Allianz Guru Series by Henry Yang: A Balanced View on Cryptocurrencies

“What’s your view on ____ (insert name of cryptocurrency)?”

This has been a recurring question that I’ve been receiving from market presentations and webinars the past few years. In this article, my intention is not only to discuss my thoughts about cryptocurrency but more importantly, give you an idea of a balanced thought process applicable not just to investing but to any form of decision making.

According to Forbes.com, cryptocurrency is decentralized digital money that’s based on blockchain technology. Whoa! Slow down! Let’s break this down into simpler components.

Let’s start with defining what money is. Have you ever paused and thought about money – why can our bills and coins be used in obtaining goods and services? Money, or currency, is humanity’s way of simplifying the barter system. Imagine directly trading products like fish, vegetables and copper– this can be very confusing (how many kgs of fish is worth 1 kg of lettuce? Of 1kg copper? Everyone in the market will just spend the whole day converting and calculating).

One critical concept in understanding money is the network effect. The value of money is there because a lot of people agree that there is value behind that currency. The more people who use and accept that currency, the more strength that currency has. At the moment, the US Dollar is the most used globally in terms of global payments, international loans, and currency reserves. For travelers to different countries, it’s a common practice to bring your excess money in US Dollars because it’s easy to convert them into local currencies. Crypto users globally, as of the end of July 2021 according to Mint.com, are at 200 million. There are  select sites  where you can use crypto to purchase coffee, travel tickets, or even do your regular shopping. 

The growth is fast in both number of users and accepting establishments, and if this continues, there is room for crypto’s value to increase from the network effect.

Now let’s move on to the term “decentralized and digital”. Digital, to put it simply, means there’s no physical bill or coin - it’s a little like a checkbook that’s distributed across countless computers around the world. Decentralized refers to not being directly affected by policies of a central bank like the US Federal Reserve or the Bangko Sentral ng Pilipinas. The appeal of a decentralized currency rings well for countries like Argentina and Venezuela where printing money has led to very high inflation (that’s when a local currency loses value and can buy fewer and fewer goods).

Lastly, blockchain is a system of recording information in a way that makes it difficult or impossible to change, hack, or cheat the system. It is essentially a digital record of ownership and transactions that is duplicated and distributed across the entire network of computer systems on the blockchain. Remember the ending of the movie ‘Fight Club”? They bombed multiple buildings where credit records are held to “reset” the financial system. Imagine what would happen if something like that would happen to bank records, real estate registration records and other registries where our ownership of wealth are kept.

Another appeal of cryptocurrencies is that it is very difficult to steal. Our bank accounts can get hacked, the cash we’re carrying can be taken from us at gun point, and in an extreme post-apocalyptic possibility, we can even be forced away from our houses by warlords. But taking away our ownership of cryptos would be very difficult – you have to practically edit all the records across the whole network.

“It seems that everything you said about cryptocurrencies are positive, does it mean I should invest in them?” you are probably thinking.

Let’s not jump to conclusions yet. Earlier, I said one of the key drivers of cryptos would be the network effect – how many users and establishments accepting this as a form of payment--but there is one roadblock here for it to become totally mainstream: crypto’s high volatility. Put simply, volatility refers to how much prices can swing either up or down. Crypto’s prices can drop by 15% or more overnight or in a matter of hours. Cryptocurrencies are usually 3x to 6x more volatile than the S&P500 (stocks). Going back to money’s role in facilitating trade and day to day expenses – it would be challenging to go to the supermarket and find that the value of your money changed significantly in a short amount of time. It would mean that the basket you’re taking home will also have to face this uncertainty of value.

Is crypto the right fit for you and your portfolio? With the balanced discussion above, I see 3 ways you can incorporate cryptocurrencies into your investment strategy (to make this write-up simple, we didn’t tackle specific cryptocurrencies, each of which also have their inherent advantages and disadvantages, but I leave it up to you to take the responsible route to study them properly).

1^st is the simplest approach. Invest only in what you understand. If you’re not yet familiar with crypto’s investment thesis, then don’t include it in your portfolio. If you have an estimate of crypto’s potential return, risk, and even how correlated it is with other assets in your portfolio, I’m sure you already have a set target allocation of crypto in your investments (good for you! I doubt you need any help from me).

The 2^nd approach is to put into crypto only the amount that you’re comfortable losing. As a rule of thumb this should only be 1-2% of your overall wealth and that your investment positions are already well diversified.

The last approach is to trade crypto actively. This requires trading skill, time, and above all, emotional intelligence. If you’re doing this, I highly recommend having a trading log, reviewing your entries and exits regularly, having a stop-loss, take-profit, and position sizing rules. 

IMPORTANT NOTICE: This document is for general information purposes only. It is not an investment advice and does not constitute any offer, or a solicitation to buy or sell any investment product. Further, any opinion stated by the author does not necessarily reflect the position of Allianz PNB Life.