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MARKET UPDATE

The crypto episode

06/21/2022

There’s more to cryptocurrency than meets the eye. We decrypt this often-misunderstood form of currency.

Podcast transcript

Coming up, everything you’ve wanted to know about cryptocurrency, but were afraid to ask.

(Music)

From Thrivent Asset Management, welcome to episode 31 of Advisor’s Market360™. A podcast for you, the driven financial advisor.

We hear about cryptocurrency on an increasingly regular basis. Digital currencies like Bitcoin seem to demand our attention from headlines and ad campaigns while they fight to prove themselves as viable in the eyes of the financial world. Yet, skepticism remains. Industry veterans may have a general idea of what crypto offers, but there are still plenty of questions. Is crypto going to turn the industry upside-down, or is this just another trend bound to fizzle out? Meanwhile, many struggle to fit cryptocurrencies into existing frameworks, seeing them as stranger things than conventional financial instruments. How is crypto used as currency? Is it a legitimate investment? An inflation hedge?

With so many questions flaying the minds of advisors, we wanted to get the scoop from an expert. That’s why we are excited to have a very special guest with us today, Paul Landahl, Senior Quant Analyst at Thrivent Asset Management.

Host: Paul, welcome to the podcast.

Landahl: Thanks for having me.

Host: Cryptocurrency ownership in the U.S. has surged from about 10 million Americans to 34 million over the past three years, according to an April report from Insider Intelligence. Worldwide, we see that in 2021, crypto ownership jumped from 106 million to 295 million, this according to Crypto.com. That’s a tremendous amount of growth! What’s been driving people to cryptocurrencies?

Landahl: Well, there's about a billion people on the planet that have a smartphone but don't have a bank account. So, if you are in that situation, then Bitcoin is a way for you to save for your future and for you to transact securely. There's also about a billion people who live in countries that have enacted capital controls at some point in the last ten years. And by capital control, I mean a restriction on citizens to own currency, usually foreign currency. So, you can imagine in this situation if you're seeing your life savings fade away due to your currency's trajectory, and meanwhile, your government is actively preventing you from divesting or diversifying into a more stable asset, then you might find Bitcoin very useful.

Host: So, it seems that the best way to tell the crypto story is by zooming out and seeing it from a global perspective. And there’s a strong narrative of empowerment there. But what about here in the U.S.? Why would you or I want to own Bitcoin?

Landahl: Bitcoin has a philosophical appeal to a lot of people, many people, Bitcoin enthusiasts will tell you that their Bitcoin feels like the first thing that they have ever owned. It can't be stopped, it can't be confiscated, and it can't be censored. It has also attracted a lot of talent, people who see the disparate technologies combined into one. And its drawn people in from the open source movement who have come together and solved the next generation of problems, problems we currently have, problems we don't even know about.

Host: There’s a lot to appreciate here, and I want to come back to this theme, but the current reality that we need to address is the tremendous volatility we’ve seen in crypto prices. Bitcoin reached a high of more than $67,000 in November of last year, but in May, it sank to under $30,000, then dropped again to about $22,000 in mid-June. What’s behind this, and how long will this volatility continue?

Landahl: We’ll expect the volatility to continue. Bitcoin is very volatile. Crypto is very volatile. And it comes from a divergence in valuation metrics. Bitcoin is best thought of as a speculative technology investment, and it is based on – the price people pay for it is based on what they think it will do. Sentiment, market sentiment, rather than fundamentals. As we see with technology growth stocks, when the market turns, sentiment turns. And those stocks get hit hardest and they get hit first, just like we've seen with the crypto market.

Host: Beyond Bitcoin, it’s worth mentioning that all cryptocurrencies are speculative and unregulated. They’re all experiencing volatility, too. Investors considering buying cryptocurrencies ought to be knowledgeable, use caution, and be able to closely monitor their investments. Above all, one should be prepared for anything and financially able to stomach the loss of their investment. No one really knows where crypto prices are heading at any given time.

Paul, do you have optimism that volatility will diminish as we look to the future? Maybe in ten years from now, if and when crypto settles in as a more accepted form of currency?

