Cryptocurrency is an Emerging Industry (Part One) | ETF Trends

By Justin McKennon

This is Part One of a three-part series intended to help financial advisors and wealth managers understand how they can bring additional value to their clients through cryptocurrency exposure.

The rate of technology acceleration is staggering. In just the last 10 years we have seen a substantial shift in the automotive market (Electric Vehicles), financial markets (automation, big data, digital banking and transactions), social media (Instagram, Tik Tok) and many other areas. Meetings are now almost entirely remote (Zoom, Skype). The way people exchange data and use the internet is currently undergoing the same transformation. Cryptocurrency, at its core, is really a technology sector in and of itself. The issue is that the perception of Cryptocurrency is varying. What are you buying? A stake in a company? Where is its value? What sets it?

For wealth managers and financial advisors, this presents a significant conundrum. How do you assess risk with something that allegedly isn’t bound to anything tangible?  Should your clients have cryptocurrency as part of their portfolio?

This topic is further complicated by just how unique the entire space is. For electric vehicles, the technology may be new, but the companies are entering an already established marketplace (stocks, etc.). Despite traditional automotive markets being disrupted, the same successful tactics that have made successful financial advisors… well successful, are applicable. Looking at market trends, company numbers, SEC filings – the “process” to decide the risk tied to a potential investment/company is somewhat of a known commodity to experts in the field.

When it comes to cryptocurrency… well the gloves are off. The valuations are different. The data is different. They are unregulated (for now). Prices swing wildly. Legacy transaction systems don’t apply here (where do you get your crypto?). As an advisor, to bring cryptocurrency to your clients requires a drastic overhaul to your processes, procedures and way you do business. If your client base comprises high net worth individuals, should you be recommending some allocation of cryptocurrency?

With an already busy schedule, how can you, as an advisor, make sound recommendations if you’re not already an expert here? These reasons are why wide scale adoption at the small to medium wealth management scale is not at its peak yet. You’re basically asked to learn an entire new industry in real time, with different tools and behaviors than anything you’ve ever had to deal with in the past.

Let’s get one thing straight – the world of Web3 and cryptocurrency is not going away. Those that find a way to carve out a place within this financial market will be positioned powerfully for the next decade or more. As an advisor it is your job to provide investment advice within the confines of your understanding of risk tolerance and situations for your clients. The beauty of cryptocurrency is that for many portfolios, even a small allocation can reap major dividends.

But where do you start? You want to offer cryptocurrency as an investment option to your clients and get ahead of the curve. What do you buy? Where do you even get it?

To make this process a little bit more manageable requires some careful recalibration regarding some fundamental properties of cryptocurrency. We’ll address those.

1. Where does cryptocurrency get its value?

Historically, most traditional investments (companies, etc.) have valuations and prices that are straightforward to determine. In the case of cryptocurrency, most tokens are “unbacked”. This is commonly referred to as a negative attribute of cryptocurrency. It is also commonly blamed as a cause for a lot of the volatility the market experiences.

Cryptocurrency values are, for legitimate projects, a combination of current utility and future speculation of utility. Almost every token has some “function” – which is fundamentally very different from stocks. Owning stocks may afford you the opportunity to vote on company matters or receive a dividend. In the world of cryptocurrency, the term “tokenomics” is a critical piece of every project. It’s a combination of the token itself and the economics tied to the token. In some projects you’re afforded the right to “vote” on how the project behaves or certain features (governance). Other projects the tokens are burned (reducing overall supply), distributed via rewards for providing critical functions or services to the project, as an in-game currency for games and many more.

Tokens are used by projects… as a currency. You can think of cryptocurrency projects as software companies and the tokens as their product. In nearly all cases in cryptocurrency:

You are buying a token whose value is based on how useful to the project the token is, not how successful the project or company behind the project becomes.

The projects, in general, drive the value to the tokens. For a fixed supply of tokens, if the project has a high demand or user base, the demand for the token is likely to be high, and prices will increase. The general laws of supply and demand still apply to cryptocurrency. As an advisor, it is imperative to understand the utility that a project provides as one key metric for evaluation (why should people care about this project?). Just as important are the utility and efficiencies the token provides (why do I want or need this token?). Projects that combine need and utility are more likely to succeed.

As an advisor, a major difference you’ll need to understand is that the value of cryptocurrency functions (while tied to utility) changes. Future speculation is a part of this, but most of it is tied to what is happening in the market. When decentralized finance began taking off in 2020-2021, the valuations of successful projects in that sector skyrocketed. In late 2021, blockchain gaming really exploded, and the valuations reflect that. As the world of cryptocurrency matures, the needs of the market and the desires of the user base change at a far faster pace than traditional finance markets. Entire sectors are born and die within the market. The “set it and forget it” strategy is often one of the riskiest due to the technology turnover that happens within the space. Obsolescence is real.

A strategy that hedges known utility (Bitcoin, Ethereum), blossoming utility with projected future growth (major L1 projects, key L2 scaling solutions, etc.) will be a great success for most clients. It’s an added step, but you’ll need to stay in tune with the developments of a project as well as have a finger on the pulse of the overall market trends/narratives. In the cases of the large market cap projects, fluctuations in price happen fast because of unfettered derivatives and leverage exposure and over the intermediate time frames according to the expected future demand.

The last point here in Part One is related to gaining expertise. It’s daunting to consider having to master all the tech and knowledge related to your investment recommendations in cryptocurrency. Projects are continually releasing new features and new ones are popping up all the time. Regulations, security issues and more introduce more variables. In most cases we are seeking sound, longer term investments to avoid day trading and other scenarios. Learning what matters and what doesn’t is hard. A major development in recent times is CoinBusters’ partnering with Willow Crypto to provide managed cryptocurrency services. Partnerships like these allow for advisors to let research firms like CoinBusters and professional asset managers like Willow Crypto handle all the minutia and provide decision-making level data to outside advisors to use for their own clients.

Part Two and Part Three will focus on the tools you need to have to physically help custody, trade (etc.) client assets and some of the strategies employed by the partnership of CoinBusters and Willow Crypto.

Justin McKennon is a co-founder of CoinBusters. https://CoinBusters.io serves as a hub for research, analysis and education across the cryptocurrency space. If you’re looking for help (as an individual firm, advisor, wealth manager, or anything in between) please reach out!