An Introduction to Digital Asset Management

Financial advisors and planners increasingly have to field questions about cryptocurrencies from curious clients. Erring on the side of caution, many advisors will tell their clients that investing in these types of assets is highly risky and likely not a good strategy. However, this “safety first” approach may be misguided, especially considering that crypto writ large has managed to attract a nearly $3 trillion market cap at its highest. While crypto may not be the best investment for every investor, there certainly is a place for crypto in a traditional investment portfolio.

What Are Digital Assets?

Digital assets are built atop blockchain technology, which integrates a system of account with the unit of account. This is to say that the cryptocurrency unit contains an immutable ledger that is distributed across many different servers. These digital assets can behave as currencies or as stores of value, or have other computational functions.

Bitcoin

Bitcoin was the first cryptocurrency to appear on the market and has sat in a category all on its own ever since. Many argue that bitcoin is the only truly decentralized cryptocurrency since there is a set amount (21,000,000) with no centralized institution controlling its function. Bitcoin ownership and transfer is validated by a decentralized computer network that competes to validate transactions. The system rewards winners with a certain amount of bitcoin. Because the ownership ledger is decentralized, it is immutable, and therefore fraudulent transactions are quickly invalidated, making fraud virtually impossible.

Other Crypto

Other cryptocurrencies like Ethereum, Polkadot, and Cardano have a similar blockchain substructure. However, these coins are programmable and are able to carry out different functions. These coins are tokenized and perform various functions like creating a network for decentralized computer hosting, creating web applications, and executing smart contracts.

NFTs

Non-fungible tokens (NFTs) are digital tokens that are attached to both digital and real-world assets. NFTs are most frequently used to validate the ownership of digital artwork or digital real estate. However, NFTs can also be attached to real-world goods like commodities (coffee, for example) to verify value chain activities and execute smart contracts.

Where to Buy Digital Assets

It’s important to note there are a few different ways to “own” digital assets. Some institutions like JP Morgan Chase allow clients to purchase ETFs with cryptocurrencies and hold them in a formal investment portfolio. Crypto exchanges like Binance or Coinbase, on the other hand, enable their customers to buy digital assets. However, in this case, the exchange still holds custody of the actual cryptocurrency. Finally, others decide to exercise self-custody of digital assets and own them directly with a cryptocurrency wallet. Each of these investment methods has its unique set of advantages and disadvantages.

Evaluating Digital Assets Quality and Longevity

It’s important to realize that many digital assets can be labeled as speculative, high-risk assets. This doesn’t mean that there is no place in an investment portfolio for these types of cryptocurrencies; it merely means that investors must understand their nature and risk. Volatility notwithstanding, Bitcoin has increased nearly 10x in value over the last five years despite copious high peaks and low valleys.

How to Hedge Against Risk

The way to hedge against risk within the cryptocurrency market is best practice for risk mitigation in any other market. First, investors must educate themselves, and they must diversify their portfolios. There are approximately 10,000 different cryptocurrencies on the market at this point. Each one has a “white paper,” which explains how the currency works and what its USP is. Investors ought to familiarize themselves with the different classes of digital assets, their functions, and their relationships to the rest of the market. Second, investors must recognize that cryptocurrency is just one part of a more extensive portfolio that may include commodities, stocks, bonds, and other assets. Within this first level of diversification into other vehicles, investors can then diversify into cryptocurrencies that strike an investor as worthwhile.

Rules for Volatility

A cursory review of any cryptocurrency market chart will reveal an uncomfortable amount of volatility. Part of this volatility is because cryptocurrencies are still so new, and the market is trying to understand their role in the world. While market understanding and adoption have shown an inverse relationship to volatility, there are still a few things to note regarding volatility. 

Memecoins and Other Low-Quality Investments

The crypto market crash in May 2022 was a shot across the bow to many cryptocurrency investors; so-called meme coins and other low-quality coins making “too-good-to-be-true” offers are often too good to be true. Coins that purport to offer high interest rates or engage in profit sharing out of pure benevolence should be avoided. The value-add and USP should make sense for everyone involved in the transaction.

Long-Term Investment

Cryptocurrency is best understood as a long-term investment. The best remedy for short-term volatility is a long-term perspective and a high-time preference. Investments in cryptocurrencies should be made in assets that appear capable of existing and profiting over a period of several years.

Only Invest What You’re Willing to Lose

Because cryptocurrencies are appropriately regarded as speculative assets, investors should only invest what they’re willing to lose. As a result, younger investors are likely to have a higher tolerance for the risk that accompanies crypto investments. Older investors, on the other hand, may want to limit their exposure to the market.

Regulatory Compliance

Realized capital gains from cryptocurrency investments are liable for tax payments. Even cryptocurrency acquired through anonymous means is still required to be reported and capital gains taxes are applicable. Other non-tax regulations can be seen on the horizon, but regulators have yet to conceive and implement them fully.

Conclusion

Investing in digital assets like cryptocurrency and NFTs requires specialized knowledge, just like any other investment. While certain opportunities are ripe for the picking, others are best left on the table. The best way to determine the difference between the two is to acquire a working knowledge of digital asset investment. 

‍

The Wharton School created the Economics of Blockchain and Digital Assets course to help financial advisors, CFOs, and other financial professionals navigate the waters of digital asset management. The course covers the fundamentals of blockchain technology for investment and implementation in businesses. To learn more about the course or to enroll, please visit our homepage for blockchain course info and next steps.

‍

This article is for marketing purposes only and does not intend to represent the opinions of the program.