Should Grandma and Grandpa Buy Bitcoin?

“I will impart a knowledge of the Art to my own sons, and those of my teachers, and to disciples bound by a stipulation and oath according to the law of medicine, but to none others. I will follow that system of regimen which, according to my ability and judgment, I consider for the benefit of my patients, and abstain from whatever is deleterious and mischievous. With purity and with holiness I will pass my life and practice my Art.”

Excerpt of the text The Hippocratic Oath (c. 400 BC). Translated from Greek by Francis Adams (1849)

“The physician must be able to tell the antecedents, know the present, and foretell the future — must mediate these things, and have two special objects in view with regard to disease, namely, to do good or to do no harm.”

Excerpt of the text Of the Epidemics

As a practitioner of a profession which should hold a client’s best interest in as high a regard as a physician considers his/her patient, I have always favored such a code of ethics that has been handed down through generations.  But what does a guide to conduct referenced in many medical school graduation ceremonies have to do with investing in cryptocurrencies?  

To answer this question, allow me to introduce one of our core principles at Brand AMG: to positively impact the trajectory of all lives we touch.  Put more simply, no one should walk out of our doors in worse shape than when they walked in.  And as fiduciaries, we honor our duty of loyalty and our duty of care.  We must act diligently in the best interest of those that pay for our counsel.  Therefore, we must always look at investment opportunities through the framework of understanding the balance of potential risk and benefit.  

“The fact is that when difficult, real-time decisions must be made, it’s hard to apply the ‘first, do no harm’ dictum because estimates of risk and benefit are so uncertain and prone to error.

But it is a reminder that we need high-quality research to help us better understand the balance of risk and benefit for the tests and treatments we recommend. Ultimately, it is also a reminder that doctors should neither overestimate their capacity to heal, nor underestimate their capacity to cause harm.”

Robert H. Shmerling, MD
Senior Faculty Editor, Harvard Health Publishing

Dr. Shmerling couldn’t frame the discussion any better.  And whenever risk and reward are brought up, Grandma & Grandpa’s goals and values are in view.  But what’s wrong with their curiosity in Bitcoin, given that its enormous run up in price has been hard to ignore?  And why can’t their goals include asset classes with the potential for eye-popping gains?  The answer is they can, but at what risk?  To better understand, let’s take a deeper dive into why Bitcoin has been rallying to all-time highs.

First, more and more investors are buying Bitcoin.  Anyone can now buy it on apps that you already have on your phone.  With the prospect of economic and political uncertainty, as well as historically low interest rates, investors are seeking new strategies.  

Second, institutional investors have been buying.  For example, a major U.S. insurance company (MassMutual) bought $100 million of Bitcoin.¹  Tesla recently announced its plans to not only purchase $1.5 billion in the cryptocurrency, but also to begin accepting it as payment for its product.²  This acceptance by well-known investors and institutions potentially fuels its legitimacy as an asset class, as well as a global currency option that may someday challenge local currencies, or even the dollar.  The latter of these potentials is most prevalent in emerging markets, where the local currency is unstable, or dollars can be difficult to find.

“Cryptocurrencies promise to help solve problems that are particularly acute in emerging markets (EM). Their governments are often centralized but relatively unreliable, which destabilizes currencies, opens the door to profiteering middlemen, and erodes public trust. Blockchain, the technology behind Bitcoin’s decentralized network, promises to cut out the grasping hands of governments and middlemen, and speed up transactions with more transparency and lower fees. It is offering what many EM customers are desperate for.”

Morgan Stanley Investment Management, Why Crypto is Coming Out of the Shadows

In addition, the massive push of every major central bank to print money in an effort to keep economies surviving during the pandemic has fueled skepticism in some global currencies.

All this is meant to indicate that cryptocurrencies and the digital ledgers that power these currencies — Blockchain —  are likely here to stay.  What was historically a conversation dominated by adamant believers and skeptics of any digital asset, is evolving into an asset class being purchased by institutions and some well-known investors.  In other words, it’s likely time to give cryptocurrencies practical consideration.  

But before concluding that the dollar will be dominated anytime soon, or that the less than attractive prospects of bond yields mean we should replace our fixed income with crypto, the discussion should include one overarching theme of our opening oath: risk.  Bitcoin is very volatile, with average annual price swings of 69 percent, 2.5 times the figure for silver, over 5 times gold, and 3.5 times an all-stock portfolio. Further, while volume and participation in bitcoin continue to increase, the fact remains that it faces an uphill battle when it comes to its potential for massive, permanent losses, as detailed by the chart below.

These levels of risk and drawdowns are simply untenable for many investors.  The mathematics of avoiding large losses is crucially important to understand.  For instance, consider a simple investment of $100,000.  A 50% drawdown requires a subsequent 100% gain just to get back to even. 

This sort of risk is likely more than Grandma & Grandpa care or need to endure.  As protectors of their best interest, and positive slope changers, it is the sort of risk we cannot stand behind for their situation.  Further, with Bitcoin trading at all-time highs, (while I’m writing it’s “value” is above $55,000, compared to 2020 lows of $3,925) it may make sense for even those willing and able to accept the risk to keep any meaningful assets on the sideline for a little longer.  

All of this is not to say that our team isn’t considering more “risk-controlled” options to gain exposure to this technology.  It should be stated that Bitcoin now totals around $647 million of a $950 million cryptocurrency market.³  There’s still plenty of runway to reach a more traditional inflation hedge like gold, which is a $10 trillion global market.⁴  As a hedge, it may have more utility.  However, it is a speculative asset, or property as the IRS classifies it.  Further, its volatility works against it as a currency.  Imagine the possibility of paying one price for your Tesla in the morning, and a meaningfully different price if you wait until the afternoon.  What gains it does produce will likely be taken on a short-term basis, which can be difficult to own in taxable accounts.  Lastly, it’s one regulation or competitor away from being worthless.

So how do we conclude the conversation with Grandma & Grandpa?  Perhaps we wrap it up by revisiting our earlier analogy to the practice of medicine: 

“A surgeon is a doctor who can operate and who knows when not to.”

Theodor Kocher (1841-1917)

“Medicine should probably be leaving the well to be well instead of constantly trying to find something wrong with them.”

Dr. Iona Heath, Too Much Medicine

¹Wall Street Journal, MassMutual Joins the Bitcoin Club With $100 Million Purchase
²Wall Street Journal, Tesla Buys $1.5 Billion in Bitcoin
³Visual Capitalist, Comparing Bitcoin’s Market Cap to Other Cryptocurrencies
⁴Market Insider, Bitcoin’s market cap could hit $1 trillion in 2021 as its growing reserve currency status drives adoption higher, a cryptocurrency expert says