What Should Investors Know About Cryptocurrency?

MARK RIEPE: I'm Mark Riepe. I head up the Schwab Center for Financial Research and this is Financial Decoder, an original podcast from Charles Schwab. It's a show about financial decision making and the cognitive and emotional biases that can cloud our judgment.

Welcome to a new season. We've got some great shows coming your way over the next few months and we're starting off our 21st season with a topic that always seems to be in the news. But despite all the coverage, at least for a lot of investors, it's still shrouded in mystery. And we're going to shed some light on it. I'm talking about cryptocurrency. We did a couple of episodes several years ago on crypto, but the landscape changes so much it's time for another. When we first did those episodes, cryptocurrency was the shiny new thing, but the market has matured in some respects.

So if you're already a crypto investor, you may learn some more about it. And if you're curious about crypto, but haven't taken the plunge yet, keep listening. Our guest has a lot of information for you. Jim Ferrioli is the Director of Digital Currencies Research and Strategy here at the Schwab Center for Financial Research. He's a resident expert on digital asset investing and related market analysis. Before joining us, he was an equity portfolio manager and cryptocurrency strategist. In addition to an MBA, Jim also has an MS in computer science and he's a chartered market technician.

Jim, hey, welcome to the show.

JIM FERRAIOLI: Hey Mark, thanks for having me.

MARK: So first time on the show, so thanks for being here. One of the things we always like to ask first time guests, give us a little bit about your kind of early beginnings in finance and what got you interested in, in this case, digital currencies.

JIM: Sure. I first got into finance. I was actually a financial advisor. I was very interested in investing in the markets. And so I realized over time, I only wanted to focus on that part of the job. you know, as you know, financial advisors have a lot of different responsibilities. And so I ultimately ended up transitioning into a research role. I've primarily been focused on equities my entire career, even as a financial advisor.

And I've always been more interested on the growth side, whether it was tech or semiconductor software, whatever the current area of growth is in the market. And so when I first started learning about cryptocurrencies, it was something that I found very interesting. So having that kind of that equities framework for thinking about cryptocurrencies is really how I became even more interested. And so I started publishing crypto research at my prior firm back in 2020 and over the years decided to completely walk away from the equity side and solely focus on cryptocurrency.

MARK: So let's maybe start at the beginning here and quickly go through, let's say, going back to 2009 when Bitcoin was launched. What factors do you think kind of propelled them from these niche origins to where they are today?

JIM: So Bitcoin was really born out of the depths of the financial crisis. There was a crisis in confidence in kind of central banks and government issued currencies and it grew from tiny to a $2 trillion asset. And the biggest driver there has been adoption. 

If you look at technology S curves, you know, such as the PC, the internet or smartphones, Bitcoin adoption has actually tracked similarly. And so that's been the biggest driving force, but along the way, as more people have started to use it, it's also become easier to invest. In 2014, there were some over the counter Bitcoin trusts that were launched. In 2018, there were futures-based exchange traded products that were launched. And then most recently in 2024, there were actual spot ETPs that could hold individual cryptocurrencies. 

Before that, you had to buy it on a crypto native exchange and either hold it on that exchange or keep it in a cold wallet, which is essentially a USB drive. And so for investors that weren't comfortable with that or wanted it linked to the rest of their portfolio, more access made it more adoptable. And so that's been a big driver.

MARK: I think it's probably a good place to start, for any kind of investment, is that the investor should have an understanding of what sort of things are driving changes in price. what is that you alluded to a little bit earlier, but tell me a little bit more about what drives… what factors are driving crypto prices up and down.

JIM: So the three long-term factors are global money supply, Bitcoin's disinflationary supply growth, and then adoption. If you think about global money supply as the outstanding stock of money expands, the second factor, Bitcoin supply, it doesn't grow at the same pace. And so you have this permanent supply-demand mismatch if you assume that demand for Bitcoin over the long run is stable.

And then the third aspect of that is adoption, which we just talked about it. As it's become bigger, as it's become more mature, more people have been comfortable investing it. And so it's had this adoption curve. so those are really the primary three long-term forces. But if that was the only thing that impacted Bitcoin, it would theoretically only go up into the right, which we know is not true. 

And so there's market forces that impact it too: Market sentiment, interest rates. There's some crypto specific factors as well. One that people refer to as whales. These are essentially institutional crypto investors. And then finally you have financial contagion.

MARK: So those are the factors that are kind of driving prices. I think another thing that investors need to think about is it's almost like thinking about your portfolio as a toolbox, right? Everything in the toolbox needs to have some purpose to it, that there's a reason you own it. So what are the kind of distinct use cases or strategic roles that cryptocurrencies can play in a portfolio?

