Cryptocurrencies are on everyone’s lips in 2023. Bitcoin, Ethereum, and Co. had a brilliant price development at the beginning of the year and raced from one record high to the next. Anyone who got carried away and wanted to invest in cryptocurrencies will now taste the bitter taste of drastic price losses in April.
Below we assess what future potential digital currencies have, what role they play in portfolio management, and explain how you can benefit from the boom in cryptocurrencies.
Are cryptocurrencies a good investment?
The sharp increase in attention has brought cryptocurrencies high price gains in the past. So far, no one can answer whether these live up to their true value. When new, promising cryptocurrencies come onto the market, they usually rise quickly and then enter a sideways phase. Anyone who is not involved from the start carries a very high risk, as high price fluctuations are the order of the day. Such a direct investment in a blockchain-based currency is for investors who want quick price gains and can also take the corresponding risk of total loss.
Nevertheless, cryptocurrencies have become an integral part of the financial world and will represent part of the asset allocation (asset mix) in the future.
What is the value of cryptocurrencies?
Even if cryptocurrencies are limited in number, are produced in a transparent process, and are viewed as a valuable means of payment, their value is anything but constant. Trading on crypto exchanges like Coinbase is subject to strong fluctuations. The prices are not only influenced by supply but also very much by demand. It is not unusual for a cryptocurrency to fluctuate by 10% over a day.
The price explosion in recent years can be attributed to various causes. They have outgrown their niche existence and have gained many new investors. Buyers no longer only include private investors, but also institutional investors such as hedge funds, investment funds, and banks. New cryptocurrency-based financial products are simplifying access for the general public and fueling demand. The persistent low-interest rates and the monetary expansion driven by the central bank and the associated inflation are also leading to increasing attention as an investment. In the case of Bitcoin, the supply limit of 21 million also causes a temporary excess demand and a resulting price increase.
The problem: As with stocks, the market value does not necessarily correspond to the “real value”. How high this is and whether the digital number series even has any intrinsic value is controversial even among experts. There is no cash flow, interest, or dividend distributions that can be used to determine fair value like the value of company shares. The Bundesbank and BaFin warn against viewing cryptocurrencies as a store of value. Given the current high fluctuations, this is obvious.
Investing in cryptocurrencies – evaluation options
Matt Hougan and David Lawant present five different approaches to valuing cryptocurrencies in their manuscript “Cryptoassets: The Guide to Bitcoin, blockchain, and Cryptocurrency for Investment Professionals,” published in 2023.
Similar to a raw material, a value calculation can be based on resource scarcity or production costs. A model based on stock analysis is the calculation of market potential or network benefit. A completely different option is to calculate the value of money from the quantity supplied, the speed of circulation, and the price level.
Due to the diverse design options, none of the models is likely to become established so quickly. Depending on whether the intended purpose is the payment function, utility applications in the Internet of Things, or the value preservation function of raw materials such as gold, a different model must be used. This makes it difficult to compare each other and therefore to make an evaluation. On this basis, cryptocurrencies have hardly been an investment alternative for classic value investors, because an objective assessment of over- or undervaluation is in the eye of the beholder.
Cryptocurrencies in diversified portfolios
The risk and return profile of cryptocurrencies to date is characterized by three key characteristics: they have exceptionally high return potential, have very high volatility, and have a very low correlation with traditional asset classes.
It is impossible to predict whether digital money can continue to offer the same earning potential in the future. Price opportunities and volatility will likely decrease as the market matures. What makes them interesting as an investment for professional investors is their diversification effect.
Cryptocurrencies are subject to different drivers than stocks, bonds, and commodities. Instead of growth, interest rates economic prospects, technical developments, market acceptance, regulations, or security aspects play a role in their performance. Significant market movements in the past were caused, for example, by hacker attacks or ambitions for regulation. According to studies, the correlation with other asset classes is usually between minus 0.25 and 0.25 in different investment periods. Only in the Corona crisis was there an increase to 0.5.
When added to portfolios, cryptocurrencies can have positive effects on risk and are therefore likely to play an important role in portfolio management in the future.
How to invest in cryptocurrencies?
Cryptocurrencies can be stored in digital wallets. They are available in different versions and from different providers. Such a “wallet” does not contain the cryptocurrencies themselves, but rather addresses and access keys that allow transactions. They have a public number and a private key and are stored on your PC. Transactions are completely anonymous.
The danger here is that whoever has the access code is practically the owner of the money. Alternatively, investors can also open cryptocurrency accounts on trading platforms such as Coinbase and manage their balances there.
In independent asset management, we are bound to asset classes that are regulated by the financial regulator and cannot invest in cryptocurrencies themselves. There are now numerous financial products that are based on cryptocurrencies and can be managed in investor portfolios.
Futures on digital currencies are traded on the US futures exchanges. Private investors can purchase certificates or ETCs based on this via the stock exchange and purchase them for their portfolios. Investment funds have also discovered the topic for themselves. BlackRock (under the label “iShares”) has been on the market with two ETFs since 2023 and Acatis Datini Valueflex invests in cryptocurrencies as an adjunct.
Another alternative is investing in stocks of companies active in the cryptocurrency sector. For example, the Bitcoin Group is an online trading platform for Bitcoin, or Coinbase is a comprehensive platform for trading cryptocurrencies. Companies in the chip industry such as Nvidia are also benefiting from increasing demands on computer performance and the resulting demand for more and more powerful computers.
Other beneficiaries include software manufacturers Micro Strategy and Tesla. In the case of Tesla, judging by the latest figures, the company generated more profit from Bitcoin than from car sales. In addition, Tesla, alongside Visa, Mastercard, and Paypal, has announced that it will accept Bitcoin as a means of payment in the future. This will likely have a very positive impact on Bitcoin.
Investing in cryptocurrencies – risks
- extreme price fluctuations (for sometimes incomprehensible reasons)
- Theft by hackers (clearing the platform or stealing from private computers)
- no investor protection (no obligation to clarify risks)
- Virtual currency without exchange rate (can be traded, but not easily exchanged for euros or dollars)
- Software errors (malfunctions are possible, have already affected Bitcoin twice in the past)
Investing in cryptocurrencies – conclusion
The cryptocurrency market is still young. As we know from many examples in history, the first innovation does not necessarily have to establish itself as the dominant force in the market. The prominent Bitcoin still leads the market and also leads the price development of its competitors. But new solutions are constantly coming onto the market and aim to eradicate the crypto pioneer’s teething problems. It remains to be seen whether cryptocurrencies as they exist today can establish themselves as a stable value and widely accepted means of payment. This is where central banks could come into play as a game changer.
However, cryptocurrencies have become an integral part of the financial world as investment options. They have long since ceased to be just a gamble by “nerdy” private investors, but have also become the focus of institutional investors. The price development of digital money follows different laws than those of conventional asset classes such as stocks, bonds, and the like and can help reduce risk in diversified portfolios. We assume that cryptocurrencies will form part of the asset mix when investing in the future.