Crypto has taken the world by storm – but from NFTs to DAOs, DeFi to blockchain, should you make a space for it in your investment portfolio?
The crypto universe can be quite complicated to figure out. In reality there’s no one ‘sector,’ rather it is a mish mash of a lot of different technologies, ideas and projects that define themselves as alternatives to traditional finance and digital services, and are typically based on ‘blockchain’ technology.
The grandfather of crypto – bitcoin – is one of the oldest cryptoassets out there. Bitcoin is unique because of its age, establishment as a household name, and its value. It is based on a blockchain, which is essentially a decentralised network of computers and computer code that all work in unison to verify a distributed ledger of ownership of the token.
Then there is Ethereum – an upstart blockchain created by Russian-born Canadian programmer Vitalik Buterin. Ethereum and its token, ether, is probably the single largest rival to bitcoin, but it is still way behind in terms of value.
There are a myriad of projects that make up the universe, many of them referred to by names such as ‘Web3’ or ‘DeFi.’ Ethereum is included in this.
DeFi is a segment of the market that purports to offer truly ‘decentralised finance’ – hence the DeFi moniker. DeFi is, broadly, a movement to create financial systems and infrastructure that doesn’t require a central supervisor, such as a bank. Again, this is a diverse area of crypto with many different tokens and projects, but some famous ones include Avalanche, Cardano and Polygon.
On top of this you have stablecoins. Stablecoins are touted as a bridging technology between traditional finance – ‘TradFi’ – and DeFi. They are digital coins or tokens that, unlike many cryptos such a bitcoin that swing in price, remain stable in value and are pegged to traditional currencies such as the US dollar. Well-known examples include DAI, Tether and USD Coin.
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Finally, another major part of the market which has emerged in the past year is non-fungible tokens or ‘NFTs’. NFTs are a digital technology that underwrite ownership of anything of value that can’t be exchanged like a currency. Artwork is a really good example of this, with the emergence of series such as Bored Ape Yacht Club and others.
Can I invest in this?
Investing sits at the core of the cryptoasset world but buying into the universe can be easier said than done. In order to hold cryptoassets such as bitcoin or ether you’ll need to get a digital wallet that can hold them. That is the first step.
But you also need to consider important aspects of the token you’re looking at:
● Why does this token have value?
● What is its use case?
● Who is behind the token or project?
● Does it appear trustworthy, and is there a track record?
Unfortunately, the crypto sector is plagued by scams, often referred to as ‘rug pulls.’ This is where a speculative token creator encourages and hypes up their own creation, often accruing millions in cash from eager investors. The creator then ‘rug pulls’ and disappears with the cash, leaving the investors with worthless tokens and no actual project to speak of.
The other major issue with cryptoassets is their volatility. The stock market has had a fairly torrid start to 2022, but broadly speaking over time the market tends to rise and investments produce growth and returns.
But cryptoassets, with a much shorter history, tend to swing in price wildly. For instance, bitcoin exploded in value in 2017, reaching a value of nearly $20,000 per token. But the price then collapsed below $10,000 and stayed there until 2020, leaving many nursing significant losses.
The token then took off massively at the end of 2020 and beginning of 2021, rising to around $60,000 – a 500% increase. It then crashed to around $30,000 in mid 2021, before again skyrocketing to nearly $65,000. It is now trading down again, around $40,000. The trouble with this is it makes it extremely difficult to manage your investments and maintain sanity – their value swings wildly and can lead to bad decisions which crystalise losses.
Should I invest in crypto?
Crypto is definitely a sector worth considering, but with such a short track record, anyone should think very carefully before diving in. As described above, the crypto universe is broad and full of exciting worthwhile projects. But there are major risks involved in it too.
Many of the projects are unproven. Like any emerging industry, there will be winners and losers. Some tokens will become the Facebook and Google of crypto – others will become the MySpace and Ask Jeeves of Web3.
If you are convinced by the investment case for crypto, we would advocate that you should only put a maximum of 5% of your portfolio into the sector, as it is very high-risk. For younger investors such a risk might be acceptable, but older investors nearing pension age or in pension drawdown should probably steer clear.
