It has been almost impossible for investors to ignore the dizzying returns of cryptocurrencies, with Bitcoin skyrocketing more than 1,500 per cent from its March 2020 low to a high of nearly $65,000 in April this year.
But that upwards momentum is typically followed by considerable downside. Price collapses can be brutal and swift – Bitcoin dropped by about half in May, while some other cryptocurrencies plummeted more than 90 per cent.
This volatility is nothing new for experienced cryptocurrency investors who have witnessed successive boom-and-bust cycles, but for newcomers – especially those whose first purchases come at what later proves to be a market peak – the experience can be less sweet.
Jason, a Dubai-based investor who gave only his first name, says he brushed off suggestions years ago from friends to invest in Bitcoin and other cryptocurrencies, considering it a risky fad. But then, after hearing how well his friends had done, he decided to take the plunge a few months ago.
“My reason for getting into crypto, like most people, was purely financial, the classic ‘fear of missing out’ [Fomo] and the hope of quick returns,” he says.
He bought Bitcoin near its all-time high in May. “Within a week, it had lost a quarter of its value,” he says.
“The chief lesson [for me] is the sheer volatility of crypto means it’s best not to pile in all at once but gradually over a period of time. Think of it as a long-term investment and don't put in money you’re going to miss any time soon.”
Nevertheless, he says that doing more research into individual cryptocurrency projects has given him confidence for the longer-term prospects, even if he expects some aspects, such as meme coins, will prove a passing fad.
“While it's true that some tokens have come and gone in a short space of time, I have no doubt that crypto as a whole is here to stay and in time will become as ubiquitous as other recent innovations have.”
The rise in trading activity can also be linked to the pandemic. Gaurav Thakkar, a Dubai resident, says he began trading in cryptocurrencies in March last year. While he had previously followed trends in the sector, movement restrictions gave him enough time to begin actively trading.
While he eased into it slowly, Mr Thakkar says he has done well over the longer run by using a relatively simple strategy: buying the dip and then exiting positions when they have a profit of about 20-30 per cent, rather than trying to hold for longer in the hope of even greater returns.
Apart from his trading positions, Mr Thakkar also has a long-term, buy-and-hold portfolio that comprises cryptocurrencies he expects will have a major impact on the global economy – even if it takes years.
And while he is bullish on the outlook for cryptocurrencies generally, he says investors should be prepared to fully lose everything they invest.
“All the money I invest in crypto I think is gone,” he says. “So that’s my process. Every money I put into the crypto account I don’t think it's coming back and I treat it as an expenditure.”
His main advice for new investors? “Always buy on the dip, never buy when it’s high. Every crypto will fall at some point or time. Don’t be greedy. Exit the moment you’re 20 to 30 per cent up and wait for the dip again.”
Investors who begin investing earlier in a market cycle will likely see better returns, says Dubai-based investor Krystina Sofronya, who first began investing in 2017. “I was lucky because I entered the market at the beginning of the previous bull run, so caught the huge rise,” she says.
Ms Sofronya has seen numerous market crashes. For investors holding cryptocurrencies that have dropped massively, her advice is simply to hold through, with the expectation that – eventually – the market will recover.
“This is a very high, risky field and not everyone is suitable for this type of investment,” she says.
Investors can lack discipline
While financial markets have seen a large influx of new investors over the past 18 months, many have chosen higher-risk routes to the market – such as stock picking, leveraged positions and market timing.
Similarly, when it comes to cryptocurrencies, many investors have lacked discipline “whether in terms of the allocation, the behaviour and where to put it alongside their other investments”, says Mark Chahwan, co-founder and chief executive of UAE-based robo-advisory Sarwa.
“We’ve seen people replace stock market investing with Bitcoin and that’s pretty scary,” he says.
In July, Sarwa added the ability for investors on its platform to opt in to a 5 per cent allocation to Bitcoin, via the Grayscale Bitcoin Trust.
Simply sitting on the sidelines and ignoring Bitcoin or discounting it as purely speculative is the wrong thing to do for a wealth manager, given that many clients are already investing in crypto, Mr Chahwan says.
But he also sees evidence that Bitcoin can add value to a diversified portfolio, with key attributes being low correlation to stocks and bonds, hedging against inflation due to fixed supply and the potential to provide higher risk-adjusted returns than other assets, including gold.
The option of adding a small exposure to Bitcoin or digital assets more broadly is gaining favour among some asset managers, as it positions investors to benefit from any continued upside while limiting their downside if the cryptocurrency market drops precipitously.
“Looked at as a long-term investment, Bitcoin can be a very good driver of returns and non-correlation. It certainly has added alpha to every portfolio that has held it for more than two years since its inception,” says Zachary Cefaratti, chief executive and principal founder of Dalma Capital.
