Unlocking Crypto: A Guide to Introducing Digital Currency to Your Clients
As Bitcoin teeters on the edge of hitting that elusive $100,000 mark, your clients might be buzzing with questions about diving into the world of crypto. Some may feel the sting of regret, watching from the sidelines as Bitcoin skyrocketed over 100% this year (with a remarkable 30% jump since the presidential election) and an astonishing 1,100% over the past five years. Others could be intrigued by these digital tokens and how they could fit into their financial landscape (if at all).
Initially, I was fascinated yet skeptical about crypto’s true value. However, after diving deep into research, I’ve come to believe that Bitcoin is more than just a fleeting trend—it’s a digital asset poised to stand the test of time. In fact, it may serve as a superior store of value compared to gold.
Bitcoin exists among nearly 9,000 active cryptocurrencies, but what sets it apart is its decentralized nature and finite supply. With only 21 million Bitcoins to ever exist, it’s frequently compared to gold due to its limited availability and status as a tangible asset. Think about other stores of value: real estate, the stock market, bank accounts, debt holdings. All come with their own sets of risks. Unlike gold and silver, crypto doesn’t have an industrial use—at least not yet.
So, what’s fueling Bitcoin’s meteoric rise today? It boils down to the fundamentals of supply and demand. With only 21 million coins available and no chance of more being minted, buyers are in a fierce competition for this limited resource. As Bitcoin gains traction as a reliable store of value, investors increasingly see it as a sanctuary against inflation and deflation. Unlike the U.S. dollar, which can be devalued through excessive government borrowing, many feel that Bitcoin’s value remains secure. Plus, with the incoming Trump administration appearing to favor crypto, the potential for less regulatory red tape adds to its allure.
The Risk of Another Crash
Let’s not forget the wild ride Bitcoin took from November 2021 to November 2022—a staggering 75% drop from its peak of over $64,000 to around $16,000, spurred by rising interest rates and shrinking liquidity in the markets. While 2022 was tough for stocks and bonds, their declines were closer to 19% and 13%, respectively. Yet, Bitcoin has often danced to its own tune, soaring while traditional assets languish. To this day, there’s little evidence suggesting a correlation between Bitcoin and the U.S. stock or bond markets (more on that shortly).
Integrating Crypto into Client Portfolios
Every client’s situation is unique, but there are three pivotal questions to consider when assessing the role of crypto in a client’s portfolio:
1. Which crypto? With nearly 9,000 cryptocurrencies to choose from, it’s crucial to analyze market conditions, supply, volatility, and liquidity. Isn’t it your responsibility to guide clients toward the cryptos with the best long-term potential?
2. Diversification. Crypto can be a key player in a client’s diversification strategy. Consider a mix of mining, direct ownership on an exchange, and crypto ETFs. With the recent launch of crypto ETFs, it’s easier than ever for investors to dip their toes in, with some even offering dividends!
3. Risk Appetite. The reality is that there are no guarantees with crypto. Advisors need to have open conversations about the potential for total loss and how clients would cope if that worst-case scenario unfolds.
Tax Considerations
Your clients’ tax responsibilities will hinge on how they acquired their crypto gains. If they mined coins, the value at acquisition is considered ordinary income without a basis—however, any appreciation is treated as a long-term gain if they hold on to it. Conversely, if they buy coins and later sell them at a profit, they’ll face capital gains taxes based on the appreciation over their original basis, just like with stocks and bonds. Don’t forget that if a client’s net investment income (NII) exceeds $250,000 (MFJ) or $200,000 (single), they might also incur the 3.8% NII tax.
Potential Risks
While regulatory risks loom large, the most significant threat to holding crypto is a market collapse. This could stem from fraud, economic crises, competition, or simply waning interest. It’s essential for investors to grasp that crypto operates on perceived value; as long as that perception exists, so does the asset. Once public sentiment shifts, values could plummet, potentially hitting zero—much like any publicly traded stock.
Volatility
When integrating crypto into a client’s investment strategy, many advisors attempt to quantify its volatility using metrics like beta. A recent report from Bloomberg suggests Bitcoin could be four to five times more volatile than the S&P 500. However, due to its inconsistent relationship with traditional markets, it defies classification under a standard “beta.” Unforeseen global events (such as wars or sudden market crashes) can impact both traditional assets and crypto if investors fear a liquidity crisis.
Liquidity Concerns
As Bitcoin remains relatively nascent, genuine marketplaces for trading are scarce. In a financial crisis, the inability to liquidate Bitcoin could be a serious risk. Recall the panic during the 2008 market crash, when it was nearly impossible to reach trading platforms. Therefore, clients should avoid investing in crypto if they anticipate significant liquidity needs during potential downturns.
Is Crypto a Viable Hedge?
Many advisors ponder whether crypto can serve as a hedge against stocks, bonds, real estate, gold, or cash. The evidence suggests no statistical correlation between crypto and traditional assets. My recommendation? Spread the investment risk across direct ownership, ETFs, and mining. Just be ready for the rollercoaster ride ahead. While many crypto ETFs are now available thanks to the SEC’s approval, their volatility won’t be any less than directly owning coins, though they offer easier liquidation.
Suggested Allocation
Investing in crypto is fundamentally about risk tolerance: how much can your clients withstand the thought of their investment disappearing? Setting accurate expectations is vital. For clients who meet our risk criteria, we recommend allocating no more than 3% to 5% of their portfolio to crypto, akin to what we suggest for emergency cash reserves.
My personal journey with crypto has been quite a ride. I began with miners and dabbled with various options, ultimately consolidating into a single miner after a halving event. I was fortunate enough to see a 10x return on one of my early miner investments, but I’ve also watched my profits evaporate, only to rebound spectacularly. Recently, I’ve enjoyed another run-up in values, reaffirming my belief in the potential of crypto.
Crypto as a Legitimate Store of Value
It’s essential to prepare your clients for the crypto landscape with their eyes wide open. Ensure they’re not reliant on short-term liquidity and have safeguards in place. Unlike risky thrill-seeking ventures, I firmly believe that crypto is a legitimate store of value. It’s becoming a credible option for preserving wealth and keeping pace with inflation, unaffected by the dollar’s fluctuations. As crypto increasingly becomes part of the mainstream financial conversation, it’s your duty to stay informed on its evolving role. Change is on the horizon, and it’s worth considering the possibilities.
Dr. Guy Baker is the founder of Wealth Teams Alliance (Irvine, CA).
