Crypto Went Through the Wringer in 2022: Now What? | Kiplinger

Cryptocurrencies, or digital assets, have been through a lot of turbulence so far in 2022. Since their high point in late 2021, major assets like Bitcoin and Ethereum have seen dramatic price declines. These withdrawals created a chain reaction in other areas of the digital asset market, which ultimately led to the bankruptcy of several crypto platforms – and a crash that wiped out the value of a few major cryptocurrencies. .

Many coins have seen massive price declines from all-time highs and have not recovered. As an investor, how should you approach crypto now?

Crypto Basics and Recent Falls

First, a brief summary of recent major crypto and events:

The blockchain technology used to exchange cryptocurrencies has been hailed as a game changer for the future of currency. Users can “confirm transactions without the need for a central clearing authoritywhich democratizes access to the economy, especially for those who have historically not had access to financial institutions. Cryptocurrencies such as Bitcoin, Ethereum and other coins or tokens are just an alternative form of payment known as digital currencies. As potential drives crypto’s allure, so does speculation. And even though the crypto has been hailed as “inflation-resistant”, its recent falls are quickly affecting its market value.

One of the major events that has happened recently has been the dramatic collapse in the value of TerraUSD, an algorithmic stablecoin, supposed to behave like cash. TerraUSD’s algorithm was structured to keep it tightly pegged to the US dollar, but the peg failed, causing a panic sell and simultaneously crashing another popular token, LUNA, which was linked to TerraUSD. Both tokens lost tens of billions of dollars in total market capitalization.

Another major event that shook the world of digital assets was the collapse of Capital of the Three Arrows (3AC), a cryptocurrency hedge fund. This had a ripple effect as other crypto trading platforms that were counterparties to 3AC had to freeze their clients’ withdrawals.

Core Value Propositions vs. “Pumping and Dumping”

I am not saying all of this to scare you away from investing in cryptocurrency. But I think the prudent approach to this asset class is to focus on the fundamental value proposition of a digital asset – while fully understanding its utility – before investing in it.

There are many websites that promote new and upcoming parts based on recent performance spikes; Optimistic assertions about the long-term potential of these coins are inevitable. Much of this is selfish, as seed investors in digital assets will try to promote their projects to keep prices up, which in turn allows them to promote further price appreciation and momentum in the market. room.

Just as we have seen with stock swings “memes”, holders of certain assets will use the internet and social media to promote the assets they currently hold in hopes of being able to pump and dump them. I recommend avoiding the temptation to chase returns in new and lesser-known alternative parts. Some investors have had success making money with this strategy, but it comes with very high risk – and can be financially devastating for investors who are too focused on these types of assets.

Bitcoin and Ethereum – the most established players

Federal regulation of digital assets is still waiting — though it may take renewed priority after the recent fallout. In the meantime, a more conservative strategy would be to invest in the more established digital assets, including Bitcoin and Ethereum. Both have started to rise in value from their mid-June lows, coinciding with positive returns from other risky assets over the same period.

Bitcoin is the largest and best-known digital asset by market capitalization. It is also the most adopted digital asset by institutional investors. BlackRock, one of the largest asset managers in the United States, recently announced a partnership with Coinbase to offer digital asset trading to its clients. Institutional demand for Bitcoin could provide a steady boost to its price given the broader demand in wallets. Bitcoin also continues to be used to send and receive global payments.

Ethereum is the second-largest digital asset by market capitalization. What makes Ethereum unique in value is the fact that it is used as a network for so many other digital assets and projects, including “DeFi” or decentralized finance applications. As more and more projects are built on Ethereum’s network, demand for its token, ether, increases. Ethereum is also working on a major upgrade in the next quarter that would drastically reduce the power consumption of its blockchain, in theory reducing its carbon footprint by 99%! Interest in ether and its price has increased since early July.

Considering crypto? Consider a conservative allocation

Given the above, it’s no surprise that I generally recommend a conservative allocation to digital assets. Digital assets, relative to stocks, are highly volatile – as we’ve already seen in 2022. The Nasdaq composite, representing tech stocks, was down about 33% year-to-date at its lowest point, while the better-known S&P 500 index (a barometer of large-cap US stocks) fell around 24% as its year-to-date low. Bitcoin, by comparison, fell more than 60% from its value at the end of 2021 at its lowest point.

For a well-diversified portfolio, cryptocurrencies can provide increased potential return and some diversification benefits when properly combined. Digital assets, in general, have a low degree of correlation with stocks. In modern portfolio construction, low-correlated assets tend to be desirable because it means that when an asset rises or falls, the price of a low-correlated asset does not move in parallel with it. In other words, if the market panics and assets sell off, you don’t want all the assets in your portfolio to go down at the same time.

Digital assets can also offer a bit of excess return potential during times when stocks are flat or trading in a range.

With any investment portfolio, it is also important to periodically reassess the strategy and determine whether or not strategic or tactical changes are necessary.