The how, what, and why of cryptocurrency.
Jake VanKersen: A few years ago, financial experts said cryptocurrency was nonsense, but flash-forward and now some of them are saying you should have 1% to 2% of cryptocurrency in your portfolio. With the conversation around cryptocurrency changing so quickly, you might be wondering how it works and whether or not you should consider it.
Kristoffer Inton: The concept of cryptocurrency has been around for years, but the modern cryptocurrency boom began with the launch of bitcoin in 2009. There are now thousands of cryptocurrencies in existence, but some of the most popular ones include bitcoin, Ethereum, Litecoin, and Ripple. The basic idea is that units of cryptocurrency are created through mining, in which computers solve complicated math problems to generate coins. The original motivation for this currency was that it's not regulated and under the radar. This is why it's curious that companies like Facebook, who are notorious for tracking everything their users do, and governments have been getting into the crypto game.
VanKersen: You know, I get the sense that some cryptocurrency enthusiasts might shudder at the thought of regulation, but couldn't that help it in the long run?
Inton: Well, I think the thing is: If it's going to be a currency, which is its original intended purpose, then it doesn't make sense for regulation. But since it's arguably become a store of value or investment asset, regulation could make sense, because then it will allow them to purge the bad actors like terrorism, drugs, etc.
VanKersen: Long term, do you see cryptocurrency ever being used for day-to-day transactions?
Inton: We don't think so. And in fact, it seems that it's being referred to as one less and less. Because there's no consumer demand for cryptocurrency for anything other than investments, its price is entirely predicated on future demand.
VanKersen: Which is different than, say, gold, because even if everybody decided that gold wasn't a good store of investment tomorrow, then there would still be a consumer demand for jewelry and whatnot?
Inton: Right. If everyone decided tomorrow that a cryptocurrency wasn't a good store of investment, there's no real price floor to catch the fall. That makes it super-volatile, and that volatility makes it even more difficult to confidently say X bitcoin is equivalent to X dollars for transactional purposes.
VanKersen: Yeah, I remember the story about the guy that bought a pizza for like 10,000 bitcoins back in 2010 because then it was as low as something like, I don't know, $0.25 or something like that, which, given that volatility, why are some now suggesting to have cryptocurrency in your portfolio?
Inton: Crypto is probably best considered as a speculative asset. Some of those experts think it works well as a diversifier because it doesn't seem to be moving with a larger economy. That being said, its short history makes it difficult to stamp that quality with significant certainty.
VanKersen: Given that, how could one evaluate whether or not cryptocurrency is good for their portfolio?
Inton: I guess the first question is: How much are you willing to lose? There's always the possibility that speculative assets could lose all their value. What the risk profile of your portfolio looks like is a good question, too. Adding speculation to something already risky is different than a portfolio of lower-risk assets. And lastly, think about your financial situation. Someone that needs asset preservation, like being near retirement, or someone young in their career have very different financial needs.
VanKersen: Chris, I know you don't have a crystal ball or access to a time machine--that I know of. But still, I was wondering if you could tell us if you have any expectations for the future of cryptocurrency.
Inton: It's hard because we're only a little over 10 years into cryptocurrency. We don't have the hundreds of years of historical knowledge that we do for gold. But based on the growing acceptance of cryptocurrency by financial institutions and regulators, there are signs that it might be around for a while. Additionally, it will be interesting to see if anything other than bitcoin emerges as the top player. Because there's so many cryptocurrencies out there, it's unclear if there's any real reason why bitcoin is the one that's really survived and thrived beyond being the biggest and most well-known.
VanKersen: Kris, thanks for helping us mine the details from all the buzz about cryptocurrency out there.