Should you Hold Bitcoin as Part of a Diversified Portfolio?

Amid the hoopla over the recent meteoric Bitcoin price rise – from $968 at the end of 2016 to over $16,500 on 11 December 2017 – some are now questioning whether the cryptocurrency should be taken more seriously. While we don’t agree that you should hold Bitcoin as part of a diversified portfolio, we believe its properties are worth exploring nonetheless.

When JP Morgan’s CEO Jamie Dimon denounced Bitcoin as a “fraud” in September 2017, and the price initially slumped, many started to wonder whether its mesmeric ascent would finally reverse. Far from it, if anything its price gained momentum after recovering. So is it time to take Bitcoin more seriously?

What is it?

Bitcoin began life in January 2009, just before the world economy began to emerge from the Global Financial Crisis (in March that year). It quickly became the standard-bearer for cryptocurrencies – digital assets designed to be exchanged using the tightest encrypted security. Its allure was also enhanced by the scent of the ‘new’, as well as the mystique surrounding its alleged founder, supposedly Satoshi Nakamoto.

Bitcoin is a digital currency, held electronically, and uses what is known as a huge distributed ledger (the blockchain) to store and verify the details of every transaction. Transactions are verified and added to the public ledger by a process known as Bitcoin mining – using special software and hardware – which is also how new Bitcoin are released.

While Bitcoin appears to have both detractors (because it’s not backed by any actual assets) and proponents (speculators or holders) in equal measure, the blockchain technology behind it has more of a solid grounding.

Fans of blockchain

The Bank for International Settlements (BIS) reported in September 2017 that several central banks were exploring the use of cryptocurrencies. Professional services company EY announced in November 2017 a “multimillion-dollar investment in blockchain talent, technology and facilities within Europe”. Recording artists like Bjork enjoy the potential to directly connect with the wallets of listeners.

Widespread blockchain adoption, however, is still in the future. Grabbing headlines now is the mania behind the Bitcoin price.

On manias and overconfidence

Many predict that Bitcoin’s price surge could have consequences like the Dutch tulip bulb mania of the 17th century, the South Sea Company’s precipitous rise and fall in 1720 and the dotcom bubble of the late 1990s – events which the chronicler Charles Kindleberger labelled a “hardy perennial”.

The truth, and the outcome, may be more nuanced. Some figures (from BullionVault’s gold investor index) suggest that a cooling of first-time gold purchases could be due to Bitcoin’s rise. A recent article in The Atlantic explored the nature of currencies, whether sharing money is in itself built on illusion and examined whether even the dollar’s foundations are built on quicksand.

It transpires that confidence is the key for any payment method or currency to thrive. And we should be mindful of the gradations between this reassurance, and what former Federal Reserve chair Alan Greenspan warned as “irrational exuberance” in a speech during the early days of the dotcom boom in 1996.

Whatever the gyrations in Bitcoin’s price, it’s likely to be around for a while. But will it be worth its weight in bits and bytes?

Our view at Netwealth

While we appreciate the merits of blockchain technology, we don’t consider Bitcoin as an investment for our portfolios. In fact, we believe that the terms “touch” and “bargepole” should be used as an apt conjunction. Or “run” and “mile”. We’re not being facetious, and while we’re respectful of the fact that many individuals will have considerable holdings, we can only subscribe to a view as responsible managers of our clients’ wealth.

We recognise that portfolios need to be diverse. Many will, for example, have exposure to property, alternatives and cash as well as traditional stock and bond assets.

But the difference between these assets and Bitcoin is that they are backed up by tangible value. And few will experience the tremorous volatility which saw its value plunge 71% overnight in the spring of 2013 (according to a Fortune report) and subsequent falls of 36% and 37% in 2017 alone.

We suggest treating Bitcoin as “going to the casino” money. You may walk away from the table smiling if it lands on black – but you’re just as likely to see red.

Please remember that when investing your capital is at risk.

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