This crypto bull run is just nuts.
I will try to provide reasons for and against owning crypto. Then if you decide it should be part of your portfolio you need to answer the following question: How much crypto should you own?
You probably don’t need another person talking crypto to you in 2021 so feel free to stop reading if you’re fed up with the subject 🙂
If you tell me crypto has zero value and has no place in my portfolio I can’t blame you. It’s very high risk. You are an investing adult so you don’t need FCA telling you you can lose all your money. It’s true. Don’t blame me if you buy some and it then goes to zero.
But you can also make a killing if you can stomach it. Maybe.
You may already have 10x your money and thinking:
- Is it time to sell?
- Am I being too greedy or will this do another 10x?
You may be watching from a distance and wondering if you’re too late to the party.
In other words: How much crypto should a portfolio own?
The truth is: nobody knows.
As all assets like stocks and property make all time highs, crypto is no exception. BTC is around $51,000 (£36,000) as I’m writing this and ETH has reached $4,000. Quite a ride if you think £10,000 last year (2020) could buy 106 ETH. This is now worth £300,000 (May ’21).
A story from the Great Depression era (1929):
When Joseph Kenedy sat on a warm leather stool to get his shoes polished, the shoeshine boy talked stocks. The boys didn’t just parrot the latest tips. They owned a piece of the cake.“
If shoeshine boys are giving stock tips, then it’s time to get out of the market.”
Joseph Kennedy sold out his significant portfolio and shorted the market. Subsequently, he banked more on the short sell than in any other business venture.
Although shoe shining is not part of my daily routine I have enough evidence. Here is my 2021 version:
- Friends who were afraid of investing in crypto now going heavy in Bitcoin mining stocks
- Listening to 14-year olds praising bitcoin outside my house
- Elon Musk’s SpaceX launching satellite Doge-1 to the moon next year (literally 😄 )
Where will this rally go?
You can make the case for both arguments.
Crypto is in a massive bubble
The price has gone parabolic. People are shouting “Take my money” as they purchase digital ownership of GIFs that can be downloaded by anyone with a dial-up internet connection (remember those?).
If you have 30x your money, you might start thinking, how high can this go? Trees don’t grow to the sky, the party has to stop at some point.
A friend reminded me that I held some Doge in a private wallet which I bought to test the wallet function and totally forgot about it. I paid $50 and they’re now worth $2,500. LOL, is this for real?
The bear market after 2017 was painful. BTC climbed up to $20,000 and crashed to around $3,500 2 years later. 80% loss not easy to stomach for those who bought at an all time high!
Of course staying the course paid off big but the ride is not easy. And even if I’m willing to wait, there are no fundamentals to convince me that if I stay the course I will eventually get paid.
Like gold, crypto doesn’t pay an income. There are no quantitative limits. When you own a stock you might say I buy it on 15x earnings or 20x earnings. When you own property that pays £1,500 monthly rent you know that buying it for £100k is too cheap, and £1M is probably too expensive.
But when you buy something that doesn’t produce anything, all bets are off.
Bitcoin makes no sense at $8,000 and it makes the same amount of no sense at $60,000.
Sure more people are using it, more services are built around it, more wallets in circulation etc. So should it be $1,000, $20,000 or $100,000? And why?
The old adage still applies: Be fearful when others are greedy. All I see around me is greed greed greed.
Not to mention the environmental impact for it to operate. In this era of sustainability and ESG investing shouldn’t we be more thoughtful about how we spend our energy? Tesla has just suspended the option to buy a car with Bitcoin, citing environmental concerns.
That stinks to me – as if he didn’t know 2 months ago – but it’s a valid argument nevertheless.
Some coins solved this by switching to a proof-of-stake model. But the environment is worse off when talking Bitcoin which operates a ‘proof-of-work’ model. For the network to operate it needs bitcoin miners. Miners need to buy hardware chips which first of all need energy to manufacture. These chips are purposefully built for the BTC network by the way, they are no good for anything else really.
Then you have power plants where miners host their chips that consume energy to operate. Some of it is renewable like hydro and solar but so what. All this hardware, manufacturing and energy spent on bitcoin.
The Crypto rally is only getting started
Here’s the counterargument. Crypto has a long way to go.
1. Bitcoin has been declared dead 390 times since 2010
While its network security is only getting stronger as more computing power is required to attack it over time. Read this great security modeling article if you’re into it.
But although the initial idea of BTC was to be a peer-to-peer decentralised payment network, it has evolved into a form of ‘digital gold’ over time. Given BTC can only handle 7 transactions per second, the tax overhead for transacting in BTC and some other limitations, it hasn’t evolved much.
A whole new world is emerging in crypto. Crypto is not just BTC.
There are a few new use cases that have a chance to actually make a difference!
DeFi is accelerating at a massive pace. Decentralised finance is when you don’t need a bank to lend you money or a market maker to perform a trade. Or when you don’t need a central authority like Binance to buy and sell digital goods.
I recently heard of the Internet Computer (Dfinity project) which sounds very promising. The internet is a network of computers. For the info to be displayed, processing needs to happen on a computer. Most companies do this on Amazon (yes, the popular Amazon) which rents out processing power for a profit. Some people don’t know this but that’s actually how Amazon makes most of its profits.
