Is the ‘Crypto Winter’ Over?

As 2024 gets underway, it’s time to consider the future of crypto and how to introduce it to clients.

By Peter Eberle

For much of 2023, the crypto market experienced what many considered a “crypto winter” — a period of less than favorable conditions. The price of cryptocurrencies such as Bitcoin reached an all-time high in late 2021 before dropping significantly toward the end of 2022. However, crypto saw a significant improvement in late 2023, with the price of Bitcoin increasing 28% in October alone.

Experts hope this recent improvement, despite a lackluster January, is a sign that the crypto winter is over, allowing the market to start its narrative anew.

External Factors Influencing the Crypto Market

Many of the struggles of the crypto market over the last year have been due to high-profile failures by significant players in the crypto market.

The controversies surrounding FTX and Binance essentially wrecked any feeling of trust the general public had in the crypto market. While platforms like FTX were supposedly founded to make crypto trading safer and more accessible for the masses, they were abused in a way that caused the opposite effect.

However, there is a silver lining: These failures have led to increased calls from critics and regulators to improve the regulation of the crypto market. Taming the “Wild West” can facilitate trade and make transactions safer for all.

For example, the verdict in the Sam Bankman-Fried trial — the former FTX head was found guilty of seven counts of fraud and conspiracy — is encouraging for the future of the crypto market because it shows that wrongdoers will be held accountable for their misdeeds.

Stepped-up Safety

Increased regulatory clarity could have a profound positive impact on the crypto market.

For example, the European Union recently passed the Markets in Crypto-Assets Regulation (MiCA) the first comprehensive set of regulations for the crypto sector passed by a major jurisdiction. Proponents of this legislation have hailed the ability of this framework to facilitate legal certainty for businesses and attract more significant investment. Particularly exciting is the prospect for more institutional investment, which has primarily been discouraged until now due to the lack of clarity.

There are also lessons to be learned by looking at how some investors were taken advantage of by unscrupulous players in the crypto market. Those who relied entirely on a single digital-asset broker, such as FTX, may have suffered tremendous losses when it collapsed. Other investors who purchased digital assets using their primary banking accounts may have found their accounts suspended or closed due to transactions with these now-disallowed digital-asset brokers.

Successfully investing in crypto and digital assets requires a meticulous eye for safety and detail to help protect against crises if they arise.

Here to Stay

Digital assets, including cryptocurrency, seem to be affected in different ways by macroeconomic factors than traditional financial securities.

Many have hailed Bitcoin as an “inflation-resistant” investment because of some of crypto’s unique properties. For example, its set market cap means there is a finite number of coins that have been or will be minted; no more can be made beyond that. In light of a potentially looming recession, many investors have begun to turn to crypto to hedge against inflation.

Digital assets are established enough that we are unlikely to see them go away anytime soon. Although many institutional investors have shied away from crypto investments due to their volatility, the increase in regulation could make them more interested in dipping their toes into the crypto waters. Once institutional investors begin to adopt cryptocurrency at a wider scale, we’ll likely see an increase in overall market activity, which will also benefit individual investors.

How to Discuss Crypto with Clients

Financial advisors should first explain that cryptocurrency is a new asset class that’s not correlated to other investments There are still huge opportunities in the largest and best-known tokens such as Bitcoin and Ethereum. However, don’t be tempted by new tokens where you don’t understand what new technology they offer. [In a recent targeted exam of more than 500 crypto asset-related communications, Finra identified “potential substantial violations” in approximately 70% of these communications.].

Crypto can be useful today in the portfolios of clients age 50+ who are interested in this alternative asset because a small allocation can offer outsized returns. However, crypto should typically be no more no more than 1% to 15% of their liquid portfolio. For most portfolios, a 1% to 5% allocation is enough to get upside potential without creating too much risk. If the volatility keeps you up at night, then your allocation is too large.

Due to the volatile nature of crypto, it should also only be in a portfolio if a client has a long-term investment horizon of five to 10 years.

Ultimately, the crypto market’s issues over the past few years can be boiled down to an image crisis. As the safety and legitimacy of digital assets were called into question with the failure of FTX and other high-profile blunders, many investors began to lose confidence in the market. However, the steps being taken to restore the public’s faith in crypto — namely, increased regulation that will provide legal clarity surrounding digital assets — enable us to look forward to a hopeful future for the market.

Peter Eberle, president and chief investment officer of Castle Funds, has extensive experience in portfolio management, derivatives trading, and risk management. He earned his MBA from the University of Pennsylvania’s Wharton School of Business.

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