By Ryan Dolan
I penned this piece to clients in late-2021 amidst the parabolic hype of crypto and frequent client questions about its appropriateness in their portfolios. I was far from enthusiastic, and convinced most not to jump in.
Now, with crypto down 70% plus, it’s crickets-nobody seems all that interested anymore. Yet another chapter in the long book about how investor behavior (or misbehavior) can dictate long-term outcomes. And the centrality of having a trusted advisor and behavioral coach riding shotgun with you.
Excerpt from Dolan Partners Client Newsletter (12/15/2021):
Given the increasing frequency of client questions, I thought I would give my perspective on the highly-charged topic of crypto.
Investing demands you balance two traits, which can seem at odds with each other. First, you need to be open-minded. The world, business and markets change and evolve-you cannot get locked in static, inflexible thinking. So you absolutely need to be adaptable and open to change.
On the other hand, you do need some core investment beliefs that are based on unchanging principles (anchoring investments to goals, patience, having a long-term orientation, balancing greed and fear, being diversified, keeping an eye on valuations, etc). It takes some time and experience to build these-but it’s critical. It’s why I reinforce them frequently. If not, you risk being unanchored-constantly flitting from one investment style to the next-always chasing what’s hot. Occasionally, markets get deeply distorted and unhinged from reality. While it continues, every fad seems to be the “next big thing.” We don’t want to fall prey to that.
With crypto, I am open-minded to the fundamental need. Throughout history, nations have abused their currency monopoly. From the leaders of ancient Rome clipping gold coins, and melting them down to create new coins to today’s digital money printing by central banks, governments have always resorted to currency debasement and price inflation (largely to reduce government debt). Since the financial crisis, governments have been suppressing interest rates, printing massive amounts of currency, and building up huge debt and deficits. The idea of having an independent sound currency, not controlled by any government, is clearly very alluring.
On the other hand, while the need is apparent, it’s unclear to me that crypto will be the solution. First, even in the event that crypto does reach widespread adoption, there is the very real risk that an investor picks the wrong currency. This is akin to investors in the early automotive industry. Let’s say you had perfect foresight in the early 1900s that cars would reach massive, global adoption and scale. Despite that, it would have been very difficult to profit from that insight. There were hundreds of automakers, and the overwhelming majority went out of business. Even if you paired perfect foresight with the right stock selection-picking the industry’s eventual winners-you would have generated pedestrian long-term returns. While Bitcoin seems to have achieved dominance, the proliferation and success of other currencies is a concern.
There is also the risk that countries will simply outlaw crypto. Governments are slow-moving, particularly when it comes to new innovations and technology. But regulation eventually comes. Ask yourself, why would governments willingly give up their currency monopoly, particularly now? The governments of China and the US can’t agree on much, but hostility to crypto is one area of alignment. Several times in US history the federal government made it illegal for US citizens to own gold-typically at a time when an investor would really want to hold it. Why would crypto be different? I’ve heard the counterpoint to this argument. Yes, proponents say crypto is untraceable. Yes, for a ban to be really potent it would need to be globally coordinated. I get it, but nevertheless it’s an existential risk.
Finally, there’s a risk-perhaps small- that crypto turns out to be a colossal bust or fraud that goes down in the annals of financial history, much like the Dutch tulip bulb mania in the 1600s. For some reason, still unclear, the typically sober Dutch lost their collective minds and bid up the prices on coveted tulip bulbs to unprecedented heights-only to have the market completely collapse. In a time of rampant investor speculation, if there was a time for a new currency to gain widespread adoption-this would be it. With regards to fraud, at a time of unprecedented cyber crime, much of it by state actors, can you be 100% certain that this couldn’t be a fraud or ponzi scheme?
At the end of the day, I won’t be buying crypto for clients anytime soon, nor will I be recommending that clients do so. Nevertheless, should clients feel an intense desire to get in on the action, let’s have a conversation. I’ve heard a reasonable argument that for people who are true believers, having an appropriately sized, diversified allocation to crypto can make sense. There is a bit of a lottery ticket approach involved. If crypto does in fact reach long-term adoption and starts to disintermediate government currencies, the winning currency would likely go up many multiples from here. But clients should go in with eyes wide open-it could also very easily be a zero. Either way, the position should be small.
Caveat emptor.
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