Risk Or Opportunity? The Good, The Bad, & The Ugly

For Financial Advisors, family offices, and investors alike, 2021 will go down in the history books as one of the most significant  with respect to  cryptocurrency. Many cryptocurrencies reached all time highs and the first ever Bitcoin ETF was approved by The SEC in the United States. At the same time, the Chinese government banned mining and trading in September. Moreover, a famous meme, Dogecoin was propped up  by Tesla’s

TSLA
CEO, Elon Musk. If that wasn’t enough, Non-fungible tokens (NFT’s) has been one of the major trends in 2021. However, the ratio of retail investors or individuals who have invested in, traded, or used cryptocurrencies is not high when compared to investments in equities. According to Pew Research Center, only 16% of Americans have invested in, traded or used cryptocurrency. In terms of stock, 56% of Americans have owned stock from Gallup’s research. When compared to crypto with stock, its ratio is rather low. To put things in perspective, as of September 30, 2021, the total market capitalization of the U.S. stock market is currently $48, million. However, as of Nov 2021, the total cryptocurrency market capitalization broke $3 trillion. This data would suggest that there is clear momentum for cryptocurrency to grow in the future.  When analyzing the pros and cons of investing in cryptocurrency, we also explicate the tensions in what we refer to as the good, the bad and the ugly. Moreover, we assume that the vast majority of investors will utilize a CEX (Centralized exchange) such as Coinbase, Gemini and Binance to trade cryptocurrencies.

Total Cryptocurrency Market Cap from CoinMarketCap

 Pros & Cons of investing in Crypto

Cryptocurrencies allow for a number of positive externalities such as: offer an opportunity to gain significant return in a short time. Rapid growth and this is expected to continue  in 2022. The amount of initial investment is very flexible (For example, Coinbase allows users to start trading from as little as $2.)- CEXs offer reasonable APY (Annual Percentage Yield) which is from 0.15% – 8% meaning credit cards can be used to invest in Crypto. The metaverse will have positive impacts on the crypto space- High volatility- The Regulatory environment will have a huge impact on the crypto space. For example, having some technical knowledge to understand the value of projects can help to make more informed decisions about investing into crypto. Some influencers have a huge impact on the volatility/ price swings in cryptocurrencies. The cryptocurrency market is constantly evolving and changing 24/7 which means some people may need to invest money to utilize technology for trading. Investors need to get used to new tools/platforms that many crypto projects use such as Twitter, Discord and Telegram.The pros and cons of crypto can be in fact two sides of the same coin. Meaning, investors can earn a significant return in a short time period but this means they can also lose a lot of money in a short amount of time. In terms of inflation, the reliability of Crypto as a hedge against inflation isn’t as good as gold since cryptocurrencies are still relatively new as an asset class, and thus the jury is still out on this. With regards to volatility, there are many cryptocurrencies that have over time proven to be relatively stable while the overall global crypto market has declined. This means technically investors can build a portfolio that reduces the risk of volatility. In terms of the crypto regulatory environment, there is the possibility that new regulations from the SEC will have an impact on the cryptocurrency market, however, it is important to note that the regulatory environment from the US will be more significant and impactful than from countries like China. China has banned cryptocurrency 20 times. However, for this first time, China’s 10 regulatory agencies including The People’s Bank of China (PBOC) jointly announced in September of 2021 to ban all crypto and mining in an effort to root out “illegal” cryptocurrency activity. Several exchanges, wallets, and other cryptocurrency companies have announced that they will stop providing services to users in mainland China and enforced a sweeping block of all Chinese IP addresses on their services. Given the wording of the official document, which explicitly singles out overseas exchanges catering to Chinese residents, the industry appears to have taken an overly cautious approach. “How much individual citizens will be threatened by the new level of enforcement remains to be seen,” says Luisa Kinzius, a director at China-focused consultancy Sinolytics. “[But] the announcement is also targeting any Chinese citizen working for crypto-related companies abroad, declaring their work as illegal and putting them at risk of being legally investigated.”

