5 myths about cryptocurrency

Madeline Hume, senior research analyst for Morningstar, debunks some myths.
By Morningstar |  01-07-22 | 
 

At $1.7 trillion in total market capitalization, cryptocurrencies can no longer hide in the shadows. The asset class’ stunning growth augurs as much promise as it does peril for those who are interested in its astonishing rise.

Cryptocurrencies warrant extreme caution. Today, cryptocurrencies lack academically substantiated valuation methodologies. Until more methods for valuing these securities become available, the absence of intrinsic valuations disqualifies cryptocurrency as a fundamental investment, in our view. As high octane securities with a spotty past, investors should treat any purchase of cryptocurrencies as a sunk cost.

Our aim is not to advise investors on whether or not to dive into cryptocurrencies but to share what we’ve learned by surveying the landscape. Namely, the asset class is still brand new, heavily concentrated, and highly volatile. Cryptocurrency returns have no parallels to traditional risk factors across the stock and bond universes, and the contours of the market’s returns in aggregate fly in the face of normal market dynamics.

Myth: Cryptocurrency is a portfolio diversifier and may even be an inflation hedge.

When people see something new, they like to compare it to things that they've seen before. So, if something walks like a duck and quacks like a duck, well, maybe it is a duck. But cryptocurrencies at this point are still a platypus. There's a couple of different things going on under there, and there's really nothing that we can compare it to that's a perfect comparison.

As far as correlations to equity markets go, there are occasions when they trade really closely together. Oftentimes, it's when markets are under stress and liquidity is compressed and people are selling across the board. So, that would be the current market that we're in. There are other times when the seas are a little bit smoother that those correlations tend to break apart. But in short, this asset class is still very new, and there is a lot that we're uncovering about how it behaves. But there is really no neat box that we can fit it into just yet.

Myth: Fraud is just rampant in cryptocurrency.

How significant is fraud in this particular asset class when you compare it to other, more established, perhaps, asset classes?

It's true that fraud in cryptocurrency, in absolute terms, has increased year-over-year. This has been accelerated by really notable, kind of, notorious hacks that have happened in the past year, which include the Wormhole hack in February 2022 and the Poly Network hack in August of 2021. But the interesting thing is that's been influenced by the sheer growth of the asset class over the past year. And so, the proportion of fraudulent transactions has actually decreased. Overall, it represents about 0.15% of all cryptocurrency transactions, which relatively speaking, is fairly straightforward for an asset class, so not all that different from other securities that people invest in.

Myth: It's really the adoption of blockchain technology that's driving interest in crypto and in its performance.

We actually kind of see the opposite where the rabid investor interest in cryptocurrencies has led companies to ask themselves how they can incorporate blockchain technology into their operations. Great example of this is Square changing its name to Block to kind of honor or announce this new era of more crypto-friendly business lines. And then, you touch base with it a year later and there really are no products to speak of just yet that deliver on that promise.

So, there is still a lot to uncover about how blockchains will be used in our everyday life, and the conversation is far from settled. But what is important for investors to keep in mind is that performance for this asset class is much more in line with what is the flavor of the month and not so much the steady adoption of blockchain technologies. There may be a day in the future where that happens, but we're just not there yet.

Myth: Cryptocurrency is really easy to buy and sell, just like you'd buy or sell a stock or an ETF.

It's certainly true that it's easy enough to open a Coinbase account and start buying and selling, but the devil is really in the details with this. Companies will charge a really high premium for the privilege of being able to buy and sell so easily.

Morningstar did a study of some of the biggest exchanges that offer cryptocurrency trades, and the average trade is about 1.5% transaction fee. That's a huge, huge commission cost relative to the frictionless trading that we see in stocks and ETFs. And sometimes transaction fees can run well in excess of that. I personally have paid more than 8% on some transactions. So, it's really important with crypto and looking through all these really pretty user interfaces to read the fine print.

Myth: Bitcoin is digital cold.

Hailed as digital gold, bitcoin's fixed supply and decentralized nature have attracted the attention of those who believe it could act as a viable competitor to the bars stored in bomb shelters by doomsday preppers.

The argument has intellectual merit, but in the near term, Morningstar analysts agree that bitcoin is unlikely to dim gold’s luster. People have used the metal to conduct business since at least 600 B.C., while bitcoin has existed for only 14 years.

Gold’s alternate use cases buffer the metal during periods of market stress so that it doesn’t depend on market sentiment to create liquidity. We believe that relative to gold, bitcoin lacks enough outside applications to outweigh the impact of market events on its price, limiting its usefulness as a store of value. Plus, the first transaction denominated in bitcoin didn’t happen until 2010, which means we have only 11 years of pricing data to study. During the one market correction in our time horizon, gold’s correlation to equities stayed low, while bitcoin’s followed the cryptocurrency market on an upward drift.

You can access Morningstar's Cryptocurrency Landscape report.

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