Bitcoin has enjoyed a meteoric rise in recent years, gaining more than 3,600% over five years as people piled into the new and exciting asset. While Bitcoin is the original, largest and best-known cryptocurrency, there are now around 10,000 others in circulation.
While the spectacular gains of cryptocurrencies are drawing in new investors, even established investment houses, Ben Seager-Scott, head of multi-asset funds at Tilney Smith & Williamson, believes they are best left out of portfolios for the foreseeable future.
Performance of Bitcoin over 5yrs
Source: Google Finance
Much attention is focused on the rises (and falls) in the value of cryptocurrencies, but their adoption in the real world is also growing steadily.
Some in emerging markets use cryptocurrencies to preserve their savings from currency devaluation while institutional investors in developed markets, such as large pension and insurance funds, have shown an interest. Meanwhile, Bitcoin is becoming a more accepted means of exchange – look at El Salvador, which has adopted Bitcoin as a form of legal tender.
Seager-Scott said: “This all sounds exciting. However, this doesn’t necessarily mean Bitcoin or any other cryptocurrency will be a good investment.”
He pointed out that the UK financial regulator appears unconvinced by the rise of cryptocurrencies, with the Financial Conduct Authority banning the sale of cryptocurrency derivatives as it considers them to be ‘ill-suited for retail consumers due to the harm they pose’.
In addition, the UK government has said it will crack down on misleading cryptocurrency investments while governments around the world are looking closely at the assets. All virtual currency trading and speculation was banned in China in 2021, for example, while US president Joe Biden recently signed an executive order instructing government agencies to explore appropriate regulation of cryptocurrencies.
“Against this backdrop, tighter regulation across the globe appears inevitable,” Seager-Scott said.
The second reason to be cautious on cryptocurrencies is their volatility. The price of Bitcoin halved between November 2021 and January 2022, the latest of several instances were vast sums have been wiped off the value of cryptocurrencies in short order. These are often followed by strong upward surges.
One issue with cryptocurrencies is that they have no inherent value, unlike equities where an investor owns a piece of a company with tangible assets such as buildings or intellectual property. This means holding Bitcoin and the others is closer to speculation than genuine investing and the market is highly influenced by sentiment.
“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,” Seager-Scott noted.
Finally, cryptocurrencies are starting to have a greater correlation with conventional assets such as stocks and bonds. While they were once touted as hedges for the stock market, they have increasingly started to move upwards with equities when investors are in ‘risk-on’ mode then sliding when sentiment sours – thereby diminishing their potential as diversifiers.
Seager-Scott finished: “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.”