Often when China makes announcements that it yet again is banning cryptocurrency, it has the short-term effect of sending the price of Bitcoin and Ethereum spiraling downwards. Beijing’s utter disdain for cryptocurrency is because it threatens to provide an alternative to the Chinese government’s top-down centralized currency control. Moreover, this is also related to the Chinese governments development to rather promote its own digital yuan and central bank digital currency.

 In terms of technical knowledge, if investors have knowledge of blockchain, that would be great but, CEXs offer useful information to investors and cryptocurrencies on CEXs are examined carefully. The most recent popular metaverse will bring positive impacts on the crypto space because NFTs will be used as an identification in the metaverse and the metaverse includes economic activity and that will be supported by cryptocurrencies so more people will start using them. Finally, let’s consider the worst scenario for investors that use CEXs. It could be shut down/banned by a government, but this would be extremely improbable. Indeed, Binance has some issues with some countries’ authorities but it keeps the biggest trading volume. Also Coinbase spent $785K on lobbying in 2021 from OpenSecrets’ data. Therefore, the worst case scenario is quite unlikely. Judging from these factors, investing in cryptocurrencies could be a good option for many investors but its critical to do your own due diligence.

Photo by Scott Graham on Unsplash

 Due diligence on crypto projects

Most cryptocurrencies have a project that solves a specific issue with blockchain technology except meme coins i.e. Dogecoin, Shibu etc. Before investing in crypto it is essential to take into consideration the following:

Team Composition

Each crypto project has a core team and understanding the team is crucial but as I mentioned, a listed cryptocurrency is examined by a CEX carefully so you won’t need to spend an exorbitant amount of time on this. Other important considerations are:* Total funds the company has raised?* Do the investors include any famous celebrity investors in the crypto space?* Who are the key partners in the company and what core competitive value do they bring?

Product

This is the same as when you invest in stocks.* Does the company’s long term strategy have consistency?* What kind of issue will the product solve?* Who are the competitors of the product?* What is the difference between the company and competitors?* How long has the company developed its product?* Does the company show milestones (long term/short term)?* Does the company conduct smart contract audits?* Does the company have a clear plan for scalability?

Marketing

Many crypto projects use Telegram and Discord to communicate with investors/developers and use Twitter for official announcements. So these accounts’ information is one of criteria to measure the projects’ expected value.* Is the company Telegram group active? (If the company has)* Does the company Twitter account have many followers?* Does the company post information regularly?* Does the company update an official website regularly?* Is the company’s Discord server active? (If the company has)* Do any high profile celebrity’s support the project?

Conclusion

Whether you are a financial advisor, family office, institutional investor, or a recent high school graduate, there are different objectives as well as risk tolerances for investing in cryptocurrencies which must be understood. As with any investment, one should  clearly ascertain the risk versus reward and the opportunity cost. At the present moment, when evaluating the pros and cons, the risk in more mainstream crypto currencies like Bitcoin and Ethereum can at times be volatile, while at the same time in certain situations provide a level of diversity as well as growth to investors’ portfolios. If you have historically chosen to ignore investing in cryptocurrency because of its high volatility or the complexity of blockchain technology, this might be a good time to reconsider if it aligns with your short, mid, or long term goals and risk tolerances as Crypto becomes more mainstream with both retail and institutional investors.

 Special thanks to Koji Kanao, Software Engineer who’s technical, editorial, and research skills significantly contributed to this article. I am also in gratitude to Quisan Adams for reading over drafts and providing comments.

 Earl Carr is the Chief Global Strategist at Pivotal Advisors based in New York City. His responsibilities include working closely with the firm’s CEO and President to manage the Global Research Team and to develop and execute the firm’s global thought leadership and cross-border business development mandate. Earl is the Editor of the recent book, “From Trump to Biden and Beyond: Reimagining US-China Relations” Palgrave-Macmillan Press, September 2021.

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