Cryptocurrencies like Bitcoin and Ethereum are growing in popularity and capturing the imagination of investors nationwide. Some clients may be afraid to miss out, after hearing about big gains and big increases in the value of certain cryptocurrencies. Given all the publicity, chances are some of your customers have asked you about these new digital assets. How should you react when clients ask you to invest in cryptocurrencies?
Don’t Just Dismiss Crypto Investing Questions
Your first reaction might be to dismiss investing in cryptocurrencies as a passing fad and discourage clients from getting into them because they are too risky and not suitable for their portfolios. But dismissing it out of hand may not be enough – it’s not going to make their interest go away. Some clients will always want to invest in crypto or fear they will miss out and should invest in it.
In fact, up to 43% of investors already own at least one cryptocurrency and there are currently nearly 100 million Coinbase accounts. It is prudent to know how to answer customer questions about cryptocurrency investing and offer a thoughtful response. If nothing else, you don’t want to be left out of the conversation.
The first step is to educate yourself so you understand the basics of what cryptocurrency investing is, how it works, and how to invest. Second, when customers learn about crypto investing, ask them open-ended questions about it. You want to find out what is behind their interest; for example, are they just curious or do they have a serious interest in investing? What is their knowledge of crypto investing and do they understand the risks involved?
Here are some suggestions on how you can talk to your clients when they ask you questions about cryptocurrency investing:
1. Explain the risks of investing in cryptocurrency.
Cryptocurrency poses many unique risks not present with traditional types of investments. One of the biggest is the fact that cryptocurrencies are not traditional businesses that make tangible products or provide services that people demand. So you can’t search and analyze them like you would for a publicly traded company.
The value of cryptocurrency is determined by supply and demand from market participants. In other words, their value only increases when new investors pay more than previous investors, not when sales and profits increase. This is a good opportunity to discuss overall risk tolerance with your clients and make sure they understand what their true risk tolerance is. If a client is risk averse, you might want to advise them to avoid investing in crypto.
As always, you should emphasize to your clients that past performance does not guarantee future results.
2. Highlight how volatile cryptocurrencies can be.
Recent headlines have touted the extreme volatility of cryptocurrencies. Between November 2020 and 2021, the overall crypto market grew from $500 billion to $2.9 trillion. Then during the six months between November 2021 and May 2022, crypto losses exceeded $1 trillion.
The history of Bitcoin illustrates this volatility. The value of a Bitcoin rose from around $2,000 in July 2017 to nearly $20,000 by the end of the year, falling below $10,000 at the start of 2018. As of September 2020, it soared to over $61,000 in just six months, only to lose half its value over the next four months before rebounding to $64,000 in late 2021. Bitcoin then plunged in the first half of 2022 as the Financial markets were struggling with inflation, falling below $30,000 in mid-May.
Not all clients are equipped to handle this kind of extreme volatility. For some, this can lead to great anxiety and sleepless nights, so make sure clients know what they’re getting into before investing in cryptocurrency.
3. Explain the lack of current cryptocurrency regulation and the potential risks of future government regulation.
The US government has been slow to regulate cryptocurrency so far, at least compared to fiat currency. Developments in May 2022 revealed what this lack of crypto regulation can lead to. TerraUSD, a so-called stablecoin believed to maintain a value of $1 per coin, fell to 36 cents on May 12. This resulted in $200 billion in losses for cryptocurrency investors virtually overnight.
Fiat currencies like the US dollar are backed by the full trust and credit of the US government, but cryptocurrencies are only backed by faith in their developers. The collapse of TerraUSD presents the risk that investors will lose faith in other virtual currencies, creating what some analysts have called “market contagion”.
A positive development is the issuance of an executive order on cryptocurrencies by President Biden in March 2022. It aims to start the process of regulating cryptocurrencies and bring them closer to the mainstream. There is a fair amount of uncertainty about the future and how possible future regulation might impact the value of cryptocurrencies.
4. Suggest that clients limit their exposure to cryptocurrencies.
Position Bitcoin and other cryptocurrencies with your clients as speculative investments so that they are prepared for losses. Help clients understand that it wouldn’t be prudent to rely on them for their basic retirement assets or overall financial strategy. Another way to put it is to tell clients that they shouldn’t invest more in cryptocurrency than they are willing to lose.
Like any particular asset class, there should be a limit to the amount of cryptocurrency held in each client’s wallet. This limit will vary from client to client depending on factors such as their objectives, risk tolerance and time horizon.
As for using cryptocurrency as a hedge against stocks, this has not been an effective strategy so far. You may need to educate customers about this fact. For example, there was a spike in the correlation between Bitcoin and the S&P 500 Index during the February-March 2020 bear market when the prices of both fell and then rebounded before a big rally. It remains unclear whether cryptocurrencies can act as a hedge to help protect investors from steep stock market declines.
5. Take a balanced approach to your conversations.
Discuss the pros and cons of investing in cryptocurrency with your clients. One way to do this is to refer to respected opinions on both sides of the conversation. For example, you could tell your clients, “Don’t just take my word for it…here’s what (fill in the blank) has to say about crypto investing. This way, you can offer clients perspective from both sides of the aisle – the cryptocurrency bulls and bears.
Consider the perspective and context of the expert opinions you share with clients. For example, are they discussing crypto investing in the context of an investment for themselves, their fund, their clients, or another entity? What do they have to gain or lose from their advice? Institutions will have a different perspective on crypto investing than fund managers and individual investors.
Finally, warn customers to beware of cryptocurrency scams. Investors lost $14 billion to cryptocurrency scams in 2021, according to blockchain analyst firm ChainAnalysis. If they are considering investing in cryptocurrency, they may want to stick with established players like Bitcoin and Ethereum.
High risk, high potential return
We are still in the early stages of cryptocurrency, so there are a lot of unknowns. This makes investing in cryptocurrency very risky, but also potentially rewarding for clients with the right risk profile.
Speak openly and honestly with your clients interested in crypto investing, sharing the pros and cons. Then, clients can decide on their best approach based on their risk appetite, investment schedule, and overall goals and objectives.