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10 Things You Don't Know about Cryptocurrencies

10 Things You Don't Know about Cryptocurrencies

July 26, 2021
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You might remember I wrote a blog post not long ago about the crypto-craze and likened it to the beanie-baby craze of the late 1990’s. Regardless of my opinion on its long-term viability, crypto-currency is a topic that comes up in close to 2 out of every 10 client meetings I have. They’re exciting and new, so they’re much more exhilarating to talk about than regular run-of-the-mill investments. For whatever reason you might be interested in them, let these 10 little-known-facts shed some light on the dark-side of this opportunity.


1) Cryptocurrencies are a contributor to climate change.

I briefly mentioned that bitcoin is an environmental hazard in another blog post. This might seem like it’s hyperbole, but it’s not. Bitcoin currently consumes around 110 Terawatt Hours per year of energy, which is 0.55% of global electricity production. It virtually consumes as much energy as the entire country of Poland, Malaysia or Sweden!  And according to  Bridgewater and Associates Bitcoin consumes more energy than Norway, the Netherlands and several other countries. 1 2

 

2) The carbon emission from mining the coins is likely significant

Harvard Business Review has been conducting research to figure the amount of carbon footprint being generated by mining, but it’s a very complicated and multi-faceted equation. It’s been found that some of the most dense “mining” areas are located in China. In China, their overall contribution rate depends on their seasons. In their dry season they are responsible for almost 10% of global Bitcoin mining and in their wet season it’s up to 50%.2

Taking this a step further as it’s not easy to calculate its carbon footprint, we can instead figure the energy source being used when mining Bitcoin, as not all energy sources emit the same level of carbon. Estimates of renewable energy sources have ranged from as much as 73% to as low as 39% renewables.2 There is obviously a large difference between these two estimates, but what it shows is that there is a possibility that a significant level of carbon emissions are being generated from mining as.

 

3) DIY investors love it, and that should scare you

You’re not the only one who’s interested and excited about trading Bitcoin, DIY investors are hooked! How do I know this? It accounts for 20% of all trades conducted on the DIY brokerage app, Robinhood. If the DIY investor sees crypto-currency as a good investment, it’s likely already too late to buy it at a good price. This statement is based on the principles of contrarian investing, which the iconic investor Warren Buffet is considered as. In fact, he has been quoted as saying, "Be fearful when others are greedy, and greedy when others are fearful".3  If you heed this message you will look elsewhere to invest.


4) Popularity of trading cryptocurrencies is generating enormous wealth for broker/dealers

As mentioned before, the DIY brokerage app, Robinhood, has reported cryptocurrency trading represents 1/5 of their overall activity! 3 Their popularity has grown exponentially for DIY investors as it’s a way for them to get into the markets and place exciting trades such as cryptocurrencies and options. As such, Robinhood, which is currently a privately-owned company, has recently decided to file to go public so as to capitalize on this trend.3 The hope is to lock-in a high price while they’re at the top of their game as this fad could fade if the markets drop.

 

5) There are over 6,000 digital coins (cryptocurrencies)

To be exact, according to Statistica.com, as of July 22, 2021 there are 6,044 crypto-currencies available.4 So how do you know which one to buy into? And have you done your due diligence on a large enough sample to know you’ve picked “the right one”? And how do you know if you’ve picked the right one? Will you continue to compare it to the others as time passes? I ask because that’s what's necessary when investing. You need to know when to buy in, but it’s easy to forget that knowing when to sell out is just as important!

 

6) Cryptocurrency exchanges are unregulated in most jurisdictions.

In some of its biggest trading markets, most country’s regulators have taken a hands-off approach to regulating the cryptocurrency markets.4 Up until 2017 the Chinese accounted for 90% of cryptocurrency traders. Since then China has banned such trading, which only made the larger players in the game move to Seychelles or Malta.4 We all can guess what could happen when complex global systems like this are unregulated, and that should scare you. I personally can’t see how we can consider these systems as trustworthy.


7) Even a tiny bit of cryptocurrency can drastically alter your portfolio risk

As Adam Milson from Morningstar, a third party analysis company, has stated, investing in crypto is “[l]ike plutonium for your portfolio: A little bit has a big impact.” 5

When you hear the word “volatility” think risk. Bitcoin’s volatility, or as I just pointed out, its risk, has historically been exceptional. In 2020 it had a 300% gain and in 2017 it had a 1,300% gain! 5 When Morningstar compared it with a 60/40 portfolio (60% stock/40% bond), since 2010 the rolling one-year volatility measurement of bitcoin has averaged 13 times more volatile than the 60/40 portfolio! 5  With this level of risk even just adding a tiny bit to a moderate mixture will be influential.  What may be surprising to you is the impact adding any new investment is to a portfolio. For example, it’s easy to think that for a standard 60/40 portfolio 60% of the portfolio’s risk comes from the equity exposure, but that’s not the case. Since equities are much more volatile than bonds it turns out that the equities account for 90% of the portfolio’s risk.So adding just a 1% or 2% Bitcoin exposure to a 60/40 portfolio will drastically increase the risk. In this case the bitcoin will contribute roughly 9% and 24% of total risk, respectively. 5 Take that up a notch, to a 5% exposure and the Bitcoin allocation contributes more than 60% of the portfolio’s total risk and increases the volatility by close to 70%.5 Now that you know this, how will you know how much cryptocurrency is right for your portfolio?


8) It’s not as valuable as a diversifier as it used to be

 It used to be that Bitcoin operated on its own schedule. Meaning, it wasn’t correlated to that of the stock or bond market, so it gave diversity to a portfolio. But over time that has changed. Bitcoin’s one-year rolling correlation to the general equity markets is hovering between 0.25 and 0.35. 5  As the Morningstar chart below indicates, in the world of investments, high correlation is between 0.70 and 1.00. So according to Morningstar a 0.25 – 0.35 correlation is considered a moderate correlation. 6 What does this mean for an investor? The higher the degree of correlation the more similar it is to another asset. In other words, when you’re investing you look to diversify so as to not put all your eggs in one basket. The higher the correlation the less separate your baskets are becoming and therefore it’s not helping like you thought it was.   


9) Investing in currencies still generates a tax liability

It feels like it might not be something the IRS will consider taxable, as it seems beneath their radar. But, surprise! It’s not! Any gain made on cryptocurrency trading is taxable, and depending on how long you held the investment you will be responsible for either short term capital gains or long-term capital gains.

 

10) Beware of Cryptojacking

Since cryptocurrencies aren’t physically held there is a risk for scammers to hijack your electronics and take control for mining purposes. Cryptojackers hack into your device (both business and personal computers, your phone, and other mobile devices) and install software that uses the device’s power and resources to not only mine the currency but also steal cryptocurrency wallets. As time moves on I imagine the level of security on these “wallets” will increase significantly, but as long as it’s computer-based there is no 100% surety that it can’t be hacked.


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1Bridgewater and Associates – 21 May 2021.

2 Carter, Nic. How Much Energy Does Bitcoin Actually Consume?.  Harvard Business Review. 5 May, 2021.

3 Bespoke Investment Group, LLC. “Charts of the Week”. 3 July 2021.

4 “Number of cryptocurrencies worldwide from 2013 to July 2021”. Statistica.com. 22 July 2021.

5 Milson, Adam. “How a Little Bitcoin Can Change Your 60/40 Portfolio a Lot.” Morningstar.com. 30 June 2021.

6 Understanding Morningstar Correlation Reports”. Court Investment Services. 17 May 2018.