which function similarly to money market funds in the traditional financial system. This complexity may lead to liquidity issues when attempting to transfer value from the traditional financial system to crypto, and vice versa.
The Potential Benefits of Crypto
Despite its risks, the crypto market remains attractive to many investors, particularly those with a high risk tolerance. One of the biggest attractions for many investors is the potential for high returns. Early buyers of cryptocurrencies like Bitcoin and Ethereum have seen enormous gains. Gains of this magnitude inevitably attract additional investor interest.
Another benefit lies in the underlying technology. For some, the philosophical appeal of a decentralized system that bypasses traditional financial institutions is the primary selling point. The technology also allows for instantaneous, low-cost international transactions, bypassing the lengthy delays and high fees associated with traditional bank transfers.
Finally, simply participating in a cutting-edge, innovative market can be an attraction in and of itself. The underlying blockchain technology, which underpins most cryptocurrencies, is seen by many as a revolutionary technology that could have significant applications beyond its use as digital money.
A key difference between cryptocurrencies and traditional investments is how they are valued. When analyzing stocks, for example, investors can use well-established frameworks to assess a company’s value based on projected cash flows and earnings. This allows for a logical assessment of whether a stock is a good investment.
Valuing Crypto Assets
Valuation methods for cryptocurrencies remain in their infancy. Without cash flows, it is impossible to conduct valuation in the traditional sense. As a result, crypto is often traded based on speculative methods, such as charting historical prices or assessing potential value as a kind of digital collectible. These speculative approaches are not well-suited to managing portfolios retirees must rely on for income.
Does Crypto Belong in a Retirement Portfolio?
When it comes to building a retirement portfolio, a foundational principle is to adopt a consistent, well-defined framework for decision-making. The speculative nature of crypto trading and valuation do not lend themselves to a disciplined framework at this time. Likewise, crypto’s extreme volatility and unregulated status render it unsuitable for many retiree portfolios. The crypto market continues to exemplify many uncertainties of the evolving financial world.
We recognize some investors with a high risk tolerance may still be interested in owning and trading crypto. In our view, the best approach is to treat cryptocurrency as a small speculative investment. A retiree should only invest an amount they are willing to lose completely—an amount that will not jeopardize their retirement security. This creates a lottery ticket-like payoff profile. The crypto investment may appreciate significantly, but the overall portfolio and retirement plan will not be at risk of catastrophic losses.
Clients should consult with their financial advisor before making any decisions about investing in cryptocurrency to ensure it fits appropriately within their overall financial plan.
Authors:
Ryan Wyatt, CFP®, CIMA®
Nick Lewandowski, CFA®, CFP®
Ron Wyatt, CFP®, CIMA®, CPWA®
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This communication is provided by Wyze Wealth Advisors LLC, a registered investment adviser. All material is for informational and educational purposes only and should not be considered personalized investment advice or a recommendation regarding any specific security, strategy, or product.
The assumptions and scenarios presented are illustrative and do not reflect actual investment results. Projections are based on current market conditions, which may change. Past performance is not indicative of, and does not guarantee, future results. All investments involve risk, including the potential loss of principal.
Investment decisions should be made based on an individual’s objectives, risk tolerance, time horizon, and financial circumstances. Additional information about our services, fees, and Form ADV Part 2A is available upon request.
