What You Need to Know
- Your clients are going to ask you about cryptocurrencies if they haven’t already, and with good reason.
- The Bitcoin investing products that are now available come with risks that advisors must understand.
- f more products receive regulatory approval, we are likely to see crypto as an asset class in far more client portfolios.
Over the past few years, conversations surrounding Bitcoin and other cryptocurrencies have become more and more common. What started out as a unique concept that appealed only to niche audiences has become much more mainstream. You are likely going to receive questions from clients about cryptocurrencies if you haven’t already, and with good reason.
In 2010-2011, there was growing concern about fiat money — money that a government can create out of thin air, and which is backed by the full faith and credit of whatever government issues the currency. When governments print too much money, they enter hyperinflation. The value of the currency approaches zero as markets realize that there is no possibility that the government can collect enough tax to back the money it has printed.
Bitcoin attempted to solve this problem by promising a limited supply. According to the Bitcoin algorithm, the maximum number of Bitcoins that can ever be created is 21 million. Bitcoin also promised full transparency as to how new Bitcoins are created.
A specific amount of mining (computer) power would be used to create each Bitcoin. The amount varies based upon the number of coins in existence and the volume of processing power recently dedicated to creating new tokens. Effectively, it becomes more expensive to fuel the computer operations necessary to create new coins.
That said, the relative value of Bitcoin right now is speculative, based on a variety of factors — the primary factor being the strength of the collective belief in its long-term viability. As market events suggest mainstream adoption, the price goes up. Events that suggest roadblocks to adoption or new problems with adoption cause prices to decline.
As a speculative product, the price of Bitcoin in dollar terms has fluctuated wildly since its inception, regularly swinging by 50% or more. Remember: Cryptocurrency is still in early adoption. Technology updates are still occurring, most recently with the acceptance of the Taproot upgrade. El Salvador recently became the first country to make Bitcoin an official legal tender for all transactions in that country, and U.S.-based retailers are more frequently announcing their willingness to accept Bitcoin transactions.
There’s no denying that cryptocurrencies are gaining momentum. But even as headlines abound, Bitcoin transactions represent a minuscule amount of the overall money flow.