So now with Dfinity you can upload your code on the blockchain and run it on the Internet Computer instead. It’s part of the Web 3.0 movement and it’s very very promising from a tech point of view. There are projects in the DeFi space like Vega that’ll hopefully democratize finance.
3. Proving ownership of digital goods
NFTs (non-fungible tokens). An NFT is a digital proof of ownership that allows collectors to reward creators for their work. Anyone can verify the ownership of a digital good on the Ethereum blockchain.
Owning a digital piece of art or music may actually sound stupid to some, as it’s more a digital bragging right but so what. People pay so much money for collectibles like cards and antiques. You can have fake copies of a popular piece of art that look exactly the same as the original. So there has to be some value to “owning” a digital piece.
NBA has released short clips of slam dunks and other footage as NFTs and people have really paid attention (+ dollars)! eBay has just said they will allow people to exchange NFTs on their platform.
4. A growing but small percentage of population owns crypto
The crypto market cap is $2.22T much smaller than Gold’s $11 tn one. If BTC is digital gold then if it can match gold’s market cap the price can go a lot higher.
BTC and ETH are emerging asset classes. Suddenly institutions argue whether a 1-2% allocation to crypto can bring higher returns. A small crypto portfolio is even suggested by the big players like JPM that used to make fun of it. The more people want to own one BTC the higher the price. Simple.
There are some pricing models for BTC based on scarcity, activity etc. Based on the popular stock2flow model BTC is on track!
Also check out MVRV Z score if you’re into BTC on chain analytics.
5. TINA: There Is No Alternative
Interest rates are close to zero and inflation is showing up. Savers are punished and are willing to take more risk. Bonds offer a lower reward than usual. People dial up the risk with stocks, crypto etc. Property in the UK is at an all-time high. The average UK house now costs £258,000. That’s £20,000 higher since the first lockdown started.
The safe 10-year bonds that used to yield 6% in 2000 now yield only 0.82%. It’s not surprising that many people seek those returns in riskier assets. More people want a slice of the riskier asset pie naturally driving their prices up (including Bitcoin’s).
Last but not least, the UK government among others, has started exploring the idea of a central bank digital currency. Unlike Bitcoin, they’re controlled by a central authority. And unlike USDC or other stablecoins, they’re not pegged to a currency. They are the currency, just in digital form. That’s not really a catalyst for crypto, but it just shows that their direction is digital.
So as you can see, there are arguments for and against owning crypto. Let’s say you decided to buy crypto, how much crypto should you own?
What is the right amount of crypto to own?
Typically people make crypto decisions like black and white. You either like it or hate it. You either sell everything or HODL forever.
For me the best approach to owning crypto is to decide on a fixed percentage in your portfolio and rebalance every month.
Take too much risk and volatility can kill you. Take too little risk and big returns won’t have the impact you can brag about at cocktail parties.
Let’s talk numbers.
Cathie Wood and ARK Invest have done some backtesting. I read their Big Ideas 2021 report which, by the way, includes some very interesting findings for industries like electric vehicles, automation, 3d printing, DNA sequencing, deep learning and yes, bitcoin.
There are thousands of portfolios in the above picture, some with more BTC than others. Each dot is a portfolio with some crypto in it.
An efficient frontier in finance is this top black line showing what the optimal portfolio is (highest return) for the given level of risk (volatility).
A 2.55% crypto allocation focuses on sleeping well at night. The red star, (6.55%) is when you want the highest risk-adjusted returns but you should expect a bumpier ride.
Based on daily returns across asset classes during the past 10 years, our analysis suggests that allocations to bitcoin should range from 2.55% when minimising volatility to 6.55% when maximising returns.
Apparently if institutions start adding a BTC allocation to their portfolio as per ARK, this could impact Bitcoin’s price by $200,000 to $500,000.
Let’s say you want to own crypto because you think there’s a bright future.
Make up an allocation that you’re comfortable with, say 5% of your portfolio. If your total investments are £100,000 this means you will always have £5,000 in crypto. When crypto goes up then you have to sell some profits in order to reduce your position back to the desired level. Psychologically that’s hard.
But you know what’s harder? Seeing your crypto bleeding and having to buy more.
If crypto drops and you now own only £2,500 of it, you need to “buy the dip” and bring the allocation back to the £5,000 level! That’s the hardest part.
Buying when losing. But a fixed allocation makes sure you always buy low and sell high while having a system to avoid being super emotional. Emotional investing leads to buying high and selling low.
If you’re too worried or stressed out, just drop the allocation percentage until you’re confident you can execute it.
Judging from my experience 5% can be too high for a beginner actually. The drops are sudden and painful.
How much crypto I own
I’m struggling to even call crypto an ‘investment’. It’s certainly in the speculation category in my portfolio.
Personally, I’m going with 5%.
Part of the reason is I used to own crypto back in 2017-18. It was a small amount (~2%) which has naturally become bigger. I recently sold one ETH for $1800 which I had bought for $200. Painful to watch it climb up to $4k! But profit is profit.
So yeah, that’s what I’m doing and it’s within the range that backtesting suggests.
Hopefully this post gives you a framework for owning or avoiding crypto as a new asset class. I want to hear from you! Some good arguments in the comments pls.
Keep it civilised 🙂
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