Cryptocurrency prices frequently vary by as much as 20 per cent in a single day, and 50 per cent fluctuations are routine in any given month. That’s an unacceptable level of price movement for all but the most risk-seeking investors.gopixa/iStockPhoto / Getty Images
Canada’s securities regulators recently gave cryptocurrencies some legitimacy as investments by approving the first publicly traded Bitcoin and Ethereum exchange-traded funds. But with this new ease of access, financial advisors are increasingly fielding queries from investors wondering whether the time has come to invest in cryptocurrencies. For most investors, the answer is still a clear no.
Holding Bitcoin and other cryptocurrencies is like a game of hot potato. You hope to get rid of it before you get burned. While there are unpublished studies that claim cryptocurrencies may have intrinsic value, the mainstream view of economists who study the history of financial markets is that cryptocurrencies are in the throes of a price bubble. And as we all know, bubbles eventually pop. Unfortunately, the only accurate way to predict when that will happen is in hindsight.
In the meantime, extreme price volatility is guaranteed. There’s no other financial product, commodity, or asset for which the price can change so drastically in response to a single tweet. Cryptocurrency prices frequently vary by as much as 20 per cent in a single day, and 50 per cent fluctuations are routine in any given month. That’s an unacceptable level of price movement for all but the most risk-seeking investors.
The possibility of restrictive new legislation adds another degree of risk for investors to consider. Regulators in China, India, and the U.S. have recently signalled their intentions to regulate Bitcoin more heavily, with one of the more extreme proposals including an outright ban on mining, trading, or merely possessing cryptocurrency. Here in Canada, Deputy Governor of the Bank of Canada Tim Lane recently gave a speech emphasizing the many flaws in cryptocurrencies like Bitcoin. That means if this country’s central bank ever endorses a digital currency, it won’t look anything like current range of options. And regardless of whether central governments eventually introduce their own competing digital currencies, the impending threat of stronger regulation stands to dampen the prices of existing cryptocurrencies.
Another consideration is that many investors are interested in responsible investing as they aim to incorporate their values into their portfolios by taking account of environmental, social, and governance factors. Cryptocurrencies are in conflict with such ideals.
An inherent feature of existing digital currencies is their use of extraordinary amounts of electricity, which contributes significantly to the world’s growing level of greenhouse gas emissions. The developers of some cryptocurrencies, notably Ethereum, aim to modify their technology to become greener by switching from computationally intensive proof-of-work mining protocols to lower resource-consuming proof-of-stake methods. However, technical challenges exist, and it remains to be seen whether those challenges can be fully overcome. There are even geopolitical concerns for responsibly minded investors to consider, including, for example, Iran allegedly circumventing economic sanctions by mining Bitcoin.
Global matters aside, cryptocurrency proponents argue prices might keep skyrocketing and investors ought not to sit on the sidelines lest they miss out. By the same logic, people who fail to buy a lottery ticket deprive themselves a long-shot chance of hitting the jackpot. But no sensible financial advisor encourages her clients to include lottery tickets – or Beanie Babies or Pokémon cards – in their portfolios. It may be fun to spend a few dollars on such whims for entertainment value, but that doesn’t qualify them as investment vehicles.
For investors who absolutely insist on having some exposure to cryptocurrencies in spite of all the concerns, there are a couple of suggestions worth considering. First, they ought to consider restricting their crypto holdings to ETFs rather than investing in cryptocurrencies directly. Although that comes at the cost of a management fee of about 1 per cent a year for currently available products in Canada, it helps minimize the complexities and the risks of fraud and theft that come with managing a cryptocurrency wallet. Second, they should be advised to wager only what they can afford to lose.
Lisa Kramer is professor of finance at the University of Toronto, where she conducts research and teaches on the topic of behavioural finance. You can follow her on Twitter: @LisaKramer.