BitcoinAug 5 2021

How to have the bitcoin conversation with clients

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by
How to have the bitcoin conversation with clients
Pexels/Pixabay

Having carefully laid the groundwork for a stable investment portfolio that will build a client’s wealth gradually towards achievable financial goals, they are met with the dreaded B word: bitcoin.

'My friend Trev has made a fortune on bitcoin and he says it can go up 1,000 per cent, why aren’t we doing that?'

The adviser then must tread a fine line between dismissing cryptocurrency and appearing as a luddite, and giving credence to an asset class so volatile that it could just as quickly wipe out a client’s wealth as grow it.

It is a major issue. The Financial Conduct Authority has found that around 3m consumers are now using bitcoin compared to the total 17.3m who are invested in some kind of investment product. 

In the same survey it found that nearly 40 per cent of those who have owned cryptocurrency claim to have made a return of greater than 100 per cent. A great many more claim even further substantial returns.

This presents a clear challenge to advisers. It is, after all, rather hard to explain to somebody who has doubled their money through cryptocurrency investment that it was a bad decision.

Perhaps it is these impressive returns that have caused a shift in attitude over the issue. In the latest research some 68 per cent claim they own cryptocurrency for investment or savings purpose. Importantly, the percentage who believe that it is ‘gambling’ has fallen to just 38 per cent.

In this context, cryptocurrency is here to stay. Few asset classes that reach a valuation of $1tn (£843bn), as bitcoin briefly did, end up disappearing.

Currently it remains rightly outside of the regulated world and inaccessible as an asset class for financial advisers or discretionary investment managers to invest in.

Our first step in discussing it with clients must be making this point clear. The question then is how on earth do we talk sensibly about the topic, and will this asset class ever play a valid role in a diversified multi-asset portfolio?

Here is our five-step plan for better conversations about cryptocurrency.

1. Focus it on bitcoin 

The real crypto-geeks will want to take the conversation towards the most unusual of cryptocurrencies. However, it is entirely legitimate to focus the conversation just on bitcoin. Having peaked at $1tn in February this year, the market capitalisation of all bitcoin is now $632bn.

The second most common coin, ethereum, is less than half the size at a $260bn market cap. After this we are into much smaller assets, with the next largest, tether, being just $62bn. Therefore, it is reasonable to say that bitcoin is the only coin with enough scale to consider and focus the conversation here.

2. Emphasise the volatility

Any client who owns bitcoin must understand its volatility. With a volatility of around 85 per cent, it is more than six times more volatile than gold and around five and a half times more volatile than UK shares. This is extraordinary.

The crucial thing about volatility is that it begets mean reversion. A big price move up for example signals a likely reversion down, rather than a moment to buy. This is poorly understood by commentators but is a foundational principle of capital markets.

3. Debunk the pricing approaches

A number of popular tools have been deployed by internet commentators to justify having a view on the price of bitcoin. They are all flawed.  The most common approach is technical analysis. Yet in an asset class this volatile this sort of approach has almost no record of being right. It aims to assume trends and follow them. There is little evidence in the turbulent journey of bitcoin that it can maintain trends with any predictability.

Likewise, the approach that looks at trading volume as a buying signal is flawed. It assumes this is a sign of market take-up. Yet, in reality, the figure can and is manipulated by the shady ‘miners’ of bitcoin as they seek to control their own inventory of coins. The publicly available data reveals little of what will soon take place in terms of the supply of bitcoin to the market.

4. Acknowledge its performance 

It is wrong to dismiss bitcoin as an asset class. Given its volatility, it can only ever make up a tiny portion of portfolios, and currently there is little regulatory scope to hold it. However, the reality is that the five-year return of bitcoin, at some 117.6 percent, justifies the volatility in mathematical terms.

Indeed, if a 1 per cent allocation is added to a mean variance optimiser to build multi-asset portfolios on an efficient frontier, then this would have helped investors with a variety of risk tolerances over the past five years. This improvement in the multi-asset efficient frontier occurs because bitcoin, for all its volatility, is a genuinely uncorrelated asset class.

5. Limit the downside

For those clients who are determined to personally allocate to bitcoin outside of the portfolio you are advising on, it is wise to remind them that this is an asset not a currency. It is far too volatile and far too inaccessible to be a currency. Therefore, it should not be seen as a store of wealth but a speculative investment. We cannot objectively dismiss bitcoin as a speculative asset because historically it has delivered a return justifying its turbulent ride.

Despite the potential impressive returns, we must encourage clients to see bitcoin in the right terms and, if anything, to only ever have a very small exposure.

A key to this is understanding how to clearly articulate why speculation about whether bitcoin will go up or go down next week is ill-founded. We simply cannot say.

This is not an asset class that provides us with data points to predict its future price. Should it work for clients then it will only ever work in the long-term and it will be a very bumpy ride.

Charlie Parker is managing director of Albemarle Street Partners