Where Might Cryptocurrencies Fit into an Asset Allocation Plan?

One of our interns proved kind enough a couple days ago to engage me in a conversation about cryptocurrencies. I appreciated the opportunity to do so as I anticipate client inquiries concerning crypto increasing going forward. As I spent quite a bit of mindshare over the past few months noodling on where cryptocurrencies might fit into an effective asset allocation plan, I valued the exchange. Little doubt exists for me that leading cryptocurrencies qualify as alternative investments in that they offer a potential store of value uncorrelated with the performances of equities and fixed income securities.

I choose not to spend any time on the costs and benefits of trading, mining, or doing anything else with cryptocurrencies, like making cashless purchases. Rather, I address investing in crypto as one would evaluate the merits of buying any other investable asset for which addressable markets exist. For folks investigating spending capital on a cryptocurrency, I highly recommend verifying that such an addressable market exists for it: confirm that active buyers and seller exist to create sufficient liquidity to move into and, more importantly, out of the investment. Without sufficient liquidity an argument could be made that the asset in question more resembles a collectible than it does an investment. I advocate always separating collectibles from investments, not unlike keeping a primary residence separate from an investment portfolio.

Providing that sufficient liquidity exists to qualify the desired cryptocurrency as an investment and not as a collectible, I recommend investors define what characteristics they anticipate their crypto investment fulfilling for their portfolio. Like gold, do they expect crypto offering hedges against downturns in other asset prices? Or, as in the case of bitcoin, does the investor estimate that the fixed number of bitcoin available to the investment community will act to counter the deleterious impacts of inflation on the values of other assets?

An important self-check in this process requires investors to satisfy their curiosity as to why they anticipate their targeted cryptocurrency outperforming alternatives within their forecasted investment environment. A failure to do so qualifies the crypto purchase as speculating and not investing. Comparing the return profiles of cryptocurrencies to those of gold, commodities, currencies, private equity and venture capital funds, and managed futures, could prove highly useful to investors evaluating the applicability of crypto to their asset allocation and investment plans.