Balancing The Ledger: Can Traditional Financial Investment Principles And Blockchain Coexist?

Aug 4, 2018 Editor's PicksInsightsResearch 0

Every year, Google compiles and analyzes its data in order to reveal the most popular ‘how to’ searches worldwide. It should come as no surprise that ‘How to buy bitcoin’ was amongst the top three for 2017. Bitcoin has garnered much attention as of late – and for good reason…

CryptoCurrency Adoption

In 2017 alone, the market cap of all cryptocurrencies rose from $18 billion USD to over $600 billion USD. Cryptos have exhibited the most aggressive growth of any asset class to date. Last December, Coinbase – one of the most popular platforms for buying and selling cryptocurrencies – announced that it hit annual revenues in excess of $1 billion and had surpassed 13 million users. To put that figure into context, the well-known brokerage firm Charles Schwab has approximately 11 million users.

Blockchain companies are raising billions of dollars in new funding through various institutional investors as well as less traditional fundraising avenues. Investment firms are beginning to specifically search for investments within blockchain to stay ahead of the curve. As an example, leading venture capital firm Andreessen Horowitz recently opened a crypto-dedicated fund and raised $300 million with plans to invest in everything from early-stage coins and tokens, to later-stage networks.

Strategically Navigating The Future

Still, blockchain technology and its applications are in their very early stages of expansion, suggesting that exciting times are ahead. However, the future is impossible to predict and during the most euphoric and exciting times, it’s more important than ever to remain principled and grounded while continuing to navigate the investment landscape.

Early adopters and founders continue to reinvest in blockchain technologies, and are some of the main contributors to the growth of various protocols, creating a “Silicon Valley effect”. However, a desire to give back to the community and to support peers often leads to a natural overweight of investments in the blockchain space – a concentration of risk that is seen far too often in the blockchain community. A ‘sound money’ or strategic approach would suggest diversifying amongst various asset classes. Given the past euphoric sensation of holding a quickly appreciating asset, and the potential growth one can still envision in the future, diversification is a concept that can be hard to come to terms with, but is essential.

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The Early Adopters

According to BambouClub’s model of the distribution of bitcoin wealth (based on Vilfredo Pareto’s power-law probability distribution), it can be deciphered that if you own 15 bitcoin (BTC) you are among the top 1% of BTC holders worldwide. If that’s the case, you should be asking yourself: “What are my goals?” For the extremely small cohort of individuals that do own over 15 BTC or more, what percent of your net worth are you risking? If the protocol achieves mass adoption, what do you stand to gain, and is that figure aligned with your investment goals? Can those same goals be achieved with a less concentrated holding of BTC?

Securing your success, no matter what you believe the future may look like, should be a high priority. Successful investors are those who are able to take an objective look at what it takes to reach their investment goals. For the early crypto adopters who have amassed incredible fortunes, the amount of capital needed to sustain their life for the long-term may only be a small fraction of their current holdings. For the 1% of the 1%, it may mean selling as little as 10% of their current crypto holdings – a rather small but meaningful decision. Early adopters, founders and developers are beginning to do exactly that by buying real estate, making capital market investments and looking at other alternative investing.

I’ve had various conversations with early bitcoin investors who continue to hesitate to sell any portion of their holdings based on their belief that the price of BTC will be far higher in the future. The truth is: no one can predict the future, and choosing to sell a portion of your digital currency now will not incrementally change what you may stand to gain. Even after decreasing their positions, early investors may still stand to gain exorbitant amounts of wealth should their vision for a decentralized future materialize.

Strategies

Old strategies such as the 60/40 stock-bond portfolio approaches are quickly becoming obsolete. For example, the market selloff on February 2018 was triggered by a selloff in the bond market which took stocks down along with them. Instead of offering a form of risk parity, stocks and bonds have been trading in the same direction. Our current economic environment continues to force investors to look for new investments that can provide risk-adjusted returns during a time when bonds are not offering much as interest rates continue to rise off historic lows. How we choose to navigate the current economic cycles will vary, but the underlying principles will remain the same. They include:

  1. Deciding if you want to maintain investment in the concentrated position (crypto) but realize the importance in filling out the remainder of your portfolio with other investments
  2. Developing an investment strategy that attempts to better balance your risk-to-reward ratio by investing across diverse asset classes
  3. Creating a network that can offer proper guidance in the forms of tax and investment advice; and specific to the crypto space –  the ability to provide liquidity
Concentration Builds Wealth; Diversification Preservers It

