Investment Viewpoint: A Deeper Look at Cryptocurrency

History has shown us that every generation experiences its own wave of “next big thing” investments—whether it was the dot-com boom of the late 1990s, real estate speculation in the early 2000s, or even the gold rushes of the 19th century.

While these opportunities often captivate headlines and spark enthusiasm, they can also lead to speculative frenzies where emotions, rather than careful planning, drive decisions. Cryptocurrency is the latest example of such a phenomenon, capturing public imagination and creating dramatic market stories.

Cryptocurrencies, particularly Bitcoin, have garnered significant attention over the past decade. Initially envisioned as a decentralized alternative to traditional currencies, their role has evolved. At OneDigital, we believe that there are many factors to consider when working with an advisor to decide about the inclusion of any investment in a portfolio. Some of these factors include risk tolerance, liquidity needs, suitability and long-term objectives. Discussing the role of each of these critical components with a financial professional and understanding impacts is a critically important step.

While cryptocurrencies such as bitcoin have introduced innovative concepts and technologies, their current role is more aligned with speculative investments than practical currencies. Unlike traditional investments, they lack natural methods for generating returns and rely heavily on market demand and speculation.

As the market evolves, it remains to be seen whether cryptocurrencies will develop into stable, widely accepted currencies or continue to be viewed primarily as speculative assets.

Opportunities and Risks of Portfolio Inclusion

The cryptocurrency market offers both potential opportunities and significant risks for investors. Each of these pros & cons should be weighed when considering them for portfolio inclusion.

Opportunities:

1. Portfolio Diversification: Cryptocurrencies can serve as a non-correlated asset class, potentially reducing portfolio risk during market downturns.
2. Potential for High Return: As an emerging industry, cryptocurrencies could provide substantial growth opportunities, with the potential for high returns as demand increases and technology continues to evolve.
3. Global Accessibility: Cryptocurrencies can facilitate cross-border transactions with lower fees and greater speed.

Risks:

1. Volatility: Extreme price swings can lead to significant gains or losses over a short time.
2. Regulatory Uncertainty: Governments worldwide are still defining their approaches to cryptocurrencies and policies could impact the viability and value of cryptocurrencies.
3. Security Concerns: Despite blockchain’s inherent security, exchanges and wallets remain vulnerable to hacking and loss.
4. Speculative Nature: Many investors buy cryptocurrencies hoping for price appreciation rather than using them for transactions. However, it's important to note that the IRS treats cryptocurrency as property for tax purposes. This means that any transaction—whether for investment or for the purchase of goods—could be subject to capital gains tax. (See IRS Notice 2014-21 for more details.)¹

Matters of Reliance

Traditional investments like stocks and bonds have intrinsic mechanisms for generating returns. Stocks represent ownership in a company, which can generate profits and pay dividends, while bonds are debt instruments that pay interest over time. Both have underlying assets or business activities that create value. In contrast, cryptocurrencies do not have inherent value-generating mechanisms. They do not produce cash flows, dividends, or interest. The value of a cryptocurrency is primarily driven by market demand and the willingness of others to buy it at a higher price.

This reliance on market demand for value appreciation in cryptocurrencies aligns with what is referred to as the "Greater Fool Theory.” This theory suggests that one can profit from buying an overvalued asset by selling it to someone else at a higher price. This strategy relies on finding a new buyer willing to pay more. However, if the market realizes the asset is overvalued, the price can drop quickly, leaving the last buyer with a loss. This speculative nature makes cryptocurrencies highly dependent on market sentiment and investor behavior rather than any type of economic value.

We are not suggesting that incorporating these types of assets into a portfolio is foolish. In fact, the U.S. dollar itself is only valuable as long as we, the people, believe it to be. For some investors it may be appropriate to consider adding speculative investments, like cryptocurrencies, to a diversified portfolio. A small allocation might enhance a portfolio's overall risk-return profile. What we are suggesting is that it is crucial to approach any allocation with caution, given the high volatility and speculative nature of these assets.

Conclusion

As your financial professionals, our role is to provide perspective amid this noise and help you focus on what truly matters: your long-term financial plan. While it’s tempting to chase trends or react to short-term excitement, history teaches us that disciplined investing and adhering to a thoughtful strategy are what ultimately lead to success. Markets will always change, and new opportunities will emerge, but your goals remain the foundation of everything we do.

The cryptocurrency market may evolve in ways we can’t yet predict, and it’s natural to feel curious or even anxious about “missing out.” However, staying calm, informed, and deliberate is key. Together, we can determine what—if any—role these investments should play in your broader portfolio, ensuring every decision aligns with your needs, risk tolerance, and long-term vision.

The Mechanics of Cryptocurrency

To understand cryptocurrencies and their implications, it’s essential to grasp the underlying technology and economic principles:

1. Blockchain Technology: At the core of most cryptocurrencies is blockchain, a decentralized digital ledger that records transactions across multiple computers. This technology works to provide transparency, immutability, and security, which are vital to cryptocurrency’s functionality.
2. Supply and Demand Dynamics: Many cryptocurrencies, such as Bitcoin, have a capped supply (e.g., 21 million coins). This scarcity principle, combined with growing demand, is a significant driver of price. However, while supply may be capped within a single cryptocurrency, there is no limit to the number of cryptocurrencies that may be launched.
3. Decentralization: Unlike traditional currencies, cryptocurrencies are generally not controlled by a central authority. This feature appeals to those seeking an alternative to fiat money, particularly during periods of political or economic uncertainty.
4. Mining and Energy Use: Mining is the process by which new cryptocurrency units are created and transactions are verified. However, it is energy-intensive, with Bitcoin mining alone consuming more electricity annually than some entire countries [Source: Cambridge Bitcoin Electricity Consumption Index] highlighting significant environmental and sustainability concerns.

¹https://www.irs.gov/pub/irs-drop/n-14-21.pdf

Investment advice offered through OneDigital Investment Advisors LLC.

This is for informational purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation. While the information is believed to be accurate, it is not guaranteed and is subject to change without notice.

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