By Dan Weil
With bitcoin trading at more than $40,000 apiece last week --
and quintupling in value over the past year -- the question arises
for investors: Get in or stay out?
There are plenty of reasons for caution. The virtual currency's
value has soared and plunged repeatedly since its introduction in
2009. It fell 52% just from Feb. 13 to March 11 last year.
And, while bitcoin is referred to as a digital currency, it
doesn't meet at least one important criterion of a currency: It
lacks widespread usage as a medium of exchange in legitimate
commercial transactions. In November, digital-payment processors
handled just $269.7 million of merchant sales world-wide in
bitcoin, according to research firm Chainalysis. By comparison,
total U.S. retail sales registered $546.5 billion in November.
Many pros think individual investors should steer clear of the
currency entirely. But others suggest investors would do well to
consider adding bitcoin to their portfolio -- but generally only as
a small percentage of their overall assets.
"Making bitcoin a significant part of your portfolio would
increase your risk substantially," says Eswar Prasad, a
trade-policy professor at Cornell University who is writing a book
about digital currencies. "But a marginal amount seems worthwhile
given recent dynamics."
Some of the best arguments for and against investing in
bitcoin:
THE PLUSES
What bitcoin really represents is a store of value. As such, it
can be used to hedge against inflation and against declines in
other financial assets, such as stocks, bonds and the dollar, some
industry pros say. Bitcoin has appreciated while the dollar has
slid since last March.
The "store of value" role for bitcoin is similar to that of
gold. "I put it in the same bucket," says John Rekenthaler, vice
president of research at investment-research firm Morningstar.
Some advocates endorse investing in bitcoin -- though its
volatility means timing can still be an issue -- saying it will
eventually stabilize and then be used more for legitimate
commerce.
PayPal has said it plans to allow bitcoin to be used as a
payment method starting early this year. A competitor, Square, also
has shown interest in bitcoin commerce, and announced in October
that it bought $50 million of the asset.
Some analysts also see an upside to bitcoin's volatility. Its
erratic trading keeps bitcoin's correlation with stocks and bonds
low, creating diversification. "Volatility is bad if you're tapping
it into the main part of your portfolio," Mr. Rekenthaler says.
"But if it's on the side, that's good. That helped gold become a
diversifier." He adds: "We mutual-fund owners should start to think
about bitcoin. But I'm not saying the average investor should have
it."
Because bitcoin is so volatile, investors don't need a lot of it
to diversify a portfolio, he says. Mr. Rekenthaler reckons that a
5% allocation in bitcoin will diversify a balanced portfolio as
effectively as a 25% position in the largest "alternative" mutual
fund, JPMorgan Hedged Equity (JHEQX).
While Karim Ahamed, investment strategist at Cerity Partners in
Chicago, isn't advocating for bitcoin investment at this point, his
company has begun studying whether to invest. Mr. Ahamed says
having a small investment in bitcoin could work much like an
allocation to venture capital. "In venture capital," he says, "one
in 10 investments is a home run, two to three lose money and the
others about break even. The home run makes up for a lot of
misses."
Bill Miller IV, a portfolio manager at Miller Value Partners and
son of legendary investor Bill Miller, has about 20% of his
personal portfolio in bitcoin. "It's a mistake for people not to
own bitcoin," the younger Mr. Miller says.
A major appeal of bitcoin for Mr. Miller is its scarcity, he
says. There is about $650 billion of bitcoin outstanding, compared
with his estimate of about $80 trillion for standard
currencies.
"Demand is outpacing supply," says Mr. Miller, who interprets
that to mean bitcoin should keep rising and trading should remain
volatile.
THE MINUSES
There is no obvious way to determine bitcoin's fair value.
Bitcoin stands as a store of value only because some investors
believe it is one. "Bitcoin depends on the faith of investors and
nothing more," Prof. Prasad says. "It could equally well go to zero
tomorrow if 10% of investors sold."
Other types of investment depend on similar underlying faith.
But when it comes to stocks and bonds, for instance, there are
legitimate mathematical models to determine their value. Stocks
produce earnings and bonds produce income, for example, which helps
determine their values.
Many analysts also question bitcoin's value as a hedge. This
year, it has largely risen in tandem with stocks and bonds at a
time when inflation is quiescent. In addition, no major inflation
has broken out since bitcoin came on the scene 12 years ago, so it
is difficult to know whether it truly guards against price
increases. "You need that empirical testing," Mr. Ahamed says.
Meanwhile, some critics question whether bitcoin's scarcity is a
selling point. That scarcity also means illiquid and volatile
trading, as evidenced by bitcoin's roller-coaster ride during its
12 years of existence.
Skeptics also challenge the view that bitcoin's volatility can
be viewed as beneficial to a portfolio for diversification
purposes. "If the volatility comes just from speculation, I'm not
sure I want it as an uncorrelated asset," Mr. Ahamed says.
Mr. Weil is a writer in West Palm Beach, Fla. He can be reached
at reports@wsj.com.
(END) Dow Jones Newswires
January 08, 2021 17:32 ET (22:32 GMT)
Copyright (c) 2021 Dow Jones & Company, Inc.
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