Ray Dalio, a well-renowned hedge fund manager and the founder of Bridgewater, does a great job at explaining how an investor can continue to obtain strong investment results with far lower risk. He describes “The Holy Grail” as a principle that if properly understood, can lead you to have “all the riches in the world”. The concept discusses uncorrelated return streams and their effect on the risk-to-reward ratio of a portfolio. Dalio discusses the math that moving from one or two good uncorrelated return streams to fifteen will decrease portfolio risk by 80% and improve the return-to-risk ratio by a factor of five as a result. That means five times the return for the same amount of risk taken. I have provided the link in the appendix if you would like to delve into this concept further.

We are living in an incredible time where the speed of technological innovation has no historical precedent. Blockchain is only one of the many potentially life-changing technologies experiencing explosive growth today. Other notable ones include robotics, artificial intelligence and biotechnology, to name a few. Separating speculative investments from those that have the potential to shape the future, and investing in these emerging technologies, can be the first steps towards obtaining portfolio diversification.

In the context of asset allocation, the emergence of bitcoin and subsequent blockchain technologies have generated a new digital asset class, one offering uncorrelated returns to any other asset class such as real estate, stocks, bonds and gold. Bitcoin, in particular, has experienced a strong risk-to-reward ratio and the low correlations it has shown to date can impact the risk-to-return profile of a portfolio in a positive way. For these reasons, a compelling argument can be made that bitcoin, can be viewed as a portfolio diversifier, similar to the common recommendation of owning gold as a diversifier. However, the fact that we have experienced strong returns under one asset class certainly doesn’t mean that we should over concentrate our holdings in it or ignore other asset classes that can provide us with strong returns.


Investments

Is Now The Time?

If you have come to terms with the importance of asset class diversification then the next logical step is to create a network that can provide liquidity, tax and investment advice. It is important to find the right investment advisors to help navigate the investment landscape while paying close attention to your personal investment goals, risk tolerance and time horizon.

Young early crypto investors have gained immense amounts of wealth in very short periods of time. Good questions for them to consider asking would be:

“With the amount of digital currency I have accumulated, is there a safer way to remain heavily invested in the asset class given the fact I still may be extremely bullish on the future?”

“If I take a portion of my crypto gains off the table now, what are the investment opportunities available to me?”

“Do I have the proper team of advisors within my direct circle that can walk me through the process?”

Although the financial environment has drastically changed, hundred-year-old principles still apply today. Just as old participants need to adapt to survive, new participants can benefit from years of wisdom and experience by accepting some traditional and proven investment principles.


About the Author:

Kyle Feigenbaum is a Private Client Analyst with KJ Harrison Investors. KJ Harrison provides advice and investment strategies to high net worth individuals and families. KJ Harrison focuses on generating solid long-term risk-adjusted rates of return and delivering exceptional advice around the various complexities of wealth.

In his role, Kyle works closely with affluent families and individuals in order to help develop investment strategies in accordance with their individual goals and risk profiles.

 Kyle became passionate about the capital markets at a young age, making his first investment when he was 14 years old. He received a Bachelor of Commerce degree (B.Comm) with distinction from the John Molson School of Business at Concordia University and is currently a CFA Exam Level III Candidate. Kyle began researching blockchain technologies in early 2016, when he first invested in Ethereum. He now spends time working with founders and early crypto investors on developing plans to diversify their digital currency holdings and to strategically position their investment portfolios for the future. Kyle has been involved in Toronto based panel discussions where he speaks to the concepts of strategic planning and asset allocation; he is often accompanied by professionals in the fields of tax and law. In addition, Kyle is an advisor to various pioneering blockchain companies.

 If you would like to join Kyle’s investor mailing list, attend the next event, or would simply like to connect, please feel free to get in touch with him at KFeigenbaum@kjharrison.com

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Jacques Y

Jacques is a founding partner and CEO of CryptoCanucks.com with a background in marketing and finance. He has a well-rounded foundation of knowledge in Investing, trading, and researching both Forex and the Cryptocurrency markets. He likes to stay active playing basketball, swimming and walking his dog while pursuing his entrepreneurial lifestyle.

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