What is cryptocurrency, and does it have a place in your retirement portfolio?

As digital currencies like Bitcoin continue to capture the attention of investors and the media, you may be wondering how cryptocurrency works and if it belongs in your investment portfolio. Below, TIAA provides its perspective on cryptocurrency and addresses important considerations for those who may be thinking about investing in the growing number of digital currencies.

What is cryptocurrency?

Unlike traditional currencies such as the U.S. dollar, which is managed by a central bank, digital or "cryptocurrencies" are not controlled by any bank, government, central authority or other middleman. Instead, they are managed through a combination of peer-to-peer technology and software-driven cryptography. While Bitcoin is the most well-known cryptocurrency in use today, other names you may be familiar with include Dogecoin, Ethereum (Ether), Litecoin and Polkadot.

Each of these currencies are backed by digital code, versus a central authority (government-issued currencies) or a physical value like gold or silver. The code behind these decentralized networks is what allows users to trust each other in conducting transactions. Rather than using any one company's proprietary software, the code is developed by independent users and developers. Open source blockchain developers constantly add to and refine the codebase.

What is blockchain and why does it matter

Introduced in 2009, Bitcoin was the first among thousands of digital currencies that are distributed, traded and stored with the use of a decentralized ledger system, known as a blockchain.

Blockchain is the key technology underpinning most cryptocurrencies. While blockchain technology can be used to store all kinds of information, its most common use is in recording cryptocurrency transactions. Once a transaction is made, it's entered on this public ledger, which is managed by a decentralized global peer-to-peer network, typically comprised of millions of computers. Once verified, the transaction is permanent and, unlike a credit card transaction, it can't be reversed.

In recent years, blockchain technology has become increasingly attractive to companies seeking secure ways to process payments, share medical and other sensitive data, and solve complex supply chain and logistics challenges. Since each computer in the chain must verify a transaction before it can be noted in the register, the result is a chain of digital blocks that contain records of each transaction. Each block is connected to all the blocks before and after it, making it difficult if not impossible to tamper with a single record. That's critical not only for deterring potential hackers, but for mitigating human error, as well. Someone intent on tampering with records would not only need to change the block containing a record, but all those linked to it.

However, blockchain technology also has a downside. You may have seen stories about cryptocurrency mining in the news lately. Mining refers to the complicated process by which new bitcoins are entered into circulation. It requires high-powered computers that solve complex mathematical puzzles to create a new "block" on the blockchain. The mining process eats up a tremendous amount of computing power and electricity, which has led to concerns about bitcoin's environmental impact.

TIAA's perspective: What we believe and why

As investors are increasingly inundated with news about cryptocurrencies and potential applications for blockchain technology across business sectors and industries, many wonder if digital currency may be a suitable addition to their retirement portfolios.

"While the underlying blockchain technology used by cryptocurrencies has many uses across industries, our consensus at this time is that cryptocurrencies by themselves are not an investable asset," said John J. Canally, Jr., CFA, IMG Chief Portfolio Strategist.

While all investable assets involve varying degrees of risk, as a group their relative risks are reasonably understandable over the longer term. There is transparency in their make-up, and they are grounded in fundamental value. However, highly speculative assets, like cryptocurrency, are typically deficient in one or more of these attributes. They experience extreme volatility and therefore, are not useful as a store of value. For example, from mid-April to mid-June 2021, Bitcoin declined in price by nearly 50% after wavering tweets by Elon Musk and a cryptocurrency ban by China.

At TIAA, our mission is to help participants achieve financial security to and through retirement. We believe this is achieved by saving through investable, as opposed to highly speculative, assets. We believe cryptocurrencies should not be part of an allocation of assets designed to meet future goals, such as saving for a child's education, purchasing a home or funding retirement needs, for the following reasons.

Cryptocurrencies are unreliable as a store of value

Cryptocurrencies exhibit extreme volatility with highly unstable correlations to other asset classes, making them almost impossible to model. They are not driven by the traditional supply and demand fundamentals that help determine the underlying value of other asset classes. This leads to a lack of transparency, increases the volatility of cryptocurrencies and makes them unreliable as an investable asset and as a store of value.

They're not income producing assets

In addition, cryptocurrencies have no risk premium, do not produce income or cash flows, and have a short history.

"When we look at the historical performance of stock or bond investments, we're able to analyze trends and performance over the course of many decades and across multiple market cycles," Canally said. "Bitcoin, while the oldest of the cryptocurrencies, has only been around for ten years."

