Crypto survives a big test

Being a crypto investor has been difficult lately.

Bitcoin is currently about 55% lower than its November high, including a more than 20% drop since the end of March. While volatility is no stranger to the cryptocurrency asset class, it’s still uncomfortable when selloffs intensify. Amid the recent downtrend, the crypto market was given a major test. And the asset class survived – this time.

The test came from a part of the crypto market that’s supposed to be more reliable and plays an important role in the functioning of the market. Last week, one of the largest stablecoins (a cryptocurrency pegged to another currency, commodity or financial instrument) imploded. TerraUSD, or UST, de-pegged from its $1 target, in part because of its operational design. Today, it’s almost worthless.

I’ll leave the details of the implosion to other sources, but this was a shocking event for the crypto complex. This was the first real risk of an event that could have caused contagion and big selling across the universe of cryptocurrencies. Some of the biggest coins could have been damaged significantly more than the moves recorded over the past week, especially if the crypto market was more closely intertwined with the broader financial system. Thankfully, the crypto market has been able to stabilize in the past few days.

It’s moments like this that remind us why it’s important to have a good understanding of what you’ve invested in, the risks associated with those investments, and your level of tolerance for that risk.

Crypto: The portfolio perspective

The last few weeks have no doubt been unnerving for newly minted crypto investors. Many could be in the red given the downward trend in crypto prices since late last year. Data from Glassnode shows that 40% of Bitcoin holders have a loss on paper (because they haven’t yet sold their holdings).

Many folks are left wondering what they should do with their coins – keep ‘holding on for dear life’ (a.k.a. HODLing) or book losses and move on? Like any other investment, you should consider your time horizon when making this type of decision.

It’s probably time to look at your bigger investment picture if volatility is driving you to this question. Take time to determine how much of your money is invested in crypto and consider how much of it you are comfortable with investing in a higher risk asset.

Consider this: The total market cap of the cryptocurrency universe is about $1.3 trillion. That number sounds huge, but let’s put it in context.

The global bond market was about $124 trillion in 2020. The value of all stocks around the world summed up to about $106 trillion in 2020. That doesn’t include other asset classes like real estate, commodities, art, fine wine and the list goes on. So, $1.3 trillion worth of crypto suddenly looks paltry.

Based on these numbers, it’s worth thinking about whether you’d want more than 1-2% of your portfolio in crypto.

Many crypto investors are applying what they learned in traditional investing to their crypto investing strategy. They are diversifying their holdings. More than a quarter of respondents in an Ally survey say they are currently investing in five or more crypto currencies. Over the long run, that type of strategy could work out well. Diversification can help ease the impact from an event like what happened to Terra, though we are still learning how correlated cryptocurrencies are to each other.

Volatility is a feature

As always, when investing in crypto, keep in mind that huge declines are nothing new. While the current 55% drop in Bitcoin from last year’s all-time high is no doubt jarring, consider that previous valleys featured ultimate declines of 90% in 2011, 80% in 2015, 80% (again) in early 2019 and even a quick 50% haircut in the middle of last year.

Recoveries can take a long time, though. After peaking in 2011, it took two years for Bitcoin to reach a fresh peak in 2013. Things seem to be moving faster more recently, but what a roller coaster ride!

What to expect

Looking ahead, I foresee regulation and consolidation as key characteristics in the crypto world. It’s no secret that all sorts of agencies are researching how to safely regulate or have a regulatory influence on the space. The market, while having matured a lot over the last decade, is likely to undergo – there are more than 10,000 cryptocurrencies in existence, according to Statista. Like most industries, as this evolves over time, so will the number of participants. The winners of today may not be the winners of tomorrow. Only time will tell.

The bottom line

Legendary mutual fund manager Peter Lynch famously quipped, “Know what you own, and know why you own it.” That’s always good advice, and it applies to many crypto investors today. This year has seen a rout in so many coins. Events of the last two weeks highlight that risk management is more important than simply HODLing.

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Lindsey Bell, Ally’s chief markets & money strategist, is an award-winning investment professional with a passion for personal finance and more than 17 years of Wall Street experience. Bell’s unique ability to connect the dots between data and real life and craft bite-sized money ideas that people can use and apply stems from her deep background as an analyst, researcher and portfolio manager at organizations including J.P. Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors across all walks of life and frequently shares her insights with the Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also serves on the board of Better Investing, a non-profit focused on investment education.

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