The last several months, and especially the last couple of weeks, have been unkind to crypto markets. The downturn in prices – and the torpedoing of the store-of-value and non-correlated-asset theories about crypto – have turned many in the public square against digital assets as both an investment and a new financial system. Financial advisors who were thinking about adding crypto to their practices several months ago are likely taking a second look, and rightfully so.
Downturns aren’t fun, but often they’re also opportunities. Contrary to conventional wisdom, could this be a good time for financial advisors (FAs) to learn about and potentially implement digital assets into their practices? Let’s discuss.
First, what happened?
Without going back too far in the annals of crypto lore, we can look to November of 2021. With the world opening back up following the COVID-19 pandemic, and the realization that we now have trillions more dollars in circulation, not to mention supply-chain and production issues, tech stocks started finally falling in value. Bitcoin and crypto also started falling from their all-time highs.
At the time, this was just seen as healthy overall, even with a 40%+ drawdown in bitcoin price.
Then, in May, Terra happened. The $40 billion layer 1, or base layer, network lost almost all its value in a few days, pushing the price of bitcoin down through forced selling in an effort to remain solvent. This drastic fall highlighted some negatives related to crypto, specifically the centralization, poor incentive mechanisms and adherence to propped-up yield as a tool.
While the prices leveled out, the overall economy kept looking worse. With 40-year highs in inflation, more supply chain issues and record energy prices, talk of a coming recession began, which has brought a flight to liquidity and safety from all risk assets.
Bitcoin fell below $20,000, and ETH below $1,000. For the last couple of years we thought we would never see these levels again … but here we are.
As an advisor, you could choose to just ignore crypto for a few years, or altogether. Based on recent events, price action and narratives, I wouldn’t blame you. You have plenty of possible investment options for your clients.
If, on the other hand, you’re still determining which direction to take, here are some points for consideration.
Networks in use
While the prices of the crypto assets are way down, the networks and protocols underlying those assets are still being used. A recent report from the Fed (yes, that Fed) shows that possibly 40 million Americans are using cryptocurrency in some form. Up to 6 million of those people are using it for payments of some sort, and 60% of them have an income below $50,000.
The very people who need a new financial system are using it as intended. And the use of the networks will eventually drive the infrastructure, adoption and value of the assets.
Also, the most recent price downturn due to liquidation happened in a very traditional finance way. Centralized entities were using leverage with crypto as the collateral. For the most part, they were not using the decentralized financial system. The decentralized finance (DeFi) protocols built for lending and trading have held up just fine so far, even with the extreme volatility and liquidations.
Increasing our understanding
While in the up-only, speculative mode, most people just pour money into tokens and protocols that produce the highest return or have a chance at an outsized return. There is maximum FOMO, or fear of missing out, at this stage, and we seldom look at the risks investors are taking to achieve those returns, other than the volatility of the assets.
When we’re in a situation like we’ve seen in the past several months, we start to better understand the risks of the interconnected system, leverage, lack of transparency, etc. We have seen the poor incentive system which could be gamed in Terra, and the rehypothecation and leverage of Celsius and Three Arrows Capital.
As an industry, we are increasingly understanding the risks inherent in the system, and how we can identify them before they negatively affect us and our clients. What are the risks of holding digital assets on an exchange, or even lending them to a centralized company, and is the return you receive enough to compensate for the risk?
We are getting better at comprehending the value of transparency as well, as we can predict the level at which major liquidations will happen, and even identify the parties that can be liquidated.
The increased understanding of transparency and value flows is also contributing to the better potential analysis of the value of certain protocols and their requisite tokens.
Regulation is coming
Even before the downturn, the growth in value and popularity of crypto had pushed U.S. regulators and legislators to talk about increased regulation. The recent events have given them even more to talk about.
We will likely see more guidance and regulation in the coming 12 months, partially to protect investors and partially to protect the dollar. This will make advisors, wealth managers, institutions and investors feel a bit safer allocating to crypto.
What this all means for advisors
The growth in value and notoriety of the crypto industry in the past few years created tremendous growth in the infrastructure, while building a wall of cash in venture capital funds waiting to be deployed into the decentralized finance ecosystem.
As an advisor, this is a great opportunity for you. The decentralized financial tools of crypto will continue to be used and grow. More money will be poured into the applications, driving even more adoption.
Your clients, and prospective clients, will need you to be the expert to help keep their money safe, have intelligent conversations around risk and reward and educate them on the value of these assets and protocols.
They will need help from someone versed in finance to explain why the potential to earn 20% is still bad if the risk is too much.
They will need help from an expert to determine how and where to custody their assets.
They will need help understanding how they can earn yield using the DeFi system, and do so in a safe manner.
In the early 2000s, tech stocks experienced a severe crash. But the years after turned out to be the best time for investing early in the technology. This might be the equivalent moment in crypto, which makes the next few years the best time to start helping clients with their crypto allocation.