Tales from the Crypto…Understanding Digital Assets
Blockchain, cryptocurrency, Digital Ledger Technology. These terms are becoming commonplace in the news cycle, on social media and even in casual conversation, but digital assets can be a very complex topic. So, we invited Scott Duba, portfolio manager and director of our investments team, to give us an introduction to the realm of digital assets and what to think about when considering investing in this asset class.
Jack Giardino: Hello, everybody, and welcome back to another episode of “Your Life, Simplified.” My name is Jack Giardino, and I’ll be the host for this episode. For today’s topic of discussion, we’re really going to be hitting from a high-level digital assets and cryptocurrencies. When we think of those two things combined, we think of Bitcoin and Ethereum and all of these newer-to-the-market types of investments that we don’t have a lot of experience in. But it seems to be a buzz, really getting hit hard on all news outlets and social media. I feel like everywhere I turn, I’m seeing someone tweeting about cryptocurrency, and we just want to really provide an understanding to our listeners of, hey, what is this new digital asset class? And hopefully you all will be able to take away the different types of cryptocurrencies that are out there and understand the technology behind this new digital asset class.
For today’s topic of discussion, I have with us Scott Duba, who is a portfolio manager and director of our investments team here at Mariner Wealth Advisors. Scott, welcome to the show.
Scott Duba: Thanks, Jack. Glad to be here.
Jack: Scott, I think a great starting point for this conversation discussion is really understanding what are digital assets. I don’t want to steal your thunder, but a quick explanation would be, we tend to hear about cryptocurrencies, and we like to take the approach of digital assets. Could you maybe just high-level 30,000-foot view, what are digital assets?
Scott: Sure. So anytime you hear the word “digital asset,” you’ve got to think blockchain. Blockchain is the real bedrock technology that you have to understand that makes this whole thing work. Cryptocurrencies is a subset of digital assets. You can think of digital assets as being, let’s say, stocks, and then cryptocurrencies would be like EM growth stocks in terms of the taxonomy of how you describe it.
Jack: So, stocks, and just a further explanation, EM, you mean like emerging markets?
Scott: Yes, like very specific. Within digital assets, you could think of cryptocurrencies, meaning things that are used just to move value. You can think of crypto commodities such as ether on the Ethereum network that basically provision some resource. There’s a couple of different subsets, but digital assets, you just got to remember, it’s all about blockchain.
Jack: Okay. So we have this digital asset class, and it’s all about blockchain. What is blockchain?
Scott: So blockchain is a distributed ledger technology. I’ve used this analogy before. It’s a little hokey, but I think it works. So the Chiefs were in the Super Bowl a few years ago, Super Bowl LIV, 49ers versus Chiefs. The score ended up being 31 to 20. If you live in Kansas City or you’re a sports fan, you probably remember that score. That’s effectively a distributed ledger that we all carry around in our head. Blockchain is kind of like that, except the ledger is held by thousands of computers or nodes that are on a connected network. So the distributed ledger provides access of the information to everybody, but nobody can change it because everyone has a copy. And so blockchain in simplistic form, if you had to explain it to my dad or your dad, just think of it as a distributed digital record book that everybody has access to, but no one can change.
Jack: I think that’s a wonderful, simple explanation. Just to dive in, I don’t want to get too into the weeds here, but you speak of these things called nodes, and those are just nodes are what make up the blockchain and are the verification process, is that fair to say?
Scott: Back in the early days of Bitcoin, the users in the nodes were somewhat interchangeable because people were using pretty basic laptop and desktop computers to power it. But over the past 10 years, there’s been tons of investment in these really beefed-up server farms that actually do the more verification parts that the nodes do. Now the user nodes are somewhat different pools of people. A node is really … people have called them miners. Cryptocurrency miners is a term I’m sure you’ve heard. And what they’re doing, they’re solving these cryptographic puzzles to add new blocks of information to the chain and basically verify that it’s all true and correct. So that’s what the nodes are. In some blockchains, they’re still interrelated, nodes can be users. But for people like you and me, you and I would more be a user, whereas a node is probably a company that’s sort of purpose-built to do that.
Jack: Wonderful explanation. So just from the top, we have the overarching digital asset class, so to speak. Within that, we have these slivers or cryptocurrencies that each thing could perform differently.
Jack: Perfect. And then from there, from the cryptocurrencies, are the specific coin names such as Bitcoin or Ethereum or Litecoin or whatever else there may be out there. I think there’s a couple thousand now?
Scott: Now there’s a HIPAA. I want to say 2,000 or 3,000. There’s a lot.
Jack: Perfect. And we have these individual coins, and all of these individual coins are driven by the blockchain technology.