JIM: We think of there being really four core use cases and depending on that use case, different cryptocurrencies may be appropriate. So the first one is you might be this digital gold bug. You're concerned about monetary inflation or kind of financial contagions. And so that's the type of investor that might want to have a small portion of their portfolio in Bitcoin. 

The next is like a tech investor. So different cryptocurrencies have different uses. And just as an example, not a recommendation, Ethereum is a cryptocurrency where you can actually build products on top of it and decentralize applications on top of it. And so if you're not really concerned about monetary inflation, stocks have been a great hedge historically against monetary inflation. And if you're not concerned about the world ending, you might not want to own Bitcoin, but you might say, "Hey, I'm interested from the technology perspective. It seems there's something here." And so for that perspective, you might want to be focused on a smart contract or something in the application space where there is more of a use beyond just a store of value. 

The third user is an asset allocator. And this is, I think, important to a lot of financial advisors. Over the long term, Bitcoin has a very low correlation to every other asset class, and because of that, it actually can work in a portfolio. It's been a secular growth asset over time, but it has a low correlation. And so it does add some diversification to your portfolio as long as you manage that position and don't let it get too big. It's a volatile asset. so that's the third user is kind of an asset allocator. 

And then the fourth user is a trader. Right? So investors who like to take advantage of short-term trading, whether they're using technical analysis or pair trading, whatever they're doing, it's a good vehicle for that because it's volatile. And so for the trader client, it might be an interesting thing for them.

MARK: Jim, there are a few different ways of owning or getting exposure to a cryptocurrency. You can, I guess, to kind of boil it down, you can own them directly, you can own them through a fund, an exchange traded product, or you can invest in a company that is spending a lot of time, in some cases, owning a lot of cryptocurrencies. Tell me a little bit about kind of the strengths and weaknesses and who might be right for those different types of methods?

JIM: So if you want to invest in spot cryptocurrencies, there are benefits. First, it's direct exposure. You own the cryptocurrency itself. The benefit there is that cryptocurrencies are viewed as property. And so there's not a wash sale rule with cryptocurrencies that would apply to other financial investments, like liquid investments, like stocks and bonds. And so if you want to own an individual cryptocurrency and maybe trade in and out of it, there is a benefit to holding the spot. 

There are crypto companies, right? So digital asset treasuries have emerged as a way to have exposure to crypto. So this is a company that primarily exists to accumulate cryptocurrencies. And there's different ways of doing this. Some fund it through cash flows, through small parts of their business. Others issue debt, convertible debt that can be converted into shares and some just do share offerings. And if you want to own an equity with crypto exposure, that's one way. 

But there are drawbacks, right? If their way of accumulating more crypto is by issuing new shares. So it dilutes the shareholder. And if you are going to be the type of person who wants to own those, one of those companies, you have to be confident that that company – the issuing company's cost of capital is less than the long-term return on the underlying cryptocurrency they're buying. And then you have actual crypto stocks. And these are companies that might be related to Bitcoin. And these tend to trade like levered Bitcoin. And so if you're looking for public market exposure or maybe you want to kind of have that levered upside price movement, that might be what you're looking for there, but leverage cuts both ways. It's leveraged to the downside as well.

MARK: Jim, I wanted to segue into some of the risks involved with crypto. You talked about a number of them already. But one of them is maybe more of a misconception than a risk. And I was hoping you could address whether all cryptocurrencies are created equal.

JIM: Great question. No, they are not. So the crypto market, there's something like 21 million different cryptocurrencies. This is a market that has zero barriers to entry. Anyone can go and launch a token that has no utility whatsoever. And so it's important to understand what you're buying. 

The number one thing you want to look for and understand first is like what is this cryptocurrency and what is it actually used for? What is the purpose of it? And then how can you quantify that usage? Does it have active users? Is it the leading cryptocurrency for what it does in its market? Does it have industry standard network effects? Is it scalable? That's a really important thing for cryptocurrencies. If you can't scale, it's hard to grow. And so understanding all these different fundamental aspects of an individual cryptocurrency is important before you even think about investing in one.

MARK: I think another thing, and you've alluded to it already, is volatility. And you've told me many times that Bitcoin, for example, has about three times the volatility of the S&P 500. So how do you think about building into your portfolio something that volatile?

