One study showed that more than a third of millennials and half of Generation Z would be happy to receive 50% of their salary in cryptocurrency.
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With over $1 trillion in cryptocurrency value wiped out since the high-water mark of 2021, many investors may be tempted to enter the cryptocurrency class at a potentially attractive, lower price point.
After all, there has been explosive growth in cryptocurrency valuations since the last dramatic fall – and all this volatility can be justified because Expectedly Bumpy Price Discovery Process of a significant brand-new asset class.
However, the deepest risk to cryptocurrency investing may lie ahead rather than in the rear-view mirror. Investors considering a long-term allocation to cryptocurrencies should be wary for five primary reasons.
1. Bitcoin’s Risk-Adjusted Returns Have Been ‘Unmistakable’
After a shiny first decade, bitcoin has become a somewhat troubled teen. In its early days, bitcoin had almost zero correlation with the broader equities and commodities, providing the potential for true portfolio diversification.
However, as crypto investments become more mainstream, and especially since 2020, the correlation of bitcoin with US equities and bonds has grown exponentially and remains consistently positive.
This could be okay if bitcoin offered great risk-adjusted returns as compensation. Unfortunately, recent empirical evidence shows otherwise: Bitcoin’s risk-adjusted returns have been fairly unremarkable compared to equities and bonds since 2018.
2. Crypto ‘Safe Shelter’ Properties Remain Unproven
Despite all the hype as digital gold, cryptocurrencies have failed to display either “safe haven” or inflation-fighting qualities when faced with the first real bout of real market volatility or severe inflation in developed markets.
Between 2010 and 2022, bitcoin recorded 27 episodes of declines of 25% or more. By comparison, equities and commodities recorded just one each. Even in the market selloff related to the pandemic of March 2020, bitcoin suffered a much deeper downtrend than traditional asset classes such as equities or bonds.
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Similarly, while bitcoin’s fixed supply – hardcoded into its blockchain – may be a resistance to monetary weakness, in recent episodes of high global inflation, bitcoin has provided limited inflation protection with falling prices, even though the US, Inflation spikes in the UK and Europe.
3. Cryptocurrency Struggles With ESG Targets
Cryptocurrencies are deeply problematic from an environmental, social and governance, or ESG, perspective. This is true even though the transition from proof-of-work to proof-of-stake that the blockchain-based software platform Ethereum is pioneering reduces the enormous energy consumption that underpins crypto mining and verification.
Environmentally, bitcoin – which represents more than 40% of the current cryptocurrency market cap – will continue to use a verification process where a single transaction requires enough energy to power the average American household for two months. is required.
Socially, the promise of financial inclusion of cryptocurrencies is even more visible, with crypto money being as unevenly distributed as traditional money, and simple phone-based payment services such as M-Pesa in Kenya or in Bangladesh. Grameen Bank’s international remittance pilot is already providing a digital platform. For households with less banking access — without the need for any new currency or payment infrastructure.
most annoying Investors with ESG GoalsHowever, there are governance issues with cryptocurrencies whose decentralized structure and anonymity make them particularly attractive to illegal activity, money laundering and clearance theft.
The increased trade between the ruble and cryptocurrencies following sanctions on Russia following the Ukraine war suggests that the evasion of financial sanctions is not just a theoretical concern. Market manipulation is another area of governance’s concern, especially with celebrity crypto influencers who can fight market prices soaring or without discounts.
4. Stable coins can be ‘redundant’
Even setting aside the recent impact of the Terra stablecoin, the living universe of stablecoins faces a potential existential risk: central bank digital currencies, also known as CBDCs, may return to normal. After that they can be made redundant as well. This is because a digital dollar, euro or sterling will provide all the functionality of a stablecoin – but with almost no liquidity or credit risk.
In other words, even if stablecoins move from their current status as unregulated money market funds (with limited transparency or auditing in reserve) to regulated digital tokens, they will not enjoy any leverage over CBDCs. Importantly, these central bank digital currencies may be a distant prospect. China has already launched an electronic currency known as the digital yuan or e-CNY.
The Fed released a long-awaited study on the digital dollar in early 2022, and the ECB will share its findings on the viability of the digital euro in 2023.
5. Patchwork Regulation Creates Uncertainty
Finally, the lack of clear and uniform cryptocurrency regulation – both within the country and for long-term investors – creates tremendous uncertainty. It is still unclear in the US, for example, when a cryptocurrency falls under the regulatory framework of a security subject to Securities and Exchange Commission regulations and when it is considered an asset or commodity such as bitcoin and ether.
Indeed, in some countries, cryptocurrencies are facing an outright ban. China’s sudden ban on all cryptocurrency trading and mining in 2021 is a prime example, but by no means the only one. Regulators are also concerned about notable and frequent breakdowns in the infrastructure that supports cryptocurrency mining and trading – another area where significant regulatory uncertainty remains.
Of course, momentum, retail speculation and “fear of missing out” could continue to propel the short-term price of bitcoin, ether and other cryptocurrencies. But there are enough dark clouds on the cryptocurrency horizon for long-term investors to carefully understand fact versus fiction and the actual value versus social media hype before deciding how, where and if to invest in the crypto ecosystem. want to see. ,
– By Taimur Hayat, Chief Operating Officer, PGIM.