“If you consider yourself a well-diversified investor and you’re on zero Bitcoin [exposure], then I’d question how well diversified you are.”
While it is hard to define a fair value for Bitcoin, over the past three years, it has emerged as a distinct asset class, “featuring its own characteristics, and that you can really measure against other asset classes such as gold, equities, fixed income, and so forth”, says Giorgio Medda, group co-chief executive and global head of asset management at Azimut Investments.
“It is very important to be able to measure these correlations and make sense within an overall investment portfolio.”
Mr Medda believes it is “quite clear” that Bitcoin’s performance is correlated to monetary policy, including near-zero interest rates. “The value of Bitcoin has been a direct function of monetary policies of fiscal stimulus that we have seen happening, particularly post-Covid,” he says.
For certain clients, exposure to high-quality digital assets should “improve portfolio performance with reduced volatility for the overall portfolio”, he says.
Azimut has introduced a digital asset fund, domiciled in Luxembourg, which has exposure to cryptocurrency-focused equities and indirectly to digital assets including Bitcoin and Ethereum.
This gives an exposure of about 1 to 2 per cent for a medium-risk prone investor and as high as 5 per cent for more risk-prone investors who are “ready to sustain losses over a short period of time”, Mr Medda says.
Nevertheless, there are plenty of wealth managers advising clients to avoid Bitcoin and other digital assets entirely.
They typically offer several reasons: its high volatility; correlation with equities appearing to rise during market sell-offs; difficulties around estimating a fair price for Bitcoin; and a relatively limited trading history (compared with assets such as gold, equities and bonds) that makes it hard to predict how its price will behave in the future, especially if there is a shift from a risk-on to risk-off investment climate.
Some wealth managers who are critical of cryptocurrencies also see the potential for a shift. In a recent report, Julius Baer noted that while Bitcoin’s high volatility and its propensity to sell off when equities drop counts against its status as “digital gold”, future events such as a decline in Bitcoin’s volatility or the return of hyperinflation could make it more attractive for portfolio construction.
Still, there are some who believe Bitcoin’s value will drop to zero. Stefan Ingves, the governor of Sweden’s central bank, recently compared investing in Bitcoin with buying stamps. “Private money usually collapses sooner or later,” he said.
Cryptocurrencies have a unique set of risks around custody, which has been one stumbling block for some investors.
“Custody has been a key factor in keeping institutional investors and the wholesale market back,” says Mr Cefaratti. Investors have also received warnings from their banks for buying cryptocurrencies, or even had their banking relationships terminated, he says.
Nevertheless, investors today can access a broader range of market instruments outside of buying cryptocurrencies directly, while custody solutions are also improving in sophistication and reducing in price, Mr Cefaratti says.
His company, Dalma Capital is acting as joint-lead arranger for The Bitcoin Fund, which in June listed on the Nasdaq Dubai, in addition to its primary listing on the Toronto Stock Exchange.
What volatility means for investors
Mr Cefaratti, who first invested in Bitcoin in 2011, views the cryptocurrency as a long-term, strategic investment and says investors should be looking at a five to seven-year time horizon. Consequently, dollar costing is the best way to approach it, rather than trying to time the market, he says.
He “strongly expects” that its volatility will reduce over time and claims that the market is far less volatile today than in the past, when a single event, such as an exchange being hacked, could have a massive impact on price. “There are regulatory risks, but the impact of idiosyncratic risks, like an exchange blowing up or something like that, is much less than it used to be,” he says.
Mr Cefaratti views Bitcoin as the most important cryptocurrency and expects it to retain the throne of largest market cap for the foreseeable future. He suggests that investors take a core-and-satellite approach to cryptocurrencies, with Bitcoin as the core portfolio, and satellite investments in alternative cryptocurrencies, including through specialist funds.
For investors who add Bitcoin exposure to their portfolio through a wealth manager, questions of when to take profits may be answered for them when there is discretionary management, while investors with Sarwa can utilise its auto rebalancing feature.
Bitcoin’s plunge from about $65,000 to $30,000 earlier this year illustrates the value that profit-taking can have if timed well.
“It’s the rule of life – you bag your profits and you keep your initial capital invested in order to make sure you don’t lose what you earned,” says Mr Medda.
Nevertheless, there is no doubt that many investors will have sold too early.
Mr Cefaratti believes that investors should refrain from rebalancing frequently as it may cause them to miss out in the longer run.
“I would consider significant rebalancing exercises happening in one-to-two-year intervals, allowing you to see the different phases in the cycle, most preferably in two-year intervals before you too aggressively rebalance the portfolio,” he says.