Scott: Yes. They’re all based on some form of blockchain technology. It might be their own blockchain, their own quote, unquote layer one blockchain. But in a lot of cases, they’re built on top of other blockchains, like Bitcoin or Ethereum.
Jack: Okay, perfect. So then we have the technology that drives these different types of coins or cryptocurrencies. What is the difference between, let’s say, Bitcoin or Ethereum? I think those are two big, heavy hitters. How does each coin vary from another coin?
Scott: Sure. So they’re built to do different things is a simple way to explain it. Bitcoin was built to be digital money. So the Bitcoin blockchain, it prioritizes security and stability and simplicity because Bitcoin is built to be a digital gold. So it doesn’t really need to be very fancy or complex or robust or do a lot of things. It just has to do that one thing really well. Ethereum is completely different because the founders of Ethereum saw what Bitcoin was doing with blockchain and realized the potential to use it in a more general application. However, Bitcoin was written in a very basic programming language, whereas Ethereum, when they built it, they wrote it in a programming language that is incredibly flexible and can do many, many different things. So whereas Bitcoin is built to be digital money or digital gold, Ethereum was built to be effectively a virtual machine to basically execute code and contracts for other applications.
Jack: That’s interesting. And so then you have, for example, I know we said a couple of thousand different types of coins or cryptocurrencies out there, and each of these are going to vary slightly from one to the other. It’s safe to say that none of them are identical.
Scott: Correct. None of them of them are identical. A lot of them do similar things. So Ethereum, as a general purpose blockchain, there’s many competitors that do something similar. I’d say Ethereum has the advantage of a very deep and developed developer community and a lot of name recognition and a lot of human capital and financial capital invested behind it. But there are other general purpose blockchains doing something similar. And there is an extremely long tail of other very random crypto assets out there. Some of which do nothing other than service, just a speculative vehicle. Others do very specific and nuanced things that a lot of people don’t have interest in.
Jack: So, call me absolutely crazy, but this is where my mind goes on an analogy for comparing all the different cryptocurrencies out there. Let’s just take fast food restaurants, for example, right? There’s thousands or hundreds of different types of burger joints out there. We could say there’s thousands of different types of cryptocurrencies out there. Each burger joint, McDonald’s, Wendy’s whoever else that may be, run their business a little bit differently but still at the end of the day kind of provides you with that burger. So, is it fair to say that that’s kind of easy to compare those with the cryptocurrencies?
Scott: Yeah, but I would make one other augmentation to your analogy. I’d say some of them are not even providing a burger. Some of them are just a wrapper that people want to buy because they think the wrapper is going to be worth more. So that’s why if you’re looking at this asset class, you really got to be digging into the weeds and know what you’re buying, because there is a long tail of these new digital assets that really do nothing other than serve as a highly speculative vehicle.
Jack: And I think that’s a great point where individuals may potentially get themselves in trouble if they don’t fully understand the digital asset class as a whole. You’re saying you may buy this coin that only provides the wrapper in our burger analogy instead of buying McDonald’s that provides the full meal type of deal. So, having these conversations with your trusted advisor and building that knowledge and having an understanding for the digital asset class before you really approach it as an investment or implementing it into part of your investment portfolio I think is extremely important. And I think that’s a perfect segue into kind of our next discussion is, how should an individual approach the digital asset class as an investment opportunity?
Scott: Sure, I’d say the first question revolves around risk and suitability. It’s not for everybody. Digital assets are new, they’re volatile, they’re risky and they’re complicated from a technological standpoint. And I would encourage people to talk to their advisors. If you do have an interest in it, make sure it fits in your overall wealth plan. I think a good way to think about digital assets are as emerging stores of value. So in any store of value investment, you’re trying to just protect your purchasing power into the future, whether that’s buying real estate, buying gold, buying stocks, buying bonds—that’s what you’re trying to do. Digital assets are emerging into something that is more broadly accepting as a way to do that. And so I’d say start the conversation with your advisor, make sure you have the right risk tolerance, the right time horizon, the right tolerance of volatility to be considering the asset class.
Jack: That’s wonderful. You know, we’re having these conversations with our clients currently. I’ve sat down from several of them having just a general discussion. And I think, you know, the first thing that I always recommend people is just to start, start learning, start talking about it, start discussing it with your trusted advisor and just start creating that understanding for the digital asset class as a whole instead of just, you know, kind of nose diving or head diving straight in and just starting to buy up whatever it may be or whatever you’re getting yourself into.
And I think as an advisor here at Mariner, it’s wonderful to have these resources such as you, Scott, and our investments team that has taken the time to really investigate the digital asset space and allow us to tap into you all. If we do need to dive into the weeds or if anything comes up and pull you into these conversations to dive in to this discussion with our clients and allow them to have a full understanding of the digital asset space. So wonderful discussion we’re having. And I think that kind of leads into the next piece I’m hoping to cover. And that’s the tax implications around investing in the digital asset space. So would you mind just kind of delving in with how these assets are treated compared to normal investments or stocks and bonds and what implications we see with the digital asset space?
