Cryptocurrencies Haven't Been Relevant in Portfolios. That Might Be About to Change.

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.

Can't Explain Bitcoin? Your Clients Will Find an Advisor Who Can

Cryptocurrencies

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.

Many people believe that a stable and predictable number of coins suggests that Bitcoin represents a “store of value,” or “digital gold.” The store-of-value philosophy, however, is a long-term view. Cryptocurrencies currently experience wild market swings, but the store-of-value philosophy suggests that once cryptocurrencies reach market saturation, people will recognize that the limited supply puts a stable value on the exchange of labor over time.

For instance, let’s say that today I agree to charge you X dollars to build a dock, but between today and tomorrow, X dollars can no longer buy what I planned to buy with it. Those dollars weren’t a great mechanism for exchanging labor or storing the value of labor exchanged in the past. One line of thinking suggests that once Bitcoin is fully mature, it will be a better option for exchanging labor or storing value over time given its stability.

At the same time, though, Bitcoin detractors have pointed out that the Bitcoin network simply isn’t fast enough to support a decentralized payment network at scale. Other cryptocurrencies such as Ethereum have emerged as options for a medium of exchange by solving some of the transaction speed problems surrounding Bitcoin. The ultimate question is how these altcoins will perform and interact with Bitcoin, with one another, and with traditional fiat currencies, and how each technology evolves over time.

What’s Coming

What does all this mean for your clients? Right now, there are only a few ways to get exposure to crypto in client portfolios without buying crypto-assets directly. The goal of these products is to wrap cryptos in familiar structures for tax reporting and regulatory compliance.

Here’s the challenge today: Many of these products can trade at significant premiums or discounts to the net asset value, making the risk discussion highly relevant for advisors who are working with any amount of crypto-assets. If more products receive regulatory approval, we are likely to see crypto as an asset class in far more client portfolios.

Financial advisors need to become knowledgeable about cryptocurrencies. It is likely that we will start to see them in client portfolios more frequently going forward. We’re going to need to plan for them, or at least be able to plan around them to help our clients reach their financial goals.

Joe Elsasser developed his Social Security Timing software in 2010 because, as a practicing financial advisor, he couldn’t find a Social Security tool that would help his clients make the best decision about when to elect their benefits. Joe later founded Covisum, a financial tech company focused on creating a shared vision throughout the financial planning process.

In 2016, Covisum introduced Tax Clarity, which helps financial advisors show their clients the hidden effective marginal income tax rates that can significantly affect cash flow in retirement. In early 2017, Covisum acquired SmartRisk, software that allows advisors to model “what-if” scenarios with account positions and align a client’s risk tolerance with their portfolio risk. In January 2019, Covisum launched Income InSight, an income planning tool.

Covisum powers some of the nation’s largest financial planning institutions and serves more than 20,000 financial advisors.