3 Must-Knows Before Investing in Crypto
Crypto is getting a lot of attention, but there are risks. Is now the time to jump in?
Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Fidelity Investments recently announced that it will offer its employer-sponsored 401(k) plans the option to invest in bitcoin. A few weeks ago, Morningstar launched a digital assets fund category, and many cryptocurrencies are trading well below their all-time highs. Is now perhaps the time to invest in crypto? Here to help answer that question is Madeline Hume. Madeline is a senior research analyst for Morningstar, who recently published Morningstar's first cryptocurrency landscape report.
Hi, Madeline, nice to see you.
Madeline Hume: Thanks for having me, Susan. So, excited to be here.
Dziubinski: Now, there were a lot of interesting things that came out of your research. But one thing that really struck me and surprised me was that you say in your research that cryptocurrencies represent the fourth-most-popular type of investment among investors behind stocks, mutual funds, and bonds. How did that happen?
Hume: Yeah, it's a pretty crazy story, Susan. It really drills down to two basic elements: investor interest and a mild corporate adoption. So, we see when crypto really takes off, the chart looks like basically a hockey stick. So, for a long period of time there was a gradual increase in investors showing a little bit more interest in cryptocurrency, and then there's an inflection point, and after that it just really took off.
Now, what was happening at that time? This was early 2021. So, this was still during the pandemic. People were at home. They were flushed with cash from the stimulus. And you had companies like Tesla TSLA that were saying they're going to start adopting bitcoin in their treasuries. One thing led to another, and all of a sudden, you see retail interest really snowball into this kind of massive momentum event. So, you have stories like NFTs taking off, you have decentralized finance protocols really starting to soar. And when you combine that with the massive growth that some of these tokens have realized, it started as a snowball and now we have an avalanche.
Dziubinski: Now, in your research, though, despite the avalanche, you do say that investing in currency warrants--and I quote you--"extreme caution." So, let's unpack that caution a little bit and some of the reasons for it. For starters, you point out that this is still a relatively new asset class. So, why is that something that should matter to investors? Why is that something that they should maybe be a little concerned about?
Hume: That's because cryptocurrencies at this point just don't have a ton of use cases outside of the four corners of our brokerage windows. We're still figuring out how blockchain technology belongs in our everyday lives, and that is an ongoing and iterative process. At this point, investor speculation about where it could go and where these sorts of technologies will start to take flight--back in 2020, none of us were talking about NFTs or decentralized finance or any of these topics. So, the market is evolving really quickly on a lot of these fronts. So, as things continue to develop within cryptocurrencies, it's really important to treat them as investments that are really kind of like an entrance fee to experiment with the technology, and not so much like a stock or a bond with fundamental values that we can measure.
Dziubinski: You also note that this asset class is highly concentrated. So, what do you mean by that? And again, why is this something that investors should be aware of?
Hume: So, I talked about entrance fees and experimenting with the technology. A close example that cryptocurrencies have been compared to frequently is tech stocks. A lot of times these technologies do have parallels to the tech boom that we had in the early 2000s. One way that that comparison is pretty apt is concentration, like you mentioned. bitcoin and ethereum alone take up more than 50% of the cryptocurrency market. And so, when you have an asset class that is so dependent on one or two individual securities, that courts a lot of volatility. We see that with tech stocks, too. I mean, if you look at the FAANG, when Netflix NFLX does poorly, the rest of the market suffers. So, it's just something for investors to keep in mind.
Dziubinski: And then, lastly, you note that this asset class is highly volatile, which we, of course, have seen a good deal of this year and the end of last year, too. But again, if you're a long-term investor, is that volatility really bad? Who should be concerned about that volatility?
Hume: Yeah, it's a great question. So, when you look at volatility, when it really starts to matter is when you're drawing down your investments. So, long-term investments like retirement, there's that accumulation phase and during that accumulation phase volatility matters as frequently as you check your 401(k), right? Out of sight out of mind. But once you start drawing down on those assets and selling out of them, that's when volatility really starts to matter. Investors can get spooked, and they can sell at the wrong time, and you can impair your capital that way. But even if you're making more-regular withdrawals from your portfolio, treating it like a paycheck where you sell out a specific time each month, over time, with extremely volatile assets, if you're selling during a market downturn, you can permanently impair your capital. This is called sequencing of returns risk, and it's a reason that cryptocurrencies are an enemy of retirement portfolios.
Dziubinski: And then, let's go back to the question that I sort of posed at the top of this video. Is now the time for investors to be considering cryptocurrency? And if it's a partial yes, why is it partial? Who should be looking at it, if anyone, in your opinion, right now?
Hume: To be honest with you, Susan, with cryptocurrencies, we don't really know what a good time to be invested in it is. It's still so early days with this kind of technology, and we don't have valuations the way that we do an equity investment or a bond. There is no floor for where the price can go. A lot of these assets could plummet to zero tomorrow. And before everything is said and done, there probably will be some assets that do die out, and those investors will be left with nothing. They call it “holding the bag” in crypto speak. You know, the Kentucky Derby was just last week. So, when I think about crypto, I like to think of it more like a bet, right? We don't know which horse is going to come out on top. The best thing that investors can do when they're looking at these types of things is to hedge their bets.
Dziubinski: Well, thank you so much for your time, Madeline. This is a very popular topic right now, and I'm sure we'll be talking to you more about crypto as the landscape continues to evolve. Thanks.
Hume: Thanks so much, Susan.
Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.
Download Morningstar's Cryptocurrency Landscape report.