Landahl: One would hope so. A lower volatility is definitely important for adoption of cryptocurrencies.

Host: Bitcoin has been characterized as being an inflation hedge or diversification tool. This goes for Ethereum, too, which is another major cryptocurrency. What do you make of this? Bitcoin’s price dropped more than other markets this year, even amid rising inflation. Did it just not work out this year?

Landahl: Well, I'm not sure it's really ever worked out. So, certainly Bitcoin, due to characteristics of finite supply and predictable money creation, looks on paper as if it would be a good inflation hedge, and it may someday be. However, the utilities of the inflation hedge has been vastly shouted down by the volatility.

Host: Another puzzle for many folks is how cryptocurrencies are valued. With stocks, you can look at price, earnings ratios, dividends, cash flow, revenue growth – all these measures give you a pretty good range of the stock's value. But what valuation can you use for cryptocurrencies like Bitcoin or Ethereum?

Landahl: Well, certainly for some crypto projects that have an established revenue stream and an established cost structure, you can sort of shoehorn those metrics into existing valuation methods. However, a lot of things like Bitcoin don't clearly fit in the paradigm. Is it a currency? Is it a security? And, depending on which mental framework you bring to it and impose upon it, you get a very different answer. That being said, crypto has some unique properties, one of which is radical transparency. We can see every transaction that happens. We can see it while it's happening. We can see how much money every single wallet has.

Host: —And just to clarify, that’s what the blockchain is. It’s a public ledger by which all transactions are verified.

Landahl: And there's a lot of information on that. For example, when a large, successful investor moves $100 million onto a centralized exchange, the market interprets that as a bearish signal because they're probably going to sell it. We can look at rates where people – currency levels where smart contracts will be liquidated. So, we can see forced liquidation and their predictable effect on the market.

Host: I’m guessing that all of that transparency also generates a lot of data.

Landahl: While we haven't really wrestled all this new data down to a science like we have with securities, we'll probably get there at some point. But really, until we have, we're really dealing with a deluge of data and a dearth of coherent analysis. Because as these aren't really regulated securities, the way people talk about them is very different. There's a real incentive to make wild predictions to get the headline. So, you can't necessarily believe everything you read. You don't know if you're getting coherent analysis from a well-informed analyst or if you're getting phase one of a pump and dump.

Host: That could be frightening for cryptocurrency owners – there’s no universally accepted measurements. Investors just ride the ride and hope that things turn around.

Not to mention, there’s so many cryptocurrencies out there that are fighting for attention. Besides Bitcoin and Ethereum, there’s somewhere around 20,000 other names in the game. Are there others here that are worth looking into?

Landahl: Out of the 20,000 or so you mentioned, about half of them don't exist anymore. And of the remaining 10,000, there's really a tiny fraction that actually has value or has the potential to continue to have value. Out of those currencies that do have a market cap, probably most of them are on the way to nothing.

However, I believe cryptocurrency is a multi-trillion-dollar sector in the future, which means somewhere in there are the next Facebook, Amazon, Netflix, and Google. And for every one of those, there's probably a thousand Pets.coms, We Works and Enrons. So how do you tell the difference? It's actually not that different than any other analysis of a technology growth company. Ask yourself, does this crypto project currently provide, or does it have the potential to provide a valuable product to a lot of people?

Host: Or, in simple terms, does it provide more than just ‘currency?’ That’s what I’m hearing. By and large, crypto has much more to offer. It’s about security, empowerment, solving problems. There’s a lot beneath the surface.

That’s a great transition back into the more positive side of the discussion. We were talking earlier about zooming out and looking at crypto from a global lens. The U.S. ranks eighth in the world in terms of crypto ownership. What regions are leading?

Landahl: Well, the leading regions when ranked by crypto ownership per capita income, I think India and Vietnam are upfront. You're looking at countries where people have smartphones, maybe not bank accounts, and where people have a lot of remittance.

Host: So, regions with greater adoption and ownership of crypto are countries where the utility of cryptocurrency means the most to people there and provides them with greater financial freedom. That makes sense; countries with greater restrictions are the places where crypto could fill more gaps, which is why we would see higher adoption there. How about situational use of crypto, where its utility can make a difference? For example, in Ukraine?