They can be highly volatile

While the lack of a central governing authority such as a central bank is often cited by proponents of cryptocurrencies as a benefit, it can also exacerbate illiquidity and volatility.

Daily volatility for digital currencies can run significantly higher than traditional markets and asset types. According to Canally, there have been times when the daily volatility for Bitcoin was nearly four times higher than the volatility in the oil market, which at the same time, was twice as high as the volatility of the S&P 500.

A significant factor driving volatility is that there is no correct or intrinsic value for cryptocurrencies. They're worth what people believe they're worth on any given day. For investors in or approaching retirement, who will rely on income from their portfolios to meet their lifestyle expenses in retirement, the combination of nonexistent cash flow, increased volatility and lack of liquidity is highly problematic.

"Think about if you were paid in Bitcoin," Canally said. "Would you want to get a paycheck on Friday for $800, have a celebrity tweet something over the weekend, and wake up on Monday with only $399 left?"

Cryptocurrency also has not proved to be a reliable hedge against stock market volatility. For example, when the S&P 500 dropped 34% in March 2020, Bitcoin trailed the market, losing 50% of its value over a two-day period. We saw a similar pattern following the global sell-off in stocks on July 19, 2021, amid concerns about the spread of the COVID-19 Delta variant. Bitcoin dropped below $30,000 that same evening, dragging the value of other digital currencies down with it, before rebounding—along with the equities market—in the days that followed.1

Yet, volatility is only one way investors can potentially lose money in cryptocurrency. If your private key (an encrypted alphanumeric code that permits access to your Bitcoin or cryptocurrency holdings) is lost or stolen, you no longer own the cryptocurrency, and you permanently lose those digital assets. Your private key, which is picked randomly as soon as you make a wallet, is the only way to prove ownership.

What could change our current view

Although many people have made money with cryptocurrency, it remains a highly volatile and speculative investment. Yet just because you can't use digital currency to pay for gas or groceries today, that's not to say things won't change in the future. Looking back to the advent of internet stocks in the 1990's, initially, it was unclear how some of these companies could make money off of something as intangible as the internet. Today, tech stocks make up an important part of a well-diversified investment portfolio.

However, it's important to remember that tech stocks didn't go from highly speculative to mainstream overnight. In addition, many companies that were household names in the 1990s and early 2000s no longer exist or were absorbed by other companies through mergers and acquisitions, such as Napster, Palm, Compaq and AOL. It's likely that we will see similar activity in the fast-growing digital currency space over the next few years. As a result, some of today's cryptocurrency names may not survive long term, which only adds to their speculative nature.

There are several things TIAA would need to see before changing its current point of view on cryptocurrency, including the world's central banks embracing digital currency, increased efforts to weed out cyberhackers and broader adoption of blockchain technology across businesses and industries.

Until some of these factors change, investing in cryptocurrencies should be considered a highly speculative activity and not suitable for investment objectives that depend on the stability of the underlying value of the funds that investors commit to the investment.

Still crypto-curious?

If you're thinking about investing in cryptocurrency, as with any investment, it's important to do your research. Not all currencies are created equal, and some are higher risk than others. Due to the myriad of risks associated with Bitcoin and other digital currencies, investments should only be made with assets set aside for speculative purposes. These are assets you either don't need or won't rely on for income in retirement. In other words, money you can afford to lose.

If you're thinking about owning cryptocurrency, consider talking with your TIAA advisor first. It's important for your advisor to understand why you are interested in Bitcoin or other digital currencies. Is it simply the fear of missing out or is there another investment challenge you are hoping to solve?

Whether you're looking for additional sources of income in retirement, a hedge against inflation or simply want help evaluating your retirement income needs, your advisor can help you determine if you are on track to have the income you will need to support your goals for a period or 20 or 30+ years in retirement. To learn more about creating a tax-efficient income stream that you can't outlive, schedule a meeting with your TIAA advisor today.

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1IMG; Bloomberg

This material is for informational or educational purposes only and does not constitute fiduciary investment advice under ERISA, a securities recommendation under all securities laws, or an insurance product recommendation under state insurance laws or regulations. This material does not take into account any specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on the investor’s own objectives and circumstances.

The views expressed in this material may change in response to changing economic and market conditions. Past performance is not indicative of future returns.

The TIAA group of companies does not provide legal or tax advice. Please consult your legal or tax advisor.

Investment products may be subject to market and other risk factors. See the applicable product literature or visit TIAA.org for details.

Advisory services are provided by Advice & Planning Services, a division of TIAA-CREF Individual & Institutional Services, LLC, a registered investment adviser.