Bitcoin!

December 20, 2024  | By Kevin Smith

A lot has changed with Bitcoin since our 2021 blog post, so it’s time for an update.

Bitcoin has achieved staying power. With a total market value of about $2 trillion, it probably isn’t going away unless its cryptography is broken or it is somehow banned by the government. Those risks are real. The rise of quantum computing creates a security risk, and governments pushing for their own centralized digital currency may not want to compete with Bitcoin. But the recent vertical path of the Bitcoin price suggests investors aren’t too concerned.

Why the recent enthusiasm for Bitcoin?

Regulatory Changes & Easier Access

The Securities Exchange Commission (SEC) approved Bitcoin Exchange Traded Funds (ETFs) in January of 2024. This made it easier for investors to gain exposure to Bitcoin in traditional brokerage accounts, and drove management fees down. These new investment vehicles attracted $60B+.

Positive Government Sentiment

The inbound Trump administration has been openly pro-Bitcoin, including favorable taxation, which is in contrast to the Biden administration’s restrictive stance. This new positive sentiment from the executive branch gives investors confidence that Bitcoin trading and innovation will be allowed to continue within the traditional financial system.

“Number Go Up”

This has become an internet meme to describe the price momentum phenomenon of Bitcoin, meaning the price keeps going up because it recently went up, causing more people to buy it because they expect the price to go up because even more people are likely to buy it for the same reason. This is sometimes called the “greater fool theory”. The “Number Go Up” strategy is the opposite of buy low, sell high, but price momentum is real and it can go on for longer than it seems to make sense.

Now that you are updated on the backdrop, let’s return to the investment questions:

1) Should I own Bitcoin? Maybe, but you don’t have to. We think you should have a clear reason if you do because it is something very different from stocks, bonds and cash, and the risk of a big decline is real. There are many reasons to choose from:

• Insurance against financial collapse – if the U.S. dollar collapses in value, some expect Bitcoin to remain valuable in global markets, and thereby protect their wealth.
• Techno-optimism – some expect Bitcoin to play a bigger role in financial transactions and possibly be the primary currency in the digital realm, and possibly even the currency used by robots to transact with one another.
• Speculation – some are trading Bitcoin for the possibility of making a lot of money in a short period and aren’t too concerned about the reason why. See “Number Go Up” concept.
• Asset allocation strategy – some believe Bitcoin should be treated like an asset class with a risk/return and correlation profile like stocks, bonds, commodities, gold, etc. Bitcoin is still very young as an asset class, so the reliability of historical data for future projections is questionable.

2) How much should I own? If you made it through the “why” question, the next question is “how much?” Bitcoin is volatile enough to be considered a speculative asset, so you should be comfortable with losing as much as you invest. For most investors, that means a maximum exposure of no more than 10% of their assets, but probably less than 5%. If your reason is strong enough, you probably want to make sure your investment is large enough to make a meaningful difference if you turn out to be right. That should help establish the minimum investment target.

3) Where should I own it? This is tied to why you own it. There are many variations of ownership, but these three categories generally cover the range of options:

• Cold Storage – means holding your Bitoin offline. This means you own the keys to your Bitcoin and you are responsible for maintaining security. The benefit is control and lower costs, but you are solely responsible for the safety of your investment. This is most in line with the purest notion of the functional value of Bitcoin, but requires by far the most technical knowledge.
• Hot Wallets – these are online accounts that make for convenient trading through exchanges like Coinbase, Kraken, Gemini or CashApp. Exchanges charge transaction fees that can be 2% or more. Your security is trusted with the provider of the hot wallet software.
• Brokerage Account – this means buying and holding Bitcoin in a traditional investment account by way of an Exchange Traded Fund. In this case, you own a claim on Bitcoin but do not own it directly. You essentially own exposure to the price change of Bitcoin.

4) How should I buy it? You can buy your target allocation all at once or over time.

Because there is no way to know if the current price of Bitcoin is high, low or just right, we encourage building a position in Bitcoin through “dollar-cost-averaging” rather than a lump sum investment. The price of a share of stock or a bond can be assessed in relation to future expected cash flows, but Bitcoin has no cash flows. The future price is a function of demand because the supply is limited.

For example, I used CashApp to buy a small amount of Bitcoin every day over the course of multiple years to establish my target value. I paid high transaction fees to do this, but ultimately benefited from being able to buy more units as the price declined. I also broke my own rule and bought a lump sum, which abruptly crashed in value and took over two years to recover. I’ll be sticking to dollar-cost-averaging for any future purchases. The chart below shows only the frequent and severe drawdowns in Bitcoin value in recent history, which created opportunities to benefit from this approach.

Investors will probably do just fine without investing in Bitcoin over the long term, using more conventional investments like stocks, bonds, real estate and maybe even gold and other alternative investment for diversification. Investing in Bitcoin is a personal preference.

We encourage you to approach Bitcoin with a thoughtful approach that makes sense for you, which may include doing nothing!