Key Considerations Before Diving into Digital Currencies

It’s easy to believe cryptocurrencies are far too futuristic to be thinking about now, but they are rapidly becoming a more mainstream asset that investors should at least have on their radar – with certain caveats in mind.

As the infographic below shows, there are many amazing facts about bitcoin. But despite the sensationalist way they are often presented in the media, cryptocurrencies aren’t just a novelty – and still less merely a tool for murky dealings via the “dark web”. Cryptocurrencies are increasingly entering the mainstream of financial services and retail and so many see them as a very interesting investment opportunity indeed.

Bitcoin, which first launched in 2009, is the undoubtedly what springs to mind when one thinks about crypto- or digital currencies. Yet large-scale advertising campaigns in the UK have recently brought others such as ethereum and litecoin into the spotlight and underscored that digital assets are no passing fad.

There is, however, a lot of jargon and hype surrounding this topic for investors to get to grips with. So, while your wealth manager will doubtlessly have expertise in digital currencies, it is well worth familiarising yourself with a few key concepts and developments before discussing their potential with them.

What are cryptocurrencies?

In simple terms, cryptocurrencies are digital representations of wealth in which sophisticated encryption techniques govern how many units can be generated and verify the transfer of funds. The foundation technology is mostly blockchain, a virtual distributed ledger of transactions shared peer-to-peer across a public network of computers in a transparent and tamper-proof way.

What are their uses and appeal?

The appeal of cryptocurrencies is therefore manifold – both for individuals and institutions making transactions, and therefore also for investing in them as an alternative asset class.

Firstly, the number of units that can be generated – or “mined” in the parlance of blockchain – is limited: there will only ever be 21m Bitcoins (of which 16.4m are currently in circulation), with the limit expected to be reached in 2140. As such, many view cryptocurrencies as representing more stable stores of value than fiat currencies in a world where central banks are very much enamoured with “printing” more money in rounds of quantitative easing.

Furthermore, because digital currencies are beyond the power of any individual government, they offer citizens a way to store wealth without fear of confiscation or restriction of movement.

Secondly, because of the transparent, secure way transactions in digital currency may be recorded, advocates see huge potential for efficiencies and cost-cutting in financial services – namely in payments, syndicated loans and equity clearing. In fact, it is thought that banks utilising blockchain stand to save $8-12m a year and as a result some 70% are experimenting with applications of the technology.

Thirdly, the possible uses of cryptocurrencies are incredibly wide-ranging as they may be used as either a digital representation of regular currencies, or as currency in themselves. Although the anonymity the latter confers has meant cryptocurrencies have found favour in the criminal underworld, regulators globally are increasingly cracking down on exchanges and distributors to reduce the potential for their use in money laundering and other nefarious purposes. Meanwhile, legitimate ways for Bitcoin and other digital currencies to be used have rapidly grown.

You may not be aware, for instance, that Bitcoin is currently accepted by approaching 100,000 retailers and organisations worldwide, from independent coffee shops right up to universities. Transacting is also increasingly visible in the real world, with seven Bitcoin debit cards available and 1,345 Bitcoin ATMs now in use across 55 countries. The fact that the FBI owns 1.5% of the world’s Bitcoins shows that cryptocurrencies are being taken seriously at the very highest levels today.

Can digital currencies be a serious investment?

It goes without saying that digital currencies are a particularly esoteric area in which investors would be foolish to dabble.

Valuations have certainly rocketed and many people many people have become very wealthy indeed through owning digital currencies. Bitcoin has hit a market cap of $73.5 billion (as of last month), taking it within sight of technology giants like Netflix, and as a whole cryptocurrencies’ market cap has surged by almost 800% to date to reach around $159bn.

A number of “spread-betting” type platforms have sprung up to cater for the huge interest that has naturally resulted from this growth, but non-professional investors should be very wary of “investing” in currencies in this way generally – let alone in virtual ones. Currency movements may be sudden and violent, and losses potentially very much larger than the original stake when using instruments like Contracts for Difference. There has been marked volatility stemming from Bitcoin’s split into two separate cryptocurrencies, for example, with recent weeks seeing both record-high valuations and dramatic slumps.

Happily, there are a growing number of ways for investors to gain access to the exciting world of digital asset management through more traditional, advised wealth management routes.

A few private banks have already started to allow clients to buy and sell digital currencies using their cash holdings, for example, while regulated funds dealing and denominated in cryptocurrencies have recently become available too.

The options will just grow and grow, yet caution and sensible allocations must remain your watchwords. Alternatives should only ever make up a small proportion of most investors’ portfolios, and the riskier, less predictable ones a smaller part of the mix still.

It may be, however, that you favour a “core-satellite” approach to investing, where you have a main portfolio managed in line with very tight risk parameters and then another smaller one of funds where you are happier to take on more risk in a bid to see higher returns. A wealth manager will be able to advise you on how to optimally balance your investments to meet a variety of needs – including those for fun, should you so choose.

Your next steps

Cryptocurrencies are a very exciting area of investments, but we needn’t cast our minds too far back to recall how the bubble has burst for many other investment crazes, particularly those around new technologies.

How far governments will continue to sit back and watch the power of central banks be eroded by cryptocurrencies is just one key consideration you need to explore before piling in. Which cryptocurrencies to invest in, and the best instruments to access them through are others.

In short, investors interested in digital currencies need to always bear in mind that they are indeed a serious investment and should be treated as such. Like any other alternative investment, they should only be entertained as part of a carefully considered asset allocation that takes full account of how their risk-return profile will interact with the rest of an individual’s portfolio.

A small “bet” might be fun, but losing pension or other important funds just to be part of the latest trend emphatically would not. As ever, you should speak to a professional before making any significant financial decisions to ensure that you can meet your objectives.

To start a conversation with the findaWEALTHMANAGER.com team to see how we can help you find the right adviser for your needs, click here.

Key Considerations Before Diving into Digital Currencies

Infographic Source: Bitcoin Play

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