Interest in cryptocurrencies such as Bitcoin, Ethereum and others is surging once again. Should financial advisors care?

These digital assets have been embraced by the likes of famous hedge fund billionaires Paul Tudor Jones and Stanley Druckenmiller, and by fintech companies including PayPal and Square. That said, cryptocurrencies lack widespread adoption in advisor-built portfolios. But should they have a place in client portfolios?

One of the arguments in favor of cryptos is their low correlation with traditional asset classes like stocks, bonds, commodities and real estate. This offers diversification for investors. Moreover, the market for established cryptos like Bitcoin and Ethereum is highly liquid with a global marketplace that never shuts down. 

And worries about both rising global government debt and the stability of fiat currencies are supportive of higher cryptocurrency prices. Indeed, Bitcoin’s 2009 launch in the midst of the financial crisis appealed to people seeking a decentralized currency away from the grasp of governments and financiers blamed for mangling the economy and manipulating money supply. Cryptocurrencies would likely benefit from a future financial crisis.

Another benefit of cryptos is their finite supply. Bitcoin, for example, has a maximum supply that’s capped at 21 million coins. Once all of these bitcoins are mined, the global supply will be exhausted. Unlike fiat currencies, which can be increased in size with printers, cryptos can’t be printed.

Despite their advantages, digital currencies have some major shortcomings.

The price volatility of cryptos can make price swings in other assets seem sleepy in comparison. For instance, a brutal bear market took Bitcoin prices from a 2017 peak of $18,984 per coin to a nadir of $3,713 in 2018. Other cryptos crashed, too. In 2020, Bitcoin experienced a year-to-date bottom at $5,884 per coin on March 22 before it took off and zoomed upward. In early December, it had more than tripled in price as it came oh-so-close to hitting the $20,000 mark. (It traded at $18,341 as of 3:10 p.m. today.) These wild moves are not for the faint of heart.

Another major hurdle is the dearth of exchange-traded products (ETPs) that transparently, efficiently and cost-effectively track Bitcoin. Up until now, the Securities and Exchange Commission has flatly rejected all submitted Bitcoin ETF proposals. But that hasn’t stopped Wall Street from trying.

After making six amendments to its Bitcoin ETF application in the course of 13 months, New York City-based asset manager Wilshire Phoenix’s effort to launch a fund was once again denied by the SEC earlier this year. The regulator cited its oft-repeated concerns about market manipulation and protecting investors. Other Bitcoin ETF applications have faced a similar fate.

Grayscale, a New York-based asset manager focused on the crypto market, offers a suite of single and diversified cryptocurrency products. The Grayscale Bitcoin Trust, which launched in 2014, is their oldest and largest product with $10.4 billion in assets. Over the past five years GBTC has racked up an impressive total gain of 4,742% versus a 182% gain for the Invesco Nasdaq-100 Trust (QQQ). But that upside has come with a good deal of volatility. For example, GBTC gained an astounding 1,557% in 2017 but lost 82% the following year. 

Impressive overall performance aside, GBTC—like other Grayscale crypto ETPs—has steep fees. GBTC charges annual expenses of 2%. Moreover, GBTC regularly trades at signficant premiums and discounts to the trust’s underlying assets. And premiums often skyrocket when cryptocurrency prices boom. As of December 8, GBTC traded at a 17.7% premium while it’s cousins linked to Ethereum (ETHE) and Litecoin (LTCN) traded at fat premiums of 138% and a mind boggling 3,163.8%, respectively. If newer and better crypto ETPs ever attain SEC approval, it’s probable that the juicy premiums in Grayscale’s lineup would crash back to Earth, thereby creating many unhappy bag holders.

Ultimately, it’s up to each advisor to figure out whether the current generation of crypto-linked ETPs are worth the risk. Despite the high fees and operational inefficiencies, the opportunity for future dazzling performance with diversified risk away from traditional asset classes could be worth the gamble. 

Ron DeLegge is founder and chief portfolio strategist at ETFguide, and is the author of “Habits Of The Investing Greats.”