JIM: The way to think about it is the crypto market is largely a momentum market. Most people don't invest on these things based on their underlying fundamentals. And what has historically happened if Bitcoin's price is increasing, the rest of the crypto market is also increasing and typically at faster paces, right? So every altcoin is essentially a levered play on Bitcoin. And so you need to think about that from your portfolio context. 

If you're adding a cryptocurrency, expect it to be more than three times as volatile as an equity because Bitcoin alone has a volatility of three times that of the S&P 500. So position sizing is really important. We don't have a view on how much you should own. You as an investor have to determine what the proper amount to own is, but you have to be really careful to rebalance it if it gets too big and again, if it gets too small, adding to it. So applying that same portfolio construction and rebalancing mindset that you apply to other asset classes is really important.

MARK: Another thing that I think is going to be important for investors in 2026 is the regulatory environment that cryptocurrencies face. What are your thoughts on that?

JIM: Yeah, that's going to be important. Last year over the summer, you had the first big crypto bill get passed. That was the Genius Act. That created a regulatory framework for stablecoins. Now, the second part of that, which made it out of the House but not through the Senate, was the Clarity Act. And that's the market structure bill for cryptocurrencies. That determines who has regulatory oversight over different cryptocurrencies. It determines if a cryptocurrency is a commodity or a security, right? If you tokenize an equity, it's still an equity, even if it's on a blockchain. So it lays out important regulations related to those. And that's important because there's still a lot of investors that are on the sidelines with cryptocurrencies.

Until there is clear regulatory landscapes, many people will continue to be on the sidelines, and so the Clarity Act is actively being discussed in the Senate. And if that gets passed, that would be an important milestone that would let investors, whether they're individual investors or institutional investors who are still hesitant to get into a space that has a gray area associated with it, that removes some of those barriers to entry.

MARK: Given the inherent risks, what insights can you offer regarding portfolio allocation for cryptocurrencies? How much, if any, should an investor consider allocating based on their risk tolerance and overall financial picture?

JIM: So we don't have an exact amount that we recommend investors allocating to. What we would suggest is an investor take one of two approaches. If they have a perspective on what the long-term return for a cryptocurrency is, they can use a classic mean variance method of determining how it should fit in a portfolio. And, right, to do that, have to have an expected return. And then you would look at things like correlation to other asset classes to determine how much should fit in the portfolio. 

Now if you don't have your own perspective on what the long-term return for, whether it's Bitcoin or Ether, or whatever cryptocurrency you're allocating to, a risk budgeting approach is useful because you could plug in potentially a return and that could actually result in an outsized position in your portfolio, right? Because the classic way of determining asset allocation allocates to portfolios based on the relative return versus other asset classes. And so that actually might result in too large of a position in cryptocurrencies given their volatility characteristics. 

And so a volatility budgeting approach lets you set how much of your portfolio's volatility you want to come from cryptocurrencies. And you can use a volatility budget then to determine, based on that, how much you should have given that budget, And so that gives you a number that is, again, it's more related to the overall volatility of the portfolio. 

And so once you go through that exercise, you can then determine if you think that that's the right amount of exposure for you. But again, I want to highlight, we don't think cryptocurrency exposure is right for everyone. It's not required for everyone and it's ultimately the decision of the individual investor of whether it's appropriate for them to have any position at all. And different investors are going to have different sized allocations based on their risk profile, their financial goals and their needs.

MARK: Jim, my guess is that there must be a prevalence of certain emotional biases affecting how we make decisions around crypto. And reflecting on that, have you observed any significant behavioral habits from how investors tend to approach crypto?

JIM: Herding is probably the biggest behavioral bias there is in digital assets. This is a market, this is an asset class that does not trade on fundamentals. It trades on momentum. And so typically the direction that Bitcoin is moving in, that determines the direction that the rest of the crypto market is moving in, albeit with higher volatility. 

That's a big behavioral bias that we look for and one of the reasons why we think it's always important to think about your cryptocurrency exposure in context to your total portfolio. The market may be moving higher. It may be exciting. Everywhere you go, you might hear someone talking about it. And we think it's important to continue to rebalance that exposure if you're going to have it to kind of help mitigate this herding behavior.

But that also works to the downside too. There's periods where the crypto market can see very strong downside momentum. We have seen bubbles burst in the past as a result of herding. And typically in these markets, investors might become discouraged. They sell, right, the narrative often goes from this euphoric case that blockchains are going to be adopted everywhere to this case that there is no case for blockchain technology and this is not a real asset class anymore. 

And so again, the herding behavior impacts you to the downside too. And again, in that situation, we would remind investors, think about this from a portfolio context. If a portfolio position becomes smaller than your asset allocation has called for, maybe you should rebalance it. And so that's what I would point to in terms of herding.

