Investment in cryptocurrencies is all the rage, and bitcoin is clearly the biggest – it has the largest market capitalization, the most infrastructure, the longest track record and is the most decentralized. In previous columns, I’ve stressed the conversations you, as an advisor, will need to have with clients, and how different they are from any conversations you’ve previously had to have about financial planning.
Now, we get to talk about three different ways to look at an investment in bitcoin for you and/or your clients: bitcoin as the revolution, bitcoin as a macro investment and bitcoin as a micro investment. I’ll review these three investment theses so you can not only determine why to allocate to bitcoin, but also so you can help your clients better understand the implications of certain news items, media hype and social media posts.
You and your clients will inevitably read articles and posts from people who fit into all these categories. Having an understanding of where they’re coming from will help you in your practice. (Keep in mind that we can’t necessarily lump every investor or every thesis into one of these three categories.)
This was really the original “investment” in Bitcoin. Starting shortly after the release of the Bitcoin blockchain’s white paper in 2008, people were mining bitcoin using their home computers and felt like this new currency would be needed sometime in the future. They likely didn’t think it would be worth in the mid-five figures someday, nor did they think of it in institutional investor terms. They held it in private wallets long before we had crypto custodians, and even used it for early transactions – like the infamous bitcoin pizza and Silk Road.
Along the way, others have started investing in bitcoin as a hedge against governments, censorship and overly powerful banks.
The revolution investment thesis is that, when fiat currency, governments and banks fail or falter we can count on bitcoin. Because bitcoin is completely decentralized, the value isn’t determined and possibly manipulated by a central bank and the transfer can’t be restricted.
While this doesn’t seem to be much of a need here in the U.S. and most of the developed world, we can see the value in countries where the government might routinely devalue their own currency to pay down national debt or limit withdrawals from banks. We’ve seen relatively recent examples in Turkey, Argentina and Nicaragua.
If I’m living in one of those countries, or I just don’t trust many of the world leaders, I might own bitcoin and store it offline in a hard wallet. I know that my bitcoin is wherever I am.
The revolution investment thesis might not be just because I think I’m going to need bitcoin to trade for goods and services, but because I just want to show my disgust with the current government and banking system. So I’m not going to let them participate in my wealth creation and growth.
While this investment thesis in bitcoin might be out of necessity, or out of revolution, its proponents are vigilant about letting the public know they should hold bitcoin. Many of the arguments hinge less on actual macroeconomics driving the dollar value and more on the need to own bitcoin as a hedge against powerful parties and as a political statement.
This investment thesis looks at bitcoin as a store of value, and compares the macro economic factors at play in the U.S. and in the world. The thought behind it is that as we see inflation rise due to the increased supply of fiat currency, the value of bitcoin will rise dramatically because bitcoin has a very fixed supply.
This is the thesis that many bitcoin investors have been following for years, but it became very popular and well-known in 2020,when legendary macro hedge fund manager Paul Tudor Jones announced he was allocating some of his portfolio to bitcoin. He was followed shortly by Stanley Druckenmiller and Bill Miller, who are also macro investors.
The fiat money printing in the U.S. and in most of the Western world as a result of the COVID-19 pandemic accelerated the potential for inflation, as we have seen trillions more dollars created and dispersed into the economy. Now, we have finally started to see evidence of inflation, which adds fuel to this bitcoin investment thesis.
Why would I need to hold bitcoin as an inflation hedge or store of value? Let’s assume I can hypothetically buy a loaf of bread for $1 today. In a year, what if that same loaf of bread cost me $1.05 – which means we had 5% inflation? That happens because we added more dollars, but not more bread, to the system. Therefore, the bread is worth more dollars.
If I keep all my money in dollars in the bank (where I’m earning virtually no interest), I can’t buy a loaf of bread in a year with my $1. If I think that will happen, I’ll want my money saved in an asset that also has a limited supply, just like the bread. In the past that asset might have been gold. Now, however, we have an asset with a very limited supply, which is very easy to buy and keep safe (compared to physical gold).
I can hold my dollar in bitcoin, and in a year I would assume the price of my bitcoin would go up by at least the same amount as the bread. Therefore, if I need to buy bread, I can sell my bitcoin for at least $1.05.
Now, extrapolate that investment over the entire world economy and we can see why these titans of macro investing want to allocate 2%-5% of their holdings to bitcoin. They see inflation coming and they want an asset with finite supply that will increase in value with a decrease in dollar value.
When you or your clients read about an increase in inflation leading to a possible increase in value of bitcoin, or about institutions like insurance companies and pensions investing in bitcoin, this is usually the thesis they’re using.
This is where most advisors are going to stand with their clients. Your role here is to identify, based partly on the previously mentioned investment theses, how to help your clients allocate to bitcoin.
Based on the risk profile, technical prowess and time horizon of your clients, you can assess not only the allocation to bitcoin but also the treatment of the asset – when you trade, how often do you rebalance, etc.
Remember that many of those institutions investing in bitcoin for the inflation hedge have a very long or even infinite time horizon. Your clients have a limited time horizon, and each will be different. If your clients are in their early 40s, you’re probably talking to them about the impact inflation will have on their retirement funds. If we also assume you subscribe to the inflation hedge thesis above, bitcoin fits as part of your clients’ retirement planning, at a reasonable allocation based on their risk tolerance.
The volatility of bitcoin also allows for an investment when thinking about it for individual clients. Because bitcoin is not correlated and highly liquid, you have the ability to rebalance, possibly quarterly, and provide clients with overall portfolio returns that are more normalized.
This bitcoin micro investment thesis is about taking the possible effects on the price of bitcoin and adapting them to individual family portfolios, with more limited time horizons, necessary expenses and traditional assets.
As you start to learn more about bitcoin, and even to help your clients with allocations to crypto, you will definitely hear from “influencers,” analysts and bitcoin enthusiasts about the reasoning for holding or not holding bitcoin.
Your role as the advisor is to understand these main investment theses, and you have the ability to determine how any opinions or analysis affects your clients’ portfolios and financial lives. If you see an influencer or analyst or the news through the lens of one of these investment theses, you’ll be better prepared to have those important conversations with your clients.