Scott: Sure. I won’t claim to be an expert in tax law, but I can kind of give the high-level view. So digital assets are not securities per the view of the government. They are considered property akin to real property. So, when you transact in digital assets, you still are bound by the normal capital gains rules in terms of short- and long-term capital gains. However, one nuance is that for these property sales, you’re not bound by the same wash sale rules you normally are for securities. So hypothetically, in a security trade if you wanted to harvest a short-term capital loss, you’d have to wait 30 days to buy it back, whereas in digital assets, you’re not bound by that same time horizon, so you can effectively do same-day wash sales.
Jack: So, in the stock world, if you buy Apple for a hundred bucks, you sell it for a loss at 80, you realize that loss, you have to wait 30 days then to buy back into Apple. So, what you’re saying, just for our listeners to kind of give a more in-depth explanation is, if you were to buy a cryptocurrency such as Bitcoin for a hundred dollars and it drops to 80, and you sell it at $80 and realize that loss, that $20 loss, you can then turn around and buy right back into Bitcoin without waiting that 30 days.
Scott: That’s correct.
Jack: And I think that’s, you know, kind of a unique aspect of the cryptocurrency space and the digital asset class, that those tax implications are important to understand and have a good feeling for those. So, kind of last question here for you, Scott. Mariner Wealth Advisors is kind of on the cutting edge of having these conversations around the digital asset space with our clients and providing different offerings to our clients in order to allow them to have exposure to the digital asset space. Would you mind just briefly touching on, you know, how we’re approaching that as a firm and the different offerings that we’re bringing to the table?
Scott: Sure. I would say we’re trying to be somewhat at the forefront in terms of bringing this to our clients, but we’re trying to do it in a strategic and prudent manner. We view the digital asset space as a very long-term development. So, we’re trying to take our time and make sure we set the right course while at the same time being able to educate and answer any questions our clients have. We think that’s kind of goal number one, is whenever there’s some new emerging investment opportunity, we need to be a trusted resource to answer the questions.
Jack: Scott, I couldn’t agree more with that explanation. And especially that start having these conversations with your trusted advisor. And if you don’t have a trusted advisor, I would encourage you to seek out the trusted advisor. And I appreciate, again, you taking the time to have this conversation and discussion with me. The knowledge that you bring to the table is truly phenomenal. And thank you for taking the time to be on the show.
Scott: Thanks for having me.
Jack: Thank you, everybody, for tuning into another episode of “Your Life, Simplified.” If you have any topic suggestions, ideas, thoughts or questions, feel free to reach out to [email protected], and please feel free to share this episode and our podcast with any friends, family or individuals that you think would find interest of this podcast. And thanks for listening to today’s episode.
The investment characteristics of virtual currencies, crypto-currencies, and digital coins and tokens (“Digital Assets”) generally differ from those of traditional currencies, commodities or securities. Importantly, Digital Assets are not backed by a central bank or a national, supra-national or quasi-national organization, any hard assets, human capital, or other form of credit. Rather, Digital Assets are market-based. A principal risk in trading Digital Assets is the rapid fluctuation of market price. The value of client portfolios relates in part to the value of the Digital Assets held in the client portfolio and fluctuations in the price of Digital Assets could adversely affect the value of a client’s portfolio. There is no guarantee that a client will be able to achieve a better than average market price for Digital Assets or will purchase Digital Assets at the most favorable price available.
There is no assurance that the virtual currency market, or the service providers necessary to accommodate it, will continue to support Digital Assets, continue in existence or grow. Further, there is no assurance that the availability of and access to virtual currency service providers will not be negatively affected by government regulation or supply and demand of Digital Assets. Currently, many of the companies providing Digital Assets custodial services fall outside of the SEC’s definition of “qualified custodian”, and many long-standing, prominent qualified custodians do not provide custodial services for Digital Assets or otherwise provide such services only with respect to a limited number of actively traded Digital Assets. The regulatory schemes possibly affecting Digital Assets or a Digital Asset network may not be fully developed and subject to change. It is possible that any jurisdiction may, in the near or distant future, adopt laws, regulations, policies or rules directly or indirectly affecting a Digital Asset network. It is also possible that government authorities may take direct or indirect investigative or prosecutorial action related to, among other things, the use, ownership or transfer of Digital Assets, resulting in a change to its value or to the development of a Digital Asset network.
Please refer to our ADV Part 2A for additional risk disclosures. You may also want to review the Investor Alert issued by the SEC’s Office of Investor Education and Advocacy
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