Is Cryptocurrency a Legitimate Asset Class

Is Cryptocurrency a Legitimate Asset Class

Historically, financial advisors have diversified their clients’ portfolios using three main asset classes: equities, fixed income (bonds), and cash equivalents like Treasury bills and CDs. Progressive firms also add real estate, commodities, and derivatives. The idea is to have a mix of financial vehicles that perform differently under specific market conditions, maximizing the chances of a decent return.

Political infighting over crypto classification

Where does crypto fit? The US Senate is reviewing a bill to classify crypto as a commodity, putting it under the Commodity Futures Trading Commission (CFTC) jurisdiction. The Senate Agriculture Committee, which oversees the CFTC, introduced the bill. They do not have purview over the SEC, which is controlled by the Senate Banking Committee.

Under the guidance of Gary Gensler, the Securities and Exchange Commission (SEC) has repeatedly called crypto “securities” in its legislative actions. They even went as far as to classify nine crypto assets as securities in an insider trading case they’re prosecuting that involves Coinbase. Keep an eye on that in the coming months.

The “Digital Commodities Consumer Protection Act of 2022 (DCCPA), which advocates for CFTC control, is getting overwhelming support from the crypto trading community. Giving a security classification to certain tokens could disrupt the crypto market and raise fees for smaller trading platforms. Virtually no one outside of the SEC wants to see that.

SEC Bulletin 121 calls crypto a “liability”

SEC Chair Gary Gensler was a professor at MIT who taught cryptocurrency and blockchain technology. His selection as the investment world’s “top cop” was lauded by the DeFi world when he first came into power. The SEC’s rhetoric and actions since then have dampened that enthusiasm. The “security vs commodity” argument is only one part of that.

Headline news is often a smokescreen for what’s going on behind the scenes. On April 11, 2022, the SEC published Bulletin 121, an accounting bulletin that advises public and private companies combining with SPACs to report cryptos as liabilities on the balance sheet and provide additional disclosures on the value of those assets.

The SEC backpedaled when the backlash hit. They called it “interpretive guidance for entities to consider” and didn’t put their official approval seal on it. Gensler defended the bulletin by saying, “Crypto assets aren’t ‘well-enough developed’ and are ‘sufficiently different’ from traditional assets like stocks and bonds.” Pause and think about that for a moment.

This argument is about regulation, not classification

Fear of change makes people do strange things. Decentralized finance (DeFi) is perceived as a threat to central bank fiat currencies. Bitcoin has the 27th largest market cap on the global currency list. It’s ahead of the Norwegian Krone, the South African Rand, and the New Zealand Dollar. Ethereum comes in 36th on the list. Tether is in the #50 spot.

United States Senators don’t particularly care about exact classification when it comes to crypto. The only reason that’s important is that it determines which regulatory body will control crypto trading rules. Commodities and securities both trade on government-regulated exchanges. This battle is about regulation and control, not classification.

The SEC cites Ripple XRP as their poster child in the argument for declaring crypto a security, but XRP isn’t a true cryptocurrency. It was sold by Ripple Labs Inc to fund company growth. The SEC had a legitimate case on that. Using that case, which was filed in 2020, as a precedent to pull other cryptos into the same bucket is proving to be a losing battle for them.

Treating crypto as an asset class in portfolio construction

Oil and orange juice are both commodities. You’d never treat them the same when constructing an investment portfolio. That’s why commodities are broken down into sub-categories like agricultural, energy, and metals. With momentum seemingly on the side of the DCCPA, it looks like we’re going to add cryptocurrency to that list. It’s best to treat it as its own asset class.

Like all asset classes, the crypto class will have winners and losers. Bitcoin and Ethereum look like solid long-term investments right now. Other tokens are newer and have a lower adoption rate. That’s no different from startup companies and new public listings on the stock exchange. Value is determined by investor participation and behavior.

When building a portfolio, the goal is to choose investments with varying degrees of risk that balance to achieve a favorable return. Crypto is a high-risk/high-reward investment, like agricultural commodities, microcaps, and emerging market equities. It’s an asset class that’s established and growing rapidly. Your clients want to be a part of that.

Cryptocurrency as a Tactive investment

Tactive investing is a term we use to describe active trading with tactical investment models. We’re not advocates of passive investing using “modern” portfolio theory. Sitting and waiting for the market to cycle back around is not a sound strategy in 2022. In our world, we minimize drawdown now and utilize all asset classes to maximize investment returns.

Cryptocurrency is one of the many financial vehicles we utilize for Tactive investing because we already view it as a legitimate asset class. The political infighting and legislative battles make for interesting theater, but they’re not affecting our portfolio construction. We’re watching the numbers for crypto, and they’re favorable. Reach out to us if you’d like to learn more.