There are a few golden rules for long-term success when building an investment portfolio. One of them is diversification.
So with the rise of Cryptocurrencies over the last few years is it a good idea to diversify your portfolio with the likes of Bitcoin and Ethereum?
Firstly what is diversification?
When investing, diversification is the idea that you want to distribute your investment into different types of assets. Each asset has its own level of risk and by diversifying into multiple areas you are spreading that risk. Or in other words, you may be familiar with the phrase ‘don’t put all your eggs in one basket.’
By spreading your investment across multiple industries you are protecting yourself if anyone investment may ‘crash’ while also increasing your chances of getting a return that’s better than average.
Typical diversification strategies include investments in real estate, bonds, shares and funds. However, with the arrival of the new asset class of cryptocurrencies, it may be a bigger risk to leave it out of your portfolio then to have it in.
What are cryptocurrencies?
Cryptocurrencies such as Bitcoin are decentralized digital assets powered by a blockchain. A blockchain is quite simply a decentralised database of information. Cryptocurrencies use this decentralised database to be able to send and receive digital assets all over the world in seconds without the need of a central authority like a bank or a credit card company.
Bitcoin, the largest cryptocurrency, brought the entire asset class into the mainstream at the start of 2017 when it rose from $1000 USD to $20,000 USD by the years end.
Like stocks and FIAT currency, cryptocurrency price is dictated by supply and demand on the market. The 24 hour volume of all cryptocurrencies is usually at least 10 billion dollars USD.
Should you consider cryptocurrencies as part of your investment?
Due to how new the industry is, cryptocurrencies are still volatile. But if you forgot about the short term price trends for a second and look at the technology you may be amazed at the global change cryptocurrencies can bring. Here are a few examples below:
For a start, they allow borderless, near-instant transfer of value anywhere in the world for very small fees. If you want to make a monetary transaction of any amount with Bitcoin and you are sending it to someone on the other side of the world, it will currently cost about 20 cents to send and the transaction will appear in the receiving wallet instantly with a confirmation 10 minutes later. Compare that with FIAT international money transfer which will set you back $25 for the initial fees and often takes 3 days to appear in the overseas account.
Cryptocurrencies are also a hedge against localised events. We can be a bit isolated here in New Zealand to think about these types of things, but think of Venezuela or Zimbabwe, where irresponsible Governments have dramatically decreased the value of their people's savings as the countries go through hyperinflation. Or when an event like Brexit happens and the markets take a dive. As Bitcoin and other cryptocurrencies are global assets, they are less affected by these localised events or an irresponsible government because they are decentralised, they are global currencies.
Cryptocurrencies also bank the unbanked. People in third world nations with no home and no government identification cannot open bank accounts as they don’t have a proof of address or a Government I.D. With cryptocurrencies, all they need is internet access and a phone and they can then start accepting and storing digital payments.
Furthermore, most cryptocurrencies are incredibly safe and secure. Once Bitcoin is in your Bitcoin wallet, no one can take it away from you unless you have poor security practices and leave your private key around for someone else to find. This video explains why your Bitcoin would be impossible to hack.
The above examples show that Cryptocurrencies may not just be a fleeting moment but a robust, revolutionary technology that can greatly improve the monetary and payment systems in the coming years.
At the end of the day it seems to be a higher risk not to have at least a small amount of crypto in your portfolio rather then not having any. The opportunity cryptocurrencies can bring to the world is immense and it is good to remind yourself that we are still very much in the early stages of this revolutionary financial technology.