What Place Does Cyptocurrency Have in Your Portfolio?

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There’s been a recent surge of interest in cryptocurrencies, such as Ethereum and Bitcoin. Bitcoin, in particular, is skyrocketing in value, but many detractors are rolling their eyes.

Cryptocurrencies rise and fall like a roller-coaster, and a fair number of people call them risky novelties. Do they really have a place in your portfolio?

What is a Cryptocurrency?

Cryptocurrencies are, by and large, complex algorithms that people agree are worth something. The value of a cryptocurrency unit is dependent on demand – the more people want it – and the more widely it’s used as currency – the greater its value.

Bitcoin and Ethereum are two of the best known right now, but many cryptocurrencies are out in the market. In fact, there’s around 900 of them in circulation, and more are expected to arrive every day.

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But is it a Serious Investment?

The financial world is actually more interested in the technology that powers certain cryptocurrencies, like Bitcoin. Blockchain technology (which we won’t go into here) is rapidly being adapted for use by banks and other financial institutions.

Still, that doesn’t mean the cryptocurrency itself isn’t taken seriously. These days, cryptocurrencies are acknowledged to have joined the list of exotic, alternative investments: like wine, art, stamps, and classic cars, they’re an asset chosen because of (theoretically) low correlation to the regular stock and bond markets.

Also attractive is the fact that cryptocurrencies aren’t controlled by any government. Unlike, say, the US dollar, there’s no central authority that can devalue it by choosing to print more of it. There is, for example, a limited number of Bitcoins in the world, which helps to lock in the value of each existing one.

While cryptocurrencies are not a great place to put your retirement fund, they can have a place in your portfolio. You’ll have to speak with your wealth manager for more details, but here are the basics you should know:

  • Don’t treat cryptocurrencies as “currencies”
  • Cryptocurrencies should be treated as speculative
  • Cryptocurrencies are highly dependent on support communities
  • Distinguish between “real” cryptocurrencies and chaff

Don’t Treat Cryptocurrencies as “Currencies”

Never count cryptocurrencies under the “cash” allocation of your assets. They are “currencies” in theory only – you cannot walk into McDonald’s and buy a hamburger with Bitcoin, or buy a condo with Ethereum (at least not yet, although investors dream of the day).

Never assume that cryptocurrencies are liquid (i.e. that there will always be someone willing to exchange cash for them, at a fair rate). You may find, at the time when you need cash, that the “market is down” and no one wants to buy your cryptocurrencies.

Cryptocurrencies Should be Treated as Speculative

Cryptocurrencies are extremely volatile. That is, their value swings up or down in large jumps. This means you can make a lot money, as well as lose a lot of money.

Most financial advisers (speak to yours for details) will suggest you put no more than five per cent of your portfolio into speculative assets. If the cryptocurrency should fail, you will take a manageable loss. If it does well, you would have made huge gains for taking a small risk.

Treat it as you would any high-risk, high-reward venture – be disciplined, and only invest what you’re sure you can afford to lose.

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Cryptocurrencies are Highly Dependent on Support Communities

Cryptocurrencies live or die on the activity of communities which use them. Remember: for cryptocurrencies to count as money, a group of people have to agree they have value. The bigger that group, the healthier and more valuable the cryptocurrency.

As an aside, a bigger community ensures you’ll have someone to sell your cryptocurrency to. If the community is too small, you may find few buyers when you need to offload it.

Bitcoin is probably the best supported cryptocurrency in the market, and beginners would do well to keep to it; at least until they understand the market better.

Distinguish Between “Real” Cryptocurrencies and Chaff

As a rule of thumb, only “real” cryptocurrencies should be seriously considered for a portfolio – the others are little more than gambles.

A “real” cryptocurrency is one that has seen actual-use cases.

For example, there are apps that allow Bitcoin to be exchanged for cash, and then used for purchases at Starbucks and Amazon. Bitcoin is also (unfortunately) used for certain Darknet transactions, which involve buying and selling (often) illegal items. The recent Ransomware attacks have demanded Bitcoin as a form of payment.

In any event, these are considered “real use” cases, which demonstrates people consider Bitcoin to have actual value.

Look for examples of where and how a certain cryptocurrency can be used. If you can’t see any exchange (other than buying and selling the cryptocurrency for cash), you may want to keep your distance for now.

Read This Next:

Is Investing the Same as Gambling?
Is Investing Better Than Saving Money?


Ryan
By Ryan Ong
Ryan has been writing about finance for the last 10 years. He also has his fingers in a lot of other pies, having written for publications such as Men’s Health, Her World, Esquire, and Yahoo! Finance.