Invest in Digital Assets?

Digital Assets Risks.

Much of the enthusiasm for crypto is due to the law of supply and demand. Sand is cheap because there’s so much and few want it. Diamonds are expensive because they are rare but desired by many. We must admit that we are still in an emerging asset class paradigm. No one knows what will happen. Must seriously consider the possibility that we could experience a massive and permanent market crash eventually. We need to always ask ourselves what we expect the return will be on our money and whether we will ever get a return. To not dream so far because in the investment world digital assets are not immune. Pump-and-dump schemes, front-running, and insider trading are common problems. Thus, why is not easy to invest in digital assets?

First of all business failure. An idea might be great, but turning it into a successful business is hard and to scale it’s even harder. We might be investing in something that fails in the marketplace. It’s always that risk. Second outdated technology. Do you know that Encyclopaedia Britannica was outdone by Wikipedia? Or that VHS videos were crushed by Netflix? This means that the innovation of today can disrupt the marketplace and with it our investment too. Then beware of Kevin Costner Syndrome (the belief that “if you build it, they will come.”) That is only in movies, in real life it takes a lot more than faith to build a successful product or company. Consider how many ads we see every day and how our attention is the most desired asset. Companies will try hard to spin it in their favor but often, successful ones only have the best marketing, not the best products. Will the digital asset gain traction because it solves a business or consumer problem? Based on this and the rapid evolution of this space, many governments frequently changed their minds creating havoc for the crypto community. Some governments have intervened by imposing onerous taxes or reporting requirements. All these actions could have risks to the price of investment. Also, choose the right custodian. What is custody? “It’s the legal term for someone holding and being responsible for something that is someone else’s.” Today, Federal Reserve, FDIC, CFPB, SEC, FTC, and other federal and state agents regulate banks safeguarding the money on deposits. So we might give it no thought. We never think about the risk that our custodian (the firm holding our account for us) might collapse or steal our assets. Be aware, (when dealing with digital assets) that our choice of custodian is as important as our investments.

Often probably hear people refer to crypto as the Wild West. It’s even worse than that. Crooks lurk everywhere, ready to trick anyone. The FTC said that people lost $164 million to crypto scams only in 2021. But why invest in digital assets if it’s risky? Because doing so will reduce risks. What?? Are you insane? Nope, neither I nor Harry Markowitz. He discovered that investing in two risky assets is safer than investing in just one of them. In 1990 Harry received the Nobel Prize for what is now known as Modern Portfolio Theory. The key, he said, is a correlation: if we own two assets and they both rise and fall at the same time we’re no better off than if we owned just one of them. But if one of them rises while the other falls and vice versa (negatively correlated) then our overall risk of loss is sharply reduced. To convert that into a practical application, all we must do is add an asset to our portfolio that’s riskier than our other assets. Which is the riskiest asset available today? Digital assets or crypto. Adding digital assets to our portfolio can help us obtain higher returns. But how much of our portfolio should we place into digital assets? It’s like carving a pie into slices. (bonds, stocks, cash, real estate) Experienced financial advisors and investors know that the size of each slice must be material and not to bother allocating anything to stocks unless we’re willing to allocate a lot. Let’s see an example: cash, earning 1% per year, and stocks, earning 10% per year. A 100% cash portfolio would earn 1.00%. If we create a 99/1 cash/stock allocation, our total return would be 1.09%. So small. A 50/50 allocation would produce a return of 5.5% but requires investing half of the money in the stock market which is riskier than having cash. That’s why advisors suggest portfolios that place 60% to 100% into stocks. If we apply this to digital assets we end up with problems. It could result in a huge loss. Investing a large portion of the portfolio into digital assets is not an option. It’s not similar to stocks. Digital assets are unlike any other asset class ever invented so my tiny advice is to place only 1% to 5% in them. To help you understand why you could check how volatile the marketplace is on crypto. For example: from January 1, 2014, to June 30, 2021, a 60/40 stock/bond portfolio with a 1% bitcoin allocation would have earned an average of 14% more per year than one without bitcoin. But past performance does not guarantee future results.

Our advice is not even to invest in crypto anymore but if you decide to do it we will cover more in the next stories. So instead of buying coins and tokens, invest in the companies that are building the infrastructure that makes all that activity happen. Invest in the chip manufacturers, in the companies compiling and selling the data, exchanges, and custodians. If volatility scares you use the strategy called “dollar-cost averaging (DCA)”. Do not forget all assets have risks. The more types of assets in the portfolio, the less risk.

This article is not a recommendation to invest in anything. Each individual’s situation is unique, so a qualified professional should always be consulted before making any financial decisions. Any references to past performance, future projections, and statistical forecasts are no guarantee of future returns and performance. Hence, anyone acting based on this information does on his/her discretion. This work here is entirely reader supported so If you enjoyed reading it please consider sharing it around and SIGN up here to get all my future articles directly to your inbox. Also if you feel like you can throw some money into the tip jar gladly will be accepted. Thank you for the support!