Landahl: Well, crypto has been a factor in Ukraine war, but I think it's almost better to say that the Ukraine war has been a factor for crypto. There was a lot of concern early on that Russia would use cryptocurrency to evade sanctions. And seeing as Bitcoin is an open ledger, we can see where the money is moving, and we can see that that really has not happened to any appreciable extent. There have been a lot of ordinary Russians who have used cryptocurrencies to seek some refuge from the ruble’s volatility. But as far as wholesale evading of sanctions, we haven't seen it.

Meanwhile, we have seen a world chipping in to Ukraine directly by cryptocurrencies: millions of dollars flooding in, millions of dollars of donations, and we've seen suppliers allowing Ukraine to pay directly in cryptocurrencies.

Host: It's fascinating how crypto can make a difference! It’s more than just an investment or a digital currency.

We can go deeper than that, even. There are big developments happening in the crypto space that accompany this term, “decentralized finance,” or DeFi for short. Can you explain DeFi for us?

Landahl: Well, decentralized finance is the word we give to a collection of projects by many different people, to replicate and extend the conventional, traditional, centralized financial system onto the blockchain.

Host: What kind of projects? For example, do you mean that you could construct a mutual fund or some other financial vehicle?

Landahl: What Ethereum does, and other similar technologies, is it allows the money to actually be programmable instead of just sending the value to you. I can say, “if gold reaches $3,000, send you $1,000,” and you can program that in into what's called a smart contract. And what you've done in this case is removed the execution risk, and in some cases, the counterparty risk from the contract. So, this is the building block of decentralized finance. And using the same method of contracts that will definitely execute or not, that are unambiguous, have no counterparty risk, no execution risk – if, assuming they're error free, you can create – really replicate all sorts of financial instruments. We see loans, you can borrow money, you can lend money, you can invest in numerous ways. Anyone who wants can go ahead and create something that looks a whole lot like a hedge fund or a whole lot like a mutual fund, but it can be done pretty easily in a web browser.

Host: “Anyone,” in the sense that all you need is a web browser, but surely it can’t be that easy, right? It sounds pretty complicated to me.

Landahl: So, complicated is relative. In my prior position, I got to see how complicated the mutual fund is. It's a nexus of contracts. There's a custodian bank, there's a broker/dealer, there's a transfer agent, there's a fund council. It's a complicated process that took some very smart people, a lot of money, and a lot of time to set up. However, I can go to a website in a couple of hours, maybe a couple of minutes, and with a couple hundred dollars of Ethereum fees, I can set up an investable fund that holds crypto assets. Maybe it has some derivatives, maybe it has tokenized gold, maybe it has some foreign currencies in it, maybe it has some call options, and I could sell that to other people.

Host: Got it. You’re saying that, compared to the process of starting and maintaining a traditional mutual fund or hedge fund, doing something like that on a decentralized – and frankly, unregulated – platform would present less hurdles. And, well, different kinds of hurdles. So, do you see DeFi as the biggest future benefit of cryptocurrency?

Landahl: I think that DeFi has the most potential out of everything that's going on in cryptocurrency today.

Host: As a means of payment, cryptocurrency seems to be gaining traction. What do you see as the growth potential in this area?

Landahl: Well, cryptocurrency is – you can buy almost anything with it, but usually when you're going to website and actually buying something, you're using a payment processor. So, in a lot of cases, it's not really the company that holds the crypto, it's an intermediary. So, it's not that different than a credit card. But there's a lot of great reasons that merchants might want to use cryptocurrency.

For example, when you buy a coffee, you swipe your credit card and you forget about it, you're done. But the merchant can't forget about it, right? They get paid down the line, they have to pay a fee, and who knows if that transaction gets disputed? Maybe a month later, Bitcoin or similar cryptocurrency can offer that merchant absolute certificate. It's an irrevocable transaction, and it settles almost immediately.

