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Friday, September 30, 2022

Is Cryptocurrency a Currency or Investment?

Welcome, and thanks for joining us for a discussion on cryptocurrency. We know this has been a popular topic in the media and with investors. so we wanna focus the conversation today around where cryptocurrency might belong in an investment portfolio. And review some key concepts to potentially consider before making the decision to purchase cryptocurrency. Our subject matter expert joining me today is Philipp Meyer-Brauns, head of Investment Solutions Analytics, and vice president at Dimensional.

Really great to see you in the studio today, Philipp, It’s great to be here. Excited to talk about cryptocurrency. And let’s start first with the price of Bitcoin. It’s been extremely volatile and interesting to see, and I’m sure that’s why it’s been in the news today. Yeah, absolutely. I think the price is probably the one metric that everyone’s looking at. That’s interested in this space and for at least two reasons I can think of. So one, of course, just the rise that we’ve seen when measured in US dollars, for example. Bitcoin has gone up from well, close to zero, just over 10 years ago to just over $30,000 today.

So certainly, a storied rise in many ways. But on the other hand, also arise, that’s been accompanied by a lot of volatility. So a lot of fluctuation in Bitcoin’s price when measured in US dollars. And that includes the most recent two months when Bitcoin peaked at about $65,000 in April of 2021. Now down to just over $30,000. So a 50% drop in a span of six weeks, and it’s not the first time that’s happened. So, certainly a very volatile experience as well. And I think that reflects a lot of the uncertainty in the space for this asset.

Whether that’s just uncertainty around technological and economic liability. So is this actually something that will be adopted to some degree in the future? Political uncertainty, we’ve been getting news out of China, for example, recently clamping down on Bitcoin mining. Certainly, uncertainty around the impact on the environment. Bitcoin’s enormous electricity usage and what that may imply for its future adoption. And I think, one thing that’s important to keep in mind here also is that despite the rise that we see charted from zero to 30,000 or in total market value, just over $500 billion today, it’s still only a tiny fraction of the overall investible opportunity sets.

So I think if Bitcoin were to be included in a portfolio at all, it certainly seems to be very clear. It should be a tiny, tiny sliver of one’s portfolio. Well, let’s talk more about that, Philipp. If we’re thinking about implementing cryptocurrency as part of our investment portfolio, what are some key considerations we might look at? Yeah, I think it’s important to have a clear framework that links your goals as an investor.

So what’s the portfolio intended to do for you to each one of the potential components of that portfolio. So how can each investment or asset in a portfolio help you achieve your goals as an investor better? And three very common goals that investors have are a positive expected return, so, many investors would like to grow wealth on expectation. Mitigating uncertainty, so forgiven expectation, reducing the uncertainty around that expectation is typically something that’s a goal of investors. And then third, liquidity provision.

So a cash function, in other words, Helping provide for short-term liquidity or expenditure needs. So these are three very common goals. And whether it’s Bitcoin or any other potential addition to your portfolio, I think it’s important to reflect on how a potential asset like Bitcoin can or cannot help you with any one of these goals. Well, let’s first start with the expected return. Can you talk more about that? Absolutely, so for expected return, again, the goal is to grow wealth on expectation and we have a traditional well-established toolkit of course, to achieve that goal, stocks, bonds, and in particular, corporate bonds, a price to give you a positive expected return.

Now with Bitcoin, it doesn’t quite work the same way. So Bitcoins don’t buy you any claim on future cash flows. If you own a Bitcoin today, gonna own a Bitcoin 10 years from now. So not necessarily a positive expected return. Certainly a lot of uncertainty around the return expectation. Yeah, when I think about Bitcoin, it’s what you’re paying today and you’re hoping that someone will buy it from you at a higher price in the future.

And that’s your expected return. Reminds me of when I used to collect beanie babies as a little kid, hoping that one day I could sell my beanie babies for 10 times more. Now that’s not the case, they’re currently sitting in my house, and my two and six-year-old boys plays with them. But that’s the idea, right? You’re hoping that somebody will pay more for that Bitcoin in the future. That very much seems to be the idea. So really, the way to make money with Bitcoin is to find somebody, down the line, who will pay you more for that Bitcoin than you paid when you first acquired it.

It’s very different, again, from having a positive expected return on a stock or a bond. Now let’s talk about more mitigating uncertainty. Let’s touch on some points there. Yeah, I think, again, it’s important to keep in mind what are the traditional tools. So for mitigating uncertainty, reducing uncertainty, the traditional tool, tools are government bonds. And if you think about inflation-adjusted wealth on uncertainty, for example, it would be inflation-protected government bonds.

So again, well-positioned without a traditional toolkit, but the question today is can Bitcoin or cryptocurrencies link to that goal? And we’ve already discussed the volatility, the enormous fluctuations in its value. So I think it’s fair to say that, given that volatility, it’s not necessarily something that can help you mitigate or reduce uncertainty. If anything, based on its historical track record and the enormous volatility in that track record, you should probably expect it to increase the volatility, potentially increase the uncertainty if you were to include it in your portfolio.

So might even do the opposite. So thinking about the last consideration, liquidity, can cryptocurrency serve a short-term cash need for you in your portfolio? Well, after all, they are called cryptocurrencies, so maybe there’s a role there. But on the other hand, their volatility comes in once more. So what I need from a cash or some kind of asset that helps me with short-term liquidity provision is of course, that I need to be sure that it buys me what I wanted to buy. So if I paid for groceries or pay my rent at the end of the month, I need to be sure that that’s gonna be possible.

That the asset, the cash, the currency holds its value up until that point. And that’s, again, given the volatility, given daily price movements of 10, 20%, which are not uncommon with Bitcoin and other cryptocurrencies, not something that necessarily allows you to connect Bitcoin to that third goal of providing for short-term liquidity needs. There you go, well, hard to measure expected return, lots of volatility, maybe some issues with liquidity.

Philipp, it’s hard for me to see where cryptocurrency might fit in an investment portfolio. What’s your take on that to close today? I think that’s a valid conclusion. And I think it also demonstrates the value of having a rigorous framework. So if you clearly link your goals as an investor, and we’ve covered three today, to how each individual component of your portfolio can help you achieve those goals, and then you see while there’s no role for a proposed asset, today, it was Bitcoin, it may be something else tomorrow. Then I think it’s also good to know that, well maybe there isn’t a role.

Maybe there’s no need to necessarily invest in Bitcoin, especially, and I think that’s the good news here. If there is a well-established toolkit that helps you achieve the goals we’ve discussed today. And we’ve given the examples, stocks, bonds, corporate, government bonds, and then, of course, cash for the short-term liquidity provision. Great, well, thanks so much, Philipp. Really appreciate your time and your being here in the studio today. Hopefully, you found that discussion is helpful.

And on behalf of all of us at “Dimensional,” thanks for tuning in and we hope you have a great rest of your day..

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