After the astonishing gains from last year it is understandable that many investors are interested in crypto-currencies, but the risks and volatility are considerable. This article examines some of the issues.

A regular contributor to Family Wealth Report, Diane Harrison, who is principal and owner of Panegyric Marketing, a strategic marketing communications firm founded in 2002, takes a look at the world of crypto-currencies. This publication has written extensively on these issues, with a wealth management audience very much in mind. Harrison, who writes about issues such as alternative investments and strategy, has her own perspectives. We are glad to share these insights with readers; please respond by emailing tom.burroughes@wealthbriefing.com

With traditional stock markets offering robust gains in 2017 and looking poised to continue their attractiveness in 2018, investors need strong persuasion to shift their equity allocations elsewhere. Enter the latest media darling: cryptocurrencies. The alternatives news feeds are awash in stories extolling the meteoric rise of cryptocurrency values  and the new funds forming to attract investors to this hyper space. Bitcoin, Ethereum, Litecoin, and Ripple are several of the better known, but still misunderstood, cryptocurrencies that inhabit this “etherworld” of finance.

The gains that some of these currencies made in 2017 are staggering; their success seems too good to be true. But volatility is the evil twin of such rapid gain, and investors must employ a healthy respect for how fast these crypto-currencies can rise and fall. The “bubble” is definitely alive and well in the virtual world of crypto.

If you don’t use it, should you own it?
With new crypto-currencies, platforms, and funds devoted to this area emerging at a dizzying rate, clearly a lot of interest and money is attracted to the space. Even the country of Venezuela is looking into launching its own national cryptocurrency. This month, Reuters reported that Venezuelan President Nicolas Maduro, despite opposition and doubt within his own government, announced his intention to launch a crypto “petro” currency, backed by oil reserves to shore up the nation’s collapsed economy. The move is largely seen as a desperate move in reaction to U.S.-led financial sanctions, but beyond this objective seems ill-defined operationally. Venezuela’s real currency, the bolivar, is in freefall, and the beleaguered country is sorely lacking in basic needs like food and medicine.

The crypto space is largely unregulated, and poses dangers for the uninformed. Financial advisors and regulators, who are working overtime to establish some governance for this brave new world, have concerns they want investors to consider. The adage of financial wisdom relevant to all investments definitely applies: ‘Don’t buy something you don’t understand.”  Still, the need for asset diversification tempered by the desire for risk control remains strong for investors wary of equities’ rapid gains. Those tempted to jump into the crypto pool uninformed might be wise to consider some of the pitfalls that await them.

Buyer beware
While still in its infancy, early guidance does exist for this financial frontier. The North American Securities Administrators Association (NASAA) is the lobbying group that represents state and provincial securities regulators. In December NASAA published a survey of state and provincial securities regulators that indicated 94 per cent believe there is a “high risk of fraud” involving cryptocurrencies. The group also identified Initial Coin Offerings (ICOs) and cryptocurrency-related investment products as emerging investor threats for 2018. ICOs use crypto tokens in lieu of shares as a fundraising method for startups in a manner that resembles an IPO. Some of the concerns and red flags regarding cryptocurrency investment offers are summarized in the following chart.

Source: The North American Securities Administrators Association (NASAA)

Other professionals are lending their voices to the crypto conversation. Warren Fisher of Manole Capital Management, LLC recently published a white paper, Bitcoin – What You Need to Know, on the financial website Hedge Connection that summarized the need for oversight: “As further legal cases and regulation are decided, the exact definition and legal standing of cryptocurrencies will become more established. In our opinion, it is too early to understand the ramifications of legal rulings on cryptocurrencies. Why is this important? Well, regulations need to be formally set and rules need to exist for this digital currency to be monitored.”

A financial fall line
This being January and winter in the northeast section of the country where I sit, an apt comparison to skiing seems fitting for the rise of cryptocurrencies in financial popularity. A ‘fall line’ is a term that refers to the imaginary line down a mountain or hill which is the steepest, or most direct. It defines the literal line of greatest slope. Skiers travelling down a mountain traverse the fall line in a zigzag fashion to maintain the optimal blend of speed and control as they navigate the terrain.

The financial investment fall line is analogous in that investors seek to carve a personal path of risk/reward that scribes their optimal blend of upward growth and downside protection. And just as skiers of different skill and terrains of varying slope define multiple shapes of fall line navigation, this path can take infinite forms. Navigating the slope of cryptocurrencies is not for the faint of heart or the ill-informed, but potentially poses an incredible challenge.