As Bitcoin breaks records again, advisor makes the case for education

Understanding the value drivers behind Bitcoin can help advisors guide their clients through hype and speculation towards opportunities

As Bitcoin breaks records again, advisor makes the case for education

Bitcoin has rallied yet again, crossing its historic highs last week. While the price of the cryptocurrency continues to fluctuate, its aggregate performance has more investors and advisors curious about the role bitcoin could play in portfolios. As they explore the cryptocurrency, however, one advisor says they need to educate themselves on the dynamics that drive bitcoin’s value.

Michael Zagari, associate portfolio manager with Mandeville Private Client Inc., has been working with and researching cryptocurrencies for around five years at this point. His knowledge in the space has become an important aspect of his practice. In the wake of this most recent price increase, he highlighted the dynamics at work driving this price. He explained the role that hype, FOMO, and speculation play in the bitcoin market and explained the fundamental value he sees in the cryptocurrency. He says that advisors can better serve their clients who are curious about bitcoin by ignoring the former and understanding the latter.

“From a demand perspective, accessing bitcoin means getting involved in the ability to transfer value from one place on earth to another across a secure network. Bitcoin is the only alternative to the traditional payment rails that exist today,” Zagari says. “It’s also a decentralized store of value. When you look at central bank policies and their ability to manipulate the money supply, when you see that the dollar is not keeping pace with the cost of living, bitcoin offers an alternative to that system for both retail investors and institutions.”   

When assessing the prospects of bitcoin for clients, Zagari accepts that it should not be viewed as a traditional security like a stock or bond. Bitcoin does not itself represent a cashflow generating body, the way the share of a company or a government bond does. Rather it functions like a commodity, with a fixed supply built into its code. Just as one might look at tensions in the Middle East to understand the supply security of oil as a commodity, Zagari says looking at the “hashrate” or the speed at which bitcoin can be mined, to understand the security of the bitcoin supply. Price discovery then comes down to a simple question of supply and demand for this commodity.

Some of the demand on the market now is a product of the fear of missing out (FOMO). Bitcoin is up over 50 per cent YTD, and up almost 200 per cent over the past 12 months. That kind of price increase will cause FOMO among investors who don’t necessarily understand the dynamics. They get in because it’s going up. Zagari acknowledges that this does have an impact on the market, but says that advisors should caution against that impulse when they explain bitcoin to their clients. They should instead outline the more fundamental idea of Bitcoin as a store of value that exists outside of mainstream fiat currency systems. If clients accept that premise and see that as enough of a long-term value driver, a bitcoin investment may be right for them.

Even on that more fundamental level, history has shown that Bitcoin is a risky and volatile asset. Zagari thinks that by focusing on those fundamentals, investors are less likely to panic when there is a dip in price. He says its on advisors to build a proper investment framework for their clients’ bitcoin holdings, one that takes into account their own risk tolerances and incorporates only a small percentage of bitcoin within a much wider diversified portfolio.

“In addition to educating them on the underlying technology, you need to create a suitability framework to understand that if your client should be involved in this or not,” Zagari says. “At the end, once they've gone through all those filters and they say they’re comfortable to proceed, then you start with a prudent approach, a one to three per cent allocation in their in their asset mix.”

To become educators on the subject Zagari believes advisors need to educate themselves. He recommends the original white paper on bitcoin by Satoshi Nakamoto, the pseudonum of the individual or individuals who developed bitcoin. Beyond that he recommends additional reading on the use cases of bitcoin and the underlying use of blockchain technology, as well as wider reading on tech innovations like quantum computing which could have an outsized impact on cryptocurrencies in the future.

“I hope that 10 per cent of the advisors out there learn enough to speak like me on this topic,” Zagari says. “Right now there’s unfortunately only one, but I want 10 per cent of advisors to be able to give good advice on this subject to investors. The next generation is taking over advisory businesses and they should understand how bitcoin works just like they should understand how money works.”