So, if merchants are willing to take cryptocurrency, they're willing to deal with the volatility, or they're willing to trust the stable point, you will see merchants being able to allow sales of their goods and services directly with cryptocurrency. And both the retailer and, in many cases, the customer can see a benefit from that.

Host: We know that most crypto owners are under 45 years of age. But what else can you tell us about the type of people or institutions that own crypto?

Landahl: Well, over the last couple of years, we've really seen a flood of investor money come into crypto. In fact, it probably dominates the space at this point. We've seen Bitcoin ETFs. They're not spot ETFs, they're future ETFs. We see companies that hold it on their balance sheet. So, it's really become a very desirable asset for people who are seeking exposure to a new kind of risk asset.

Host: But surveys have shown that fewer than 2% of baby boomers own crypto. Is that a mistake? Who should own crypto and who shouldn't?  And is a speculative asset appropriate for this age group?  

Landahl: Well, I think the story with the older users is pretty predictable. When you have accumulated a lifetime of experience that served you very well and something comes along that doesn't fit in one of your frameworks, perhaps it purports to do something improbable or impossible, then it's certainly reasonable to expect a reticence among people to jump right into it with their time and their money. And I don't think we really expect our older citizens to be early adopters of new technology.

Host: What makes cryptocurrencies so attractive to younger investors? Is it their young age, their potential tolerance for more risk? 

Landahl: I think the younger half of the equation is a little more interesting because what we've really seen in the past couple of years is the loss of confidence in capitalism and in markets, specifically financial markets. So, we've seen a lot of young retail investors come into crypto because they don't think the traditional financial system will work for them. They think it's rigged. And this really isn't good for anyone because we know what works at this point, right?

Slow, methodical investing of your whole career into a prudently, diversified portfolio, the sort of thing we at Thrivent funds do for people here. So, when you invest in crypto instead of that, you're really taking an enormous risk. And indeed, we've seen a couple of winners and a whole lot of people who haven't been so lucky. And this is terrible for the crypto world because it really attracts a lot of negative attention and, frankly, regulatory scrutiny, which this young emerging sector does not really need at this point.

Host: Let’s wrap this up with one more question. What would you say to our listeners who want to learn more or are considering investing in crypto?

Landahl: Well, I think there's three ways to invest in crypto. You can invest your time, your money, or your time and your money. You can go and buy crypto at a centralized exchange. But if you really want to learn stuff, put it in your own wallet and go out and experience DeFi, lend money, borrow money, invest in it, provide liquidity, do all sorts of other things that aren't even really possible in the traditional financial system. Your first foray into DeFi probably will not be financially profitable, but educationally, it's going to be a windfall.

(Music transition)

And this has been an educational windfall for us! Thank you, Paul, for bringing your passion into decrypting cryptocurrency for us. You’ve given us a lot of valuable information today, and we’re eager to see how cryptocurrencies will continue to shape the future.

Before we wrap up, it’s vital that we reiterate some key information. Cryptocurrencies including Bitcoin and Ethereum are very speculative, unregulated, experience significant price volatility, and are not suitable for all investors. Fluctuations in the underlying cryptocurrency’s value between the time you place a trade and the time you attempt to liquidate it will affect the value and the potential profit and losses related to it. Be very cautious and monitor any investment that you make. Speculating in these markets should be considered a high-risk transaction. Investors must have the financial ability, sophistication, experience, and willingness to bear the risks of an investment, and a potential total loss of their investment.

(Music)

Thanks for listening to this episode of Advisor’s Market360™. All episodes are available on Apple Podcasts, Spotify, and Google Podcasts. We’d like to hear from you! If you’ve got questions or comments about this episode, or if you have an idea for a topic, email us at podcast@thriventfunds.com. You can also learn more about us at thriventfunds.com and find other items of interest to you, the driven financial advisor. Bye for now.

(Disclosures)

All information and representations herein are as of June 14, 2022, unless otherwise noted.

Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product.  Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

Thrivent Asset Management, a division of Thrivent, offers financial professionals a variety of investment products to help meet their clients’ needs. Thrivent Distributors, LLC, is a member of FINRA and SIPC and a subsidiary of Thrivent, the marketing name for Thrivent Financial for Lutherans.

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