As we discussed in Blockchain and Financial Advisory: Why It Matters, blockchain is the technology on which the first and best known cryptocurrency, Bitcoin, is built. But why does the crypto space matter in the first place? And how can financial advisors intelligently leverage crypto to create value for clients?
Let’s find out:
As of January 2021, cryptocurrency is at an all time high and Bitcoin is slated to cross its previous highest peak of $23,000. Crypto as an asset class demonstrates immense long-term growth potential. It is important for financial advisors to shift their focus to blockchain, crypto-assets, and cryptocurrency to help clients reap the benefits.
What is cryptocurrency and how does it work?
Before we look at actionable insights, it’s important to understand exactly what crypto is.
Cryptocurrency is a digital alternative to standard fiat currency. It holds value in terms of supply and demand, just like stocks, in a decentralized market. Cryptocurrencies rely on blockchain technology, both to enable and validate transactions, and for proof-of-work through mining. As the name suggests, cryptocurrency is designed to be secure and relatively anonymous leveraging the cryptography that lies at the heart of blockchain.
Because blockchain is decentralized, users can make crypto transactions securely and store money without it being regulated by any authority, including banks. Some of the most common cryptocurrencies today include Bitcoin, Ethereum, Ripple, and Litecoin.
Crypto currencies can mainly be divided into two sub-categories – Altcoins and tokens. Altcoin is simply a broader term used to talk about the various alternatives to Bitcoin, including Litecoin, Batcoin, Namecoin, and others. Tokens, on the other hand, are often created and distributed through an Initial Coin Offering (ICO). Their values are represented through bitcoins, security tokens, or utility tokens. Tokens either stand in for a particular value of cryptocurrency or a number of shares, or represent other kinds of value (such as reward points).
Many cryptocurrencies have seen an exponential increase in value over the past few years. This has incentivized millions of DIY investors to invest in cryptocurrency to reap high rewards.
DIY crypto-trading poses a threat to financial advisors worldwide. Many amateur investors don’t see the risk inherent in crypto assets, making conventional asset management seem redundant. What can financial advisors do about this? Exactly what they were hired for in the first place: to educate clients on a range of investment options -including crypto- and to better prepare clients with a mitigation plan in case of a crisis scenario.
Financial investments are based on trust and acceptance. This becomes even more important when it comes to cryptocurrency, which operates on market sentiment as it’s very basis. Financial advisors have always helped clients understand the market to take sound investment decisions. That role remains relevant in the cryptocurrency era. Here are some actionable steps advisors need to take in order to leverage crypto to maximize benefits while managing risk.
Speak the Crypto language: In the current market environment, the most important step any advisor should take is to educate themselves end-to-end about the technicalities of blockchain, cryptocurrency, crypto assets. This could involve learning through experience: If you trade in crypto-currencies and crypto assets, you are likely to be taken more seriously by your clients when it comes to advice about crypto-currency. In this dynamic space, practical knowledge vastly outweighs theory. Educating yourself also means that you’ll understand what crypto terminology means. Just throwing buzzwords at your clients isn’t going to help and might end up doing more harm than good. You need to first understand crypto, learn the language, and then explain the meaning behind terms like blockchain,, mining, hash, heights, and ETFs, and their implications.
Use additional security measures: If you are trading on behalf of your client, you need to consider doing this in a secure manner. Secure your wallets, use private networks, secure and compartmentalize devices, back up your data, and enable strong, multifactor authentication processes. If you’re handling larger volumes of crypto assets, you might want to consider investing in managed cybersecurity to mitigate risk and ensure the safety of your clients’ digital assets.
Explain the risks of crypto being an unregulated sector: While there are high gains to be made from a volatile market like the crypto space, there’s also the chance to incur massive loss. Most governments don’t recognize cryptocurrency as legal tender. Even in jurisdictions where crypto is under some kind of regulation, the underlying blockchain technology makes it effectively impossible for the government or other actors to enforce policy decisions. This makes the sector unregulated, opening the door to immense risk with relatively little accountability. While government limitations can constrain gains in certain asset classes, they also act to shield investors from major shocks and unfair practices. Because this isn’t the case with crypto, IFAs need to ensure that their clients understand the risk they’re taking. It’s a great idea to then build a risk mitigation strategy to ensure that, no matter what happens to crypto, your clients’ overall portfolios remain healthy. This could involve controlling the investment quanta in crypto assets, and building in buy-sell safeguards.
Cryptocurrency doesn’t have to be cryptic!
Cryptocurrency offers us an unprecedented, direct person-to-person approach to value exchange, without having to rely on third-party regulators. In today’s digital, increasingly connected world, crypto is set to play an increasingly major role in the economy. From an investment perspective, the possibilities are immense. The technicalities that underlie cryptocurrency and blockchain on the whole, though, can make it tough for IFAs and investors to really know what they’re getting into. Instead of feeling threatened by crypto and blockchain, IFAs should embrace their role as a vital bridge of trust between this new asset class and potential investors. Education and understanding are key: learn about crypto, understand how to manage it effectively, then transfer that value to your client base.