Investor sentiment of risk aversion in recent months has hammered the stock market. But the cryptocurrency market has been crushed harder. After peaking at nearly $3 trillion in November 2021, the total market value of digital assets is $900 billion at the time of writing this document.
Nowhere is this pessimism more evident than with Bitcoin (BTC 9.19%). The world’s most valuable cryptocurrency, seen by many as the wake-up call of the entire industry, has plummeted 67% in the last seven months.
Is now a good time to buy Bitcoin on the decline? Here’s what smarter investors know.
Crypto is extremely volatile
Probably the most obvious thing to know about crypto is that the asset class is incredibly volatile. Even investors in some of the most volatile high-growth tech stocks are poised for a rude awakening when it comes to harrowing daily price movements in crypto.
While many proponents of blockchain technology and cryptocurrencies are hoping for the development of real-world use cases, so far the industry has been characterized primarily by speculation. And this makes sense, given that the soaring prices of some tokens naturally attracts others in search of a quick profit. Despite its recent fall, Bitcoin has produced an 800% return over the past five years. This crushes the total return of 65% of the S&P 500 over the same period.
The proliferation of financial instruments and service providers for the cryptocurrency market has somewhat exacerbated the problem of volatility. Companies like Block, Coinbase Global, and Robinhood Markets make buying and selling cryptocurrencies seamless. This user-friendly approach reduces friction for transactions, which could help sustain wild price swings.
Owning any cryptocurrency, even Bitcoin, requires you to be able to withstand the inevitable ups and downs.
Crypto is full of uncertainty
Where will Bitcoin and crypto be in 10 years? And five years? These questions are almost impossible to answer because there are too many unknowns surrounding the nascent asset class. To begin with, perhaps the biggest bear case is the possibility of onerous government regulation. Countries that feel that their power is threatened can simply ban the possession and mining of cryptocurrencies, as China did last year.
In addition to regulation, cryptocurrencies simply have an extremely wide range of outcomes. Bitcoin is slowly seen as a legitimate store of value and a substitute for owning gold. But some, like Block founder and CEO Jack Dorsey, see it as the native currency of the internet and a way to transact with others in a more digital future. And when it comes to the world of decentralized applications, the potential to turn a number of different industries upside down by empowering service users is vast.
Crypto could change everything, die completely or end up somewhere in the middle. I don’t think anyone knows that with any level of certainty. Launched in 2009, Bitcoin has the longest operational history of any cryptocurrency out there. Even so, its future is far from certain.
Investing in cryptocurrencies requires proper risk management
With a ton of volatility and a wide range of future outcomes related to its development and adoption, investing in cryptocurrency requires proper risk management. If someone has a very long time horizon when it comes to their portfolio, it may be prudent to invest 100% in stocks. But because of some of the arguments I made above, this wouldn’t be the right approach to cryptocurrencies.
Therefore, for those investors who understand and accept the various risks and uncertainty of this asset class, I think it makes sense to allocate 1% to 2% of a well-diversified portfolio to cryptocurrencies. The thinking behind this strategy is quite simple. It’s an asymmetric bet, where the downside is limited to that small amount and the upside potential is absolutely huge if digital assets were to reach mainstream adoption.
Some of the best investment returns can be obtained by those who are willing to put money to work when it seems like everyone else is running for exits. That time is today.