Until the end of 2021, the astonishing rise of Bitcoin had provoked a mixture of awe and resentment. The cryptocurrency saw a 10-fold rise from early 2020 to November 2021 . Every spike higher piqued the interest of a new group of investors. However, investors need to be careful not to let FOMO get the better of them.
What is cryptocurrency?
Cryptocurrency is a form of digital currency. Cryptocurrencies operate much like a conventional currency in that they can be exchanged for goods and services (though this is still limited), operate as a store of value and are a unit of account. However, rather than being attached to a specific country or government, they are decentralised and controlled by the network that operates them. There are around 10,000 cryptocurrencies, but Bitcoin is the original and largest by market capitalisation.
Digital currencies have existed previously, but it was the innovation of blockchain technology that set Bitcoin and other cryptocurrencies apart. A blockchain is a shared public record of changes in the ownership of assets. Blockchains have multiple uses, including non-fungible tokens as well as applications in more traditional areas, but cryptocurrencies are where they originated.
There is a finite supply for many cryptocurrencies. The total supply of Bitcoin, for example, is capped at 21 million, of which around 90% has already been mined. This is in notable contrast to a normal, government-controlled currency, where more money can be printed, inflating away its real value.
Is cryptocurrency a fad?
While it is tempting to dismiss cryptocurrencies as a bubble, there are ‘real world’ uses for cryptocurrencies, as there are with all currencies. Blockchain data platform Chainalysis has devised a Global Crypto Adoption Index, which shows the vast growth in cryptocurrency adoption from July 2020 to June 2021 . Its most recent report says: “By the end of Q2 2021…global adoption had grown by over 2,300% since Q3 2019 and over 881% in the last year.”
There are various reasons for this increased adoption. Emerging market countries turn to cryptocurrency to preserve their savings in the face of currency devaluation while in developed markets, adoption has been more recently driven by institutional investors, such as large pension and insurance funds. Bitcoin is more widely accepted as a means of exchange – and has even been adopted as a form of legal tender in El Salvador . It is worth noting that crypto adoption is now growing faster than internet adoption in the late 1990s.
Is cryptocurrency a good investment?
This all sounds exciting. However, this doesn’t necessarily mean Bitcoin, or any other cryptocurrency will be a good investment. The UK regulators have yet to be convinced about the merits of cryptocurrencies. The FCA has banned the sale of cryptocurrency derivatives saying it “considers these products to be ill-suited for retail consumers due to the harm they pose.” The UK Government has also unveiled plans to crack down on misleading cryptocurrency investments . Direct investments in cryptocurrency derivatives, along with related investments such as crypto exchange-traded products are unavailable to UK retail investors, though UK investors can buy cryptocurrencies on regulated exchanges.
The UK is not alone. Governments across the world have started to look more closely at cryptocurrencies, uncomfortable with having a widely used currency out of their direct control. Chinese regulators banned all virtual currency trading and speculation in 2021. Cryptocurrencies have also been associated with criminal activity, being used to pay ransoms and bribes. However, some countries have started to recognise that their use may be inevitable – President Biden, for example, recently signed an executive order to instruct government agencies to look at the risks and benefits of cryptocurrencies and explore appropriate regulation.
The Financial Stability Board, a global committee of regulators and central bankers, recently said it didn’t believe cryptocurrencies posed a systemic risk to global financial markets in the short term. However, it added: ‘Cryptoassets markets are fast evolving and could reach a point where they represent a threat to global financial stability.’ Against this backdrop, tighter regulation across the globe appears inevitable.
Does cryptocurrency have a place in investment portfolios?
The Bitcoin price halved between November 2021 and January 2022. While this only takes it back to where it was in February 2021, this highlights the biggest problem with cryptocurrencies – they are hugely volatile, and the price can often be extremely unpredictable. It is evolving as an asset class. Equally, it is important to bear in mind that unlike an equity investment, where you own a piece of a company with tangible assets such as buildings or intellectual property, a cryptocurrency has no inherent value. Like other currencies, or gold, its value is all ‘extrinsic’ rather than ‘intrinsic’; it is a medium of exchange. This makes it difficult to ‘invest’ rather than ‘speculate’.
This volatility is also a problem for the real-world adoption of cryptocurrencies. It is difficult to use them as a medium of exchange or store of value if the price halves in just a few months. Ultimately, they will need this real world adoption if they are to thrive.
Equally, there are signs that crypto assets are starting to show a greater correlation with conventional equity and bond markets. Increasingly, the price of cryptocurrency moves higher when equity markets are in ‘risk on’ mode and slides when they are nervous. This diminishes the appeal of cryptocurrencies as a diversifying source of returns for investors.
Against this backdrop, it is difficult to make the case for investment in cryptocurrencies on regulatory grounds, on volatility grounds and on diversification grounds. It could undoubtedly be a revolutionary change in global payment systems and we continue to keep an eye on the opportunities it presents. However, for the time being, the risks are too great for it feature in our portfolios.
 Bitcoin to Pound sterling Y5, Google Finance, [accessed 16 March 2022].
 Number of cryptocurrencies worldwide from 2013 to February 2022, Statista, 8 February 2022.
 Nearly 90% of all Bitcoin has already been mined — here's how its limited supply has driven up its value, Business Insider, 24 December 2021.
 The 2021 Global Crypto Adoption Index: Worldwide Adoption Jumps Over 880% With P2P Platforms Driving Cryptocurrency Usage in Emerging Markets, Chainalysis, 14 October 2021.
 Bitcoin will become legal tender in THREE more countries this year, predicts global finance expert, City A.M., 4 January 2022.
 Internet Growth Statistics 1995 to 2021 - the Global Village Online, Internetworldstats, [accessed 16 March 2022]
 Treasury plans crackdown on ‘misleading’ cryptocurrency ads, The Guardian, 18 January 2022.
 Biden just put out an executive order on cryptocurrencies — here’s everything that’s in it, CNBC, 9 March 2022.
 Regulators have cryptocurrencies in their sights, Financial Times, 17 February 2022.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
Please remember investment involves risk. The value of investments and the income from them can fall as well as rise and investors may not receive back the original amount invested. Past performance is not a guide to future performance.
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This article was previously published on www.smithandwilliamson.com prior to the launch of Evelyn Partners.