Bitcoin, invest or not invest? Today, I've decided to include it in the portfolio allocation. Below, I explore my assessment and reasoning for including Bitcoin in my Investments. I also cover how to manage the volatility that Bitcoin introduces so we can minimize risks and maximize profit potential.
I'm not going to cover the fundamental Bitcoin pros's and con's, many other sources cover this content thoroughly. If you would like to explore the basics further Investopedia has some great coverage on these topics:
Crypto Currency
Rather I'm going to explore how I approach a Bitcoin investment and maximize the expected returns.
Reasons to Consider Investing in Bitcoin
High Growth Potential
Whether Bitcoin increases or decreases in value does not matter as much as the fact that it does move significant amounts in rather short periods. I think of this volatility as the driving engine behind investment returns. Using our risk mitigation strategies I can minimize the pain as it contracts and leverage the momentum as it explodes.
Hedge Against Inflation
Bitcoin’s limited supply makes it susceptible to FOMO, which creates significant momentum when market greed takes over. My investment approach will allow me to maximize this potential gain.
Increasing Mainstream Adoption
Major institutions, including Tesla and MicroStrategy, have added Bitcoin to their balance sheets. Payment platforms like PayPal and Visa now support Bitcoin transactions, signalling growing acceptance. This mainstream integration creates more certainty around demand.
Lack of demand is the greatest risk to this investment. I'll cover this in more detail down below.
Decentralization and Financial Sovereignty
Bitcoin allows individuals to control their assets without relying on traditional financial systems. For people in countries with unstable currencies or restrictive monetary policies, this can provide an opportunity to participate in the market that would otherwise be unavailable to them. In turn, creating additional demand.
Risks and Challenges
The ultimate risk for Bitcoin is gravity. No matter how good the returns are, if it returns to zero (or close to it) only once and it wipes out whatever gains have been made, whether this is $100 or $1,000,000 it doesn't care it all returns to zero. The graph below demonstrates that despite the general uptrend over the last decade in 4 separate occasions there have been many significant drawdowns, up to 86%!
To mitigate this risk I will approach it in Three phases:
Limit exposure - as I start investing in Bitcoin I will limit the size of the investment I make relative to my overall investment portfolio, this way if it takes a nosedive straight out the gate we're relatively insulated (losing 1% of a portfolio won't make too much impact on the long term).
As the market moves I will make strategically larger and larger investments in Bitcoin until I reach my investment cap.
Don't invest my own money - After the first 100% return I will withdraw 50% of the investment. Which is the entirety of my invested capital. Therefore even if the market returns to zero I have lost none of my own investment.
The harvest - From then on our strategic investing will continue increasing the returns the Bitcoin investment creates, producing additional diversification and returns to our larger portfolio in the long run.
Extreme Volatility
Bitcoin's price is notoriously volatile. Massive price swings can occur within hours, making it a lucrative investment opportunity for the astute investor in the long term. For instance, Bitcoin reached an all-time high of over $69,000 in November 2021, only to plummet below $20,000 within a year.
Our strategy allows us to leverage this volatility to double our invested returns within the year.
Security Risks
Although Bitcoin itself is secure, investors face risks of hacking, scams, and losing access to their wallets. Without proper precautions, an investment could disappear in an instant.
To mitigate this risk I will only invest in well-regulated investment funds that retain their bitcoin holdings in cold storage. This means that the bitcoins aren't stored online in any way minimizing the risk of remote hacking.
Specifically, EvolveETF is my preferred fund due to its cold storage specifications.
Regulatory Uncertainty
Governments worldwide are still grappling with how to regulate cryptocurrencies. Potential bans, tax changes, or strict regulations could impact Bitcoin’s value and usability.
As mentioned before the value change is an advantage to our strategy and with more global adoption an outright 'ban' is becoming more unlikely. However due to the USD 'global reserve' status I'm taking a more cautious approach an investing outside of the US, given they have the most to lose they could also take the most drastic regulatory action. But any country is prone to this so we're ready to move the investments to a different jurisdiction with a moment's notice.
Lack of Intrinsic Value
Unlike stocks, which represent ownership in a company, or bonds, which pay interest, Bitcoin does not produce income or have a tangible backing. Its value is driven entirely by market demand, which some critics argue makes it speculative.
Is investing in Bitcoin worth the risk?
My Risk Tolerance
Bitcoin’s volatility means it’s not suitable for risk-averse investors. Without a volatility-tuned strategy, this can mean large losses for the average investor. But in our strategy, this is an advantage.
Portfolio Diversification
The purpose of using this volatility is so we can increase the diversification in our portfolio. However, diversifying without a working plan to manage downside risk is just another way of losing money. Therefore we will be prioritizing our risk management first, as the volatility increases to the downside our diversification will increase because our Bitcoin holdings increase.
Time Horizon
We will be investing for the long term so we can ride the ups and downs of the Bitcoin rollercoaster, but sticking to our strategy like a drill sergeant! If you don't hold on tight to a proven strategy you're likely to panic and let go at the worst moment.
Stay Informed
Bitcoin is influenced by market sentiment, technological developments, and regulatory changes. We need to stay informed about these updates and have a plan of how we will respond ahead of time so that we can react quickly and correctly at a moment's notice.
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