What You Need to Know
- Cryptocurrency has been neither a reliable diversifier nor an adequate inflation hedge, especially recently.
- There is an uncertain regulatory framework, especially given the potential role of cryptocurrencies in money laundering.
- One transaction on the Bitcoin blockchain requires roughly the same energy needed to power the average American home for over two months.
Cryptocurrencies continue to receive significant media attention, and financial advisors likely are constantly bombarded with questions from clients about their potential role in a portfolio.
In some recently released research, which draws on the insights of over 30 PGIM investment professionals (and colleagues), the potential benefit of cryptocurrencies for institutional investors is explored, seeking to explicitly answer the question of whether cryptocurrencies are a power diversifier or portfolio kryptonite. Long story short, the verdict of the researchers is clearly more along the lines of portfolio kryptonite versus power diversifier.
To be honest, I’ve always been a little skeptical of cryptocurrencies when viewed from an investment perspective. While cryptocurrencies clearly have the potential to provide utility, and some of the underlying technologies used in the cryptocurrency appear to have potential, individual cryptocurrencies have always seemed like a risky gamble (to put it mildly).
The researchers make the point that in order for them to add an asset class to a portfolio, it must meet three criteria: The asset needs a clear regulatory framework, it needs to be an effective store of value and it needs to have a predictable correlation with other asset classes. Cryptocurrency meets none of these three criteria and therefore falls more into the realm of speculation versus investing.
The analysis demonstrates that cryptocurrency has been neither a reliable diversifier nor an adequate inflation hedge, especially recently. While risk-adjusted returns are on par with other asset classes, there are notable frequent drawdowns, which subject an investor to greater market timing risks.