Decoding Crypto Assets for Investment Strategies

The American College of Financial Services
November 13, 2020

In the current uncertain investment landscape, many advisors are looking for new asset classes to help their clients meet financial goals. One rising asset class could hold A key to the financial future: crypto assets.

The term "crypto asset" usually conjures up ideas of confusing technical jargon or dark net payments for shadowy, suspicious characters through digital coins that don't actually exist in the real world. The truth, however, is much different and more complex, if also less controversial. To be called a crypto asset, a product must have three main characteristics:

 

It is Digital

 

Crypto assets, as we've already noted, don't exist in a physical sense. They're chains of code in computer programs embedded all over the internet and networks across the world. They're not alone in this sense: while the US Federal Reserve has around $2 trillion of physical money in circulation, almost $7 trillion more exists solely as digital entries in electronic ledgers. However, while all crypto assets are digital, not all digital assets are crypto assets.

 

It Uses Cryptography

 

Cryptography, from which crypto assets derive their name, is the process of securing communications and information from some or all third parties. While the rightful owner of a dollar bill is whoever holds it at the time, crypto-asset ownership is determined by whomever has the proper digital key to unlock it.

 

It Uses Blockchain Technology

 

In simplest terms, blockchain is computer code spread out among multiple computers or servers in order to keep data more secure. Blockchains provide the digital infrastructure needed to create crypto assets and record transactions safely.

 

Crypto assets also share certain characteristics with typical physical currencies: they’re created at will by an outside source (in this case computer programs rather than people), and they aren’t backed by any real asset. Like the money in your wallet, they have no inherent value other than what we ascribe to them ourselves when exchanging them for goods and services.

Crypto assets generally fall into four distinct categories: cryptocurrencies like Bitcoin; platform tokens used in a specific online ecosystem; utility tokens used as payment within that ecosystem; and security tokens, which represent ownership in a real-world asset. All have different uses in the digital world. But for financial professionals, the question remains: do crypto assets have long term potential as an asset class for investors?

Let's use Bitcoin, the most well-known crypto asset, to provide an example. Bitcoins are created when computer programs controlled by a real-world user solve mathematical puzzles online in a process called "mining." The controller then receives payment virtually in Bitcoin. Bitcoins cannot be created in other ways, and under the rules of the cryptocurrency only 21 million Bitcoins can ever exist. This leads some experts to view Bitcoin as "digital gold" due to its limited supply, much like real gold was at one time used to back up the value of the US dollar They argue the upper limit will allow Bitcoin to protect itself against inflation and maintain its value long term in a way paper currencies can't.

Believers in the power of Bitcoin say it's a dream come true for some investors as a hedge against the volatility inherent in many other asset classes. However, since Bitcoin is also thinly traded, its pricing is more vulnerable to manipulation and it can be a volatile asset, much like the equities that have caused many investors portfolio woes of late. According to statistics on Bitcoin, fluctuations in its value can be directly tied to the status of markets like the S&P 500, potentially making it a poor hedging instrument and not appropriate for risk-averse clients.

 

Keeping You Informed on Trending Topics

 

Are crypto assets representative of the financial future, or are they an investment risk your clients simply can't afford to take? To learn more about crypto assets and how they could factor into your financial planning efforts, download our latest article, What are Crypto Assets...and Why Should You Care?, to get the inside scoop on this emerging asset class.

For more information on how goal-based wealth management strategies can help your clients reach their financial goals, visit TheAmericanCollege.edu/WMCP.

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