The game-changing announcement that Fidelity would allow bitcoin investments in their core 401k plans was undoubtedly one of the biggest cryptocurrency news items of 2022. Unfortunately, no one bothered to tell the market, as evidenced by the roughly 25% drop in bitcoin valuation since the story dropped.
But the last few months shouldn’t end the discussion.
Asset prices rise and fall, and crypto is no exception. According to Matthew Sigel, head of Digital Assets Research at New York-based Van Eck Advisors, the thesis for digital currencies is intact, and advisors should continue to engage clients on how the asset class should be positioned in qualified plans.
In that spirit, the following three talking points should help advisors navigate the discussion in this most nascent of asset classes.
A perfect storm
According to Sigel, several challenges hit bitcoin that explain the bulk of the current bear market. Weakness in equities is an obvious cause, and as investors reassess their appetite for risk assets, crypto has fallen along with large-cap tech names.
Another, more esoteric reason for the current drawdown is where bitcoin lies in the so-called “halving cycle.” In a halving event, it takes twice as much computing effort to mine the same amount of bitcoin. “This occurs roughly every four years, and we happen to be right in the middle of the cycle – a period that roughly corresponds with bitcoin price weakness,” says Segal.
In Sigel’s view, another issue holding back digital assets is the lack of a regulatory framework. He cites New York state’s banning of bitcoin mining as an example. “This legislation will only encourage miners to move to other states,” he says, adding that this decision only adds to the morass surrounding cryptocurrencies.
The need for crypto regulation is glaringly apparent with so-called stablecoins like Luna and TerraUSD, which have dominated the press since their collapse in May. As their name suggests, these cryptocurrencies are pegged to fiat currency such as the dollar or euro and are meant to have a stable price to facilitate commerce in decentralized finance. “The failure of these stablecoins is mainly due to under-collateralization. Their value was supposed to be backed by reserves, and their demise is akin to a bank failure.
Stablecoins should eventually be able to opt into a regulatory regime that is similar to a money market fund.
Meeting a higher level of disclosure and safety of asset mix should grant them some sort of regulatory status. But at present, they are unregulated and highly speculative,” says Sigel.
Gateway to crypto
Sigel cites three ways for investors to gain access to virtual currencies and recommends a 0.5% allocation to each of these strategies.
First, “bitcoin stands alone as a uniquely secure cryptographic network,” he says, and direct investment in the currency is a logical way to build a crypto position. There are exchange-traded funds that gain access to the space through publicly traded funds, as well as publicly-traded bitcoin miners. This approach is the most relevant for plan participants.
His list also includes gaining access to the 19,000 “tokens,” a type of cryptocurrency that can be used for investment purposes, as a store of value, or participating in lending and borrowing strategies to complement one’s fixed income portfolio.
In the former approach, investors can gain exposure to promising smart contract technology, which in Sigel’s view represents a revolutionary approach to database management and community-governed networks. If done with the most sophisticated and largest balance sheets in the space, the latter, lending and borrowing strategies still offers compelling yields at an attractive risk. Both these approaches typically require the use of a private investment vehicle, which is currently outside most retirement plans’ scope.
Meanwhile, the integration of crypto and the traditional economy is continuing. In the last month, online payment systems Stripe and PayPal have started accepting bitcoin. Bloomberg recently reported that Citadel and Virtu are building a cryptocurrency trading platform with Fidelity and Schwab.
And let’s not forget one of the central tenets of the asset class–that cryptocurrencies like Bitcoin and Ethereum offer relatively predictable monetary policies compared to the Federal Reserve’s recent gyrations. The most extreme example of printing press madness is Japan, which decided this week to go full-bore with Modern Monetary Theory. Japanese rates are now pegged at zero across the entire yield curve using open-ended QE (quantitative easing). They may have no choice except to continue this policy because if rates rise only modestly, their interest payments will exceed tax revenue. It is premature to speculate if other countries will follow this strategy, but the central thesis behind fiat currencies might be severely damaged. Crude oil is now up 85% in Yen terms vs. 58% in U.S. dollars.
The future of crypto
The most relevant question for investors is if the current bear market is a buying opportunity. The wildcards are sovereign and institutional adoption, the passage of time to the next halving event, and a change of political guard in the U.S. It is also important to note that the volatility of large-cap tech stocks and cryptocurrencies, albeit at highly elevated levels, are converging. If that sticks, it makes to invest in the asset class with the most upside. Segal’s price target for bitcoin is $250,000—nearly a 10x return from current levels.
Ben Warwick is Chief Investment Officer of Denver-based Aveo Capital Management.
Ben Warwick founded Quantitative Equity Strategies (QES) in 2002 as a platform for implementing his quantitative investment strategies. The firm advises on assets with traditional long-only equity and fixed income, private equity, managed futures, and alternative investment mandates. Warwick is the author or editor of six books on investing, including Searching for Alpha: The Quest for Exceptional Investment Performance (Wiley, 2000).
