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The rise of the digital economy has led to the creation of new investment asset classes such as cryptocurrencies. As a result, financial planners and financial advisors need to evaluate whether cryptocurrencies should be a part of the asset-allocation strategy within their clients’ portfolios.

Traditionally, the assets typically included in clients’ portfolios have been stocks, bonds, index funds and real estate. Today, with the rise of cryptocurrencies — especially bitcoin — more investors are turning to new frontiers in their portfolios. But is it a good idea to for clients to diversify their portfolios with cryptocurrencies?

The first step in determining whether cryptocurrencies are good investments for your clients is to understand exactly what they are. Simply put, cryptocurrencies are electronic cash that rely on peer-to-peer exchanges. This means that they’re fully decentralized and have no central authority or central server to manage those transactions. Instead, they rely on a network of individual computers to recognize, validate and record transactional data.

For the transaction to be verified and then recorded, every device on that network needs to agree that the transaction is valid. Once verified, the transaction is added to a permanent, unalterable ledger that exists on that network as a new “block” on the chain of data, called a blockchain. Other than the method of exchange, cryptocurrencies function just like any other currency, rising and falling in value.

The next step is to outline cryptocurrencies’ advantages and disadvantages with your clients to determine if this investment class fits within their long-term financial goals.

Here are some advantages to discuss with your client:

  • Cryptocurrencies are not hackable due to the encrypted nature of the blockchain technology, nor can they be counterfeited, such as paper currencies. So, these threats will not compromise the investment’s potential value.
  • Cryptocurrencies also don’t have settlement charges because they’re settled immediately without requiring a third-party.
  • These currencies also don’t have transaction fees as the network already pays users known as “currency miners” to verify the transactions.

In contrast, there are some major disadvantages associated with cryptocurrencies:

  • Much like stocks, many cryptocurrencies are trading at their all-time high and may be in a bubble.
  • Cryptocurrencies are highly volatile investments. They’re going to fluctuate — sometimes wildly — before stabilizing. They’re certainly not for your low-risk clients.
  • There’s much uncertainly as to how cryptocurrencies will eventually be regulated, especially initial coin offerings (ICOs).
  • There’s also a lot of competition as, much like penny stocks, there are hundreds of cryptocurrencies coming in and out of existence. This increases their risk and uncertainty.
  • Other considerations are the scalability of the cryptocurrency networks, whether their use increases greatly, and the adoption level of cryptocurrencies for the payment of goods and services.
  • Finally, most cryptocurrency networks don’t provide important tax reports.

The final step in this process is to consider if cryptocurrencies — despite their disadvantages — are a strategic allocation asset class such as gold against macropolitical economic risks.

The biggest reason for clients to consider cryptocurrencies is to protect the long-term value of their money and to have a strategic diversification asset class that will insulate their portfolios against political and macroeconomic risks as cryptocurrencies are decentralized and not under the direct control of nation governments and central banks. This may give cryptocurrencies more long-term potential than traditional fiat paper currencies, which have been and may continue to be devalued through excessive government fiscal policies and inflationary central bank policies.

On the diversification argument, because cryptocurrencies are decentralized and not tied to any one government, physical asset or market, they may, hypothetically, be valuable as a diversification asset. This means that they won’t grow or shrink in direct correlation with any of your clients’ other assets that are affected more by political and macroeconomic risks. (Nevertheless, it’s worth noting that a recent J.P. Morgan Chase & Co. study found that cryptocurrencies did move up and down in direct correlation with other traditional asset classes during the past five years. That may change as this asset class matures and stabilizes.)

Although cryptocurrencies are a new asset class that carries risks, financial planners and advisors need to understand them, at the very least, and follow cryptocurrency market trends. That’s because these digital assets may become very important, from a strategic perspective, to protect your clients’ money from devaluation and diversify their portfolios against political and macroeconomic risks.