MARK: Another powerful bias is the endowment effect, or the tendency to get attached and overvalue something just because you own it. Do you see this bias influence investors' decisions when they hold crypto, where maybe they don't want to let go of a specific coin out of a sentimental desire for it to come through for them?

JIM: A lot of people who have historically invested in Bitcoin specifically, they view it as more than just an investment. It's almost like a belief system, right? The early adopters of Bitcoin first adopted this because it was viewed as a neutral money. It had its own monetary policy programmed into it. It wasn't tied to a government or a central bank that could print money. And so it was just this narrative that it's this pure form of money. 

So when you start framing your investment cases really around these beliefs, when facts change or maybe valuations become stretched, it can be very hard to change how you think about it. And so that's a very common thing we've seen in Bitcoin, but also, you know, extends to the broader crypto market. 

This is a momentum market and absent, you know, a changing narrative, people cling to, you know, what else is, what everyone else is saying in the market. They let their own feelings maybe overpower, rational decision-making. And so those are some big issues that we should look out for.

MARK: When confronted with decisions that bring out biases like these, what practical strategies can investors utilize to identify and potentially mitigate their impact?

JIM: Yeah, I would think about it like this. If you're the type of investor that likes riding the positive days of the market, but you really struggle with volatility, cryptocurrency may not be the most appropriate investment for you. These are very volatile assets. Just to put it in perspective, Bitcoin is about three times as volatile as the S&P 500.

When you move beyond Bitcoin to smaller cryptocurrencies, they get even more volatile. everyone likes momentum to the upside. If you can't stomach momentum to the downside, you may want to pass. That said, there are ways to mitigate this. And the biggest one for me is thinking about it from a portfolio context. If you regularly rebalance your portfolio, you can miss some of the blow-off tops, but you might also kind of rebalance at the bottoms when you should be rebalancing. 

One of the things I kind of get cautious about is, and this applies to any financial asset. During these big price run ups, people think that there's this narrative shift, something has changed. And you start to ignore maybe some cracks showing in the foundation. And so again, I like to just take a step back and think about it. Okay, if this part of my portfolio has really risen dramatically over the past few months, other areas of the portfolio haven't participated as much. Maybe it's a good opportunity to take a gain. I might be giving up some upside by rebalancing, but at the same time, you may also kind of cap potential downside in the short term.

MARK: Looking ahead, what do you envision for the future of cryptocurrencies and blockchain technology in the financial world, let's say the next five to ten years? Are we approaching a level of maturity or is there still significant evolution to come?

JIM: Yeah, I'm excited for the coming five to 10 years. Crypto is interesting from a financial perspective in that it's largely been a retail market and institutional investors are the people that are coming to it last, whereas traditionally institutions would be in the market first and then retail would get involved. 

Incremental adoption is likely to come from institutions who have not entered this space yet, mostly because of a lack of regulatory clarity. The Senate is actively working on the Clarity Act. That's the market structure bill for digital assets. It determines things like who has regulatory power over them. And I suspect that upon the passing of that, that will result in new institutional investors who may have been hesitant to enter this market, finally entering into it. 

We saw last summer with the Genius Act passed, institutions start to get involved. A lot of this was through investment funds, like exchange traded products, things like that. But I would suspect that as the market matures and new investors come in, that they begin investing beyond investment products, actually in spot cryptocurrencies, using various decentralized finance products and applications and things like that. And so I think that's interesting. And what I would expect to see from there, is with a level of maturity in the markets, more institutions in it, the market actually begin to trade more on fundamentals as opposed to being a momentum driven market today.

MARK: Jim Ferraioli is a director here at the Schwab Center for Financial Research and he's our cryptocurrency strategist. Jim, thanks for coming by.

JIM: Thanks for having me on, Mark.

MARK: That's it for this episode. Crypto is a big topic and Schwab has many additional resources on it for those who want to learn more, including articles and videos. All this can be found at schwab.com/cryptocurrency. As always, we have that link in the show notes. 

If you'd to hear more from me, you can follow me on my LinkedIn page or at X @Mark Riepe. That's M-A-R-K-R-I-E-P-E. If you like the show, one great way to help us find more listeners like you is a rating or review on Apple Podcasts. Or if you listen to the show on Spotify, you can leave a comment there or tell a friend about us. It's one of the most effective ways to broaden our audience. They can follow us for free in their favorite podcasting app.

For important disclosures, see the show notes and schwab.com/FinancialDecoder.