Episode 1

A Crypto Currency Primer

bitcoin crypto currency diagram

Curious about crypto? In our debut podcast Heritage Financial President, Sammy Azzouz, chats with David Lebovitz, JP Morgan Global Market Strategist to provide listeners a primer on cryptocurrency. What they are, how the technology behind them works, why the buzz, talking about the different coins, and how to think about them as an investor.

00:00:11 – 00:05:04


Welcome to Wealthy Behavior, talking money and wealth with Heritage Financial. The podcast that digs into topics, strategies and behaviors that help busy successful people build and protect their personal wealth. I’m your host, Sammy Azzouz, president of Heritage Financial, a Boston based wealth management firm working with business owners, executives and retirees for more than 25 years. Now, let’s talk about the wealthy behaviors that are key to a rich life.

So welcome to episode one of wealthy behavior talking money and wealth with heritage financial. I’m Sammy Azzouz, the president of heritage and your host. I’m excited to do our very first episode of wealthy behavior on cryptocurrencies. What they are, how the technology behind them works, why all the buzz, the different coins and importantly, how to think about them as an investor. With me today is David Lebovitz global market strategist on the JPMorgan asset management global market insight strategy team, welcome to wealthy behavior David. Thanks for having me. Glad to be here. Absolutely. Thank you. So today, we’re going to be talking about something that depending on your perspective is the greatest new investment opportunity of all time. A speculative trap waiting to happen. Something investors love, something friends of mine in the industry can’t wait to stop talking about, and that topic is digital assets and cryptocurrencies. So let me start quickly with your background in this topic as a global market strategist with JPMorgan. How closely are you following the crypto market? And are you invested yourself in it? So we are following it very closely. Mostly because it continues to come up in pretty much every client conversation that we have across both the retail and the institutional spectrum. We actually wrote a dedicated paper on the topic as part of our 2022 long-term capital market assumptions, which came out at the very end of last year. And we’ve been giving presentations on the topic. We’ve been working with colleagues in the investment bank who actually focus on blockchain for the purposes of the broader business itself. So it’s definitely an area where we’ve been spending a lot of time here over the course of the past couple of months. I will say though, you know, working for a big bank. I am not personally invested. Compliance has put up a handful of hurdles, but that doesn’t mean that that won’t change here at some point down the road. Got it. Great. Thank you. You know, my first question really on this is I think when these first came notice, people started talking about them. They went by the term cryptocurrencies, but now I’m hearing a lot more the term digital assets, what’s the difference or does that really matter? So I think for the average individual and then I’ll kind of share our take on this. The biggest difference between a cryptocurrency and a digital asset is that most people believe that a cryptocurrency is a digital token. That