Economic uncertainty can play havoc with investments, causing the price of assets to be exceptionally volatile and often driving the prices of some investments, such as stocks, down. Bear stock markets, declines of 20 percent or more in a year, are often triggered by economic uncertainty.

Economic Uncertainty and Investments

Economic uncertainty is especially prevalent in times of crisis, such as war, recessions, and pandemics, simply because outcomes are not clear and the usual workings of economies can’t be forecast with any accuracy. 

But other events can cause economic uncertainty as well. Elections, for example, can cause uncertainty because, until the outcome is clear, it isn’t known which policies a new president or governing body will adopt. Economic measures such as high inflation or declines in the employment rate can cause uncertainty because they often cause unpredictable movement among investors and businesses, to hedge inflation or protect against recession. 

Therefore, it is often recommended that investors hedge against economic uncertainty. 

Diversification is a hedge. The more diversified you are among asset classes such as stocks, bonds, and cash, the more you are cushioned against the risks uncertainty poses in any one asset class. 

Other forms of diversification include investing in the type of assets often known as safe harbors. Gold is one example. When uncertainty such as wars or inflation occur, investors often flock to gold as a safe harbor for their money because it is not subject to the same kind of fluctuations that stock markets or currencies are. Gold is virtually universally used for exchange, making it safer than a particular country’s paper money.

Strategies such as diversification and safe harbor investing are time-honored methods of diversification. But what about a relatively new asset class, cryptocurrency? Can investing in cryptocurrency be a hedge against uncertainty?

Is Cryptocurrency a Hedge Against Uncertainty?

The short answer is yes. Cryptocurrency has the potential to be a hedge against uncertainty. 

Cryptocurrency, of course, is a digital asset that can be used as money, in exchange for goods and services. Cryptocurrency transfers take place via digital exchanges, digital wallets, and other digital systems (such as smartphone apps), outside of the central structure of banks. Cryptocurrency purchases and other transfers take place through blockchain, a distributed ledger system that is independently verified and, many believe, more secure than legacy systems. 

The first reason that cryptocurrency has the potential to be a hedge against uncertainty is that it is essentially another asset class, to add to stocks, bonds, cash, real estate, commodities, and other assets. Because diversification of assets is a primary hedge against economic uncertainty, it stands to reason that increasing the number of asset classes increases one’s chances of diversification.

Second, some observers believe that some types of cryptocurrency, such as Bitcoin (the first cryptocurrency and still one of the best known) can function somewhat analogously to gold as a safe harbor against uncertainty, particularly inflation Why? Because there is a finite amount of Bitcoin, just as there is a finite amount of gold. Scarcity, combined with widespread acceptance, can ultimately lead to higher prices, just as it can with precious metals.

Pros of Cryptocurrency

In fact, hedging against economic uncertainty is one of the main pros of cryptocurrency investing. It is a good tool to have in the arsenal of risk management and portfolio diversification.

Another advantage of cryptocurrency is its upside potential. Many observers believe that cryptocurrency and blockchain are the wave of the future, and have the power to change the way we do business just as computers and the internet did in the 1980s and 1990s. Some economic sectors, such as banking and real estate, have the potential to be transformed by the digital asset transfer possible with crypto. 

This is particularly important for Generation X investors, who were often too young to be invested in the stock market during the wave of early computer and early dot.com investment. They do have the potential to catch the wave of cryptocurrency and blockchain investment.

Cons of Cryptocurrency

That said, cryptocurrency investing has several disadvantages as well. 

First, it’s an extremely volatile asset class. All cryptocurrencies are subject to intense price swings. Investors should be aware that it is a high-risk, potentially high-reward asset class. It’s prudent to make cryptocurrency investments no more than 5 percent to 10 percent of your portfolio as a result.

Second, there are a vast number of cryptocurrencies to choose from. Investors interested in adding cryptocurrency to their portfolio need to work with a qualified financial advisor experienced in cryptocurrency to choose the best investments for their portfolio. Options include individual coins, stocks with cryptocurrency or blockchain operations and interests, mutual funds, and exchange-traded funds (ETFs). Of these options, both mutual funds and ETFs are a basket of stocks involved in cryptocurrency and blockchain. The fact that they have multiple stocks in them diversifies the investment.

Sapiat Asset Management:  CFP® in Greeneville, TN

At Sapiat, our investment recommendations are carefully tailored to meet your financial goals and individual risk tolerance. We are fiduciary financial advisors who always put your financial interests ahead of our own. Contact us to discuss cryptocurrency investing within a comprehensive financial plan in Greeneville, TN today.