Why Crypto Has No Place in Your Practice
It started slowly. An inbound question or two from the odd client. Then came the continuing education credits for seminars on blockchain. In the fall of 2021 the SEC started approving crypto-linked products for sale to the public. Today a veritable ecosystem of consultants and sub-advisors has sprung up around crypto, and it’s possible for advisors to directly trade crypto for clients in an integrated fashion through at least one mainstream custodian. And oh, the questions from clients keep coming.
With this backdrop, ignoring crypto altogether can feel impossible. Certainly, there is a risk that having nothing to say about the subject can leave you looking like a dinosaur in the eyes of some clients. Seeing an asset class outside of your purview gain so much popularity may also leave you worried about declining wallet-share. These are valid concerns, and it’s incumbent on all of us to get up to speed on crypto. All the same, NextStep’s view is that crypto has no place in the portfolios you manage for clients today. Here are just a few of the reasons why:
Fiduciary standards of care and diligence may be difficult or impossible to meet in the context of crypto. This is because it’s still truly unclear whether crypto has any real intrinsic value. Unlike stocks and bonds, they generate no cash flows. Unlike commodities, they have no inherent usefulness as inputs of any kind. For the most part, they also fail as currencies and stores of value. As a fiduciary, how are you going to justify the decision to own this type of asset? How are you going to justify the price you paid? Some kind of naive mean-variance optimization? Greater fool theory?
Claims that crypto is a good diversifier are overstated, at best. There isn’t a lot of historical data to tell us exactly how we should expect crypto to behave relative to other risk-assets. But we know for sure that it’s been a major beneficiary of excess liquidity in our economy and excessive risk appetite amongst retail investors. In other words, crypto prices are driven by the very same factors that tend to push stocks into bubble territory. It follows, that when stock markets next collapse, crypto will likely do so as well. Crypto’s performance in early 2020 may be informative. The S&P experienced a draw-down of -34% during COVID, while Bitcoin drew down -46%. We believe there is very little chance crypto will bring or deliver diversification value at the times when you need it the most.
Implementation risk remains enormous. The crypto ETFs available today are riddled with weaknesses that mean they are likely to under-perform the assets they purport to track and in extreme cases simply collapse. One popular US exchange traded bitcoin ETF lagged Bitcoin spot returns by 53% in 2021 and regularly priced at 20 to 30% off of NAV. Wow! These instruments rely on thinly traded derivative markets and have not yet been fully stress-tested. Then there is cyber risk. Even if you hold crypto directly, it has a bad habit of being stolen, or simply disappearing when online wallets and exchanges are hacked, defrauded or lapse into bankruptcy. Lastly, are you ready to talk your client back from the ledge when they want to sell at the bottom, after the value of their crypto position halves - every couple of years?
The question of whether crypto has legs in the long term is a fascinating one. There seems no doubt that interesting, novel and useful things are set to come out of blockchain technology. Some forms of crypto will probably stick around, even after the hype and get-rich-quick schemes have dissipated. But that’s not happened yet, and despite the potential, advisers need to make decisions on how to run their practice based on today’s reality. That reality does not presently support investing in crypto for clients.
Still, what to do with clients that are particularly keen on these types of ‘alternative-alternatives’ if you’re not going to provide access for them? Taking an aggressive stance against crypto can be dangerous for the relationship simply because extremely volatile assets can rise as well as fall, and you may end up on the wrong side of that trade if you dissuade a client from investing altogether. Especially if they had strong conviction in the idea.
A nice way to sidestep the issue with those suffering serious crypto-FOMO is to note that they have the ability to set up a ‘fun money’ account elsewhere with which they can make investments outside of your advisory relationship. Coach them to limit their exposure to exotic assets to what they can truly afford to lose, in the context of their existing financial plan. If it works well, the client will be pleased with themselves. If it doesn’t, it will simply confirm the wisdom of letting their advisor handle the bulk of their portfolio.
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The information and opinions expressed herein are for general information and educational purposes, and may change at any time. They do not constitute investment advice and are not a solicitation for the purchase or sale of any security or implementation of any specific investment strategy.