Digital Assets—Like Stocks, but with Additional Risks
The return of stocks comes from two sources:
- Expected future earnings that can be estimated as cash flow which becomes dividends to the investor. How much are you willing to pay for dividends? That determines the price of the stock.
- Expected stock price appreciation because of company productivity. Will someone else pay me more than I paid for my shares in the future?
The return of bonds comes from two sources:
- Earning/taxing power of the issuing source becomes the interest/yield/coupon that’s paid to investors periodically. (Estimable)
- Interest rate changes that can result in another investor paying you a higher price to purchase your bond prior to maturity. (Less estimable)
Digital assets such as blockchain-based “coins” or non-fungible tokens (NFTs) have a value purely based on what a future purchaser is willing to pay for them. They are a speculation on what is often called the “greater fool theory” that someone else will come along and pay a higher price for them later. They do not produce predictable cash flows nor are they backed by any physical assets. (A bankrupt company usually produces some value in liquidation, although bondholders are first in line for the scraps.)
This may change if a central government chooses to use them as currency or otherwise assign or protect value. This does not mean that investors shouldn’t consider digital assets. For now, digital assets have many similar risks to single stocks:
High Volatility: Digital assets are known for their extreme price volatility, leading to significant investment risks.
Regulatory Uncertainty: The regulatory environment for digital assets is still evolving, which could lead to significant impacts on their value and legality.
Security Risks: While blockchain technology is secure, digital asset exchanges and wallets can be vulnerable to hacking and fraud.
Limited Historical Data: Digital assets are relatively new, providing limited historical data to base investment decisions on.
Environmental Concerns: Certain digital assets, like Bitcoin, require substantial energy for “mining” and transactions, raising environmental concerns.
Market Manipulation Risks: The digital asset market is less regulated and more susceptible to manipulation and fraud compared to traditional financial markets.
Lack of Intrinsic Value: Unlike stocks or bonds, most digital assets do not represent a stake in a physical asset or a claim on future cash flows, making valuation challenging.
Technology Dependency: Digital asset investments are heavily reliant on technology, making them susceptible to technological failures or obsolescence.
Digital assets, whether a single “coin” or fund of multiple assets share the uncompensated risk aspect of single stocks. The lack of cashflow creates a complete reliance on future price appreciation. This may or may not occur.
As with single stocks, prudence is warranted with digital assets. Investors should be prepared to lose 100% of the value, wake up to find that the “rules” changed, and ensure that retirement plans can withstand a complete loss of the digital assets’ value. A portfolio percentage below 10% is a good starting point for analysis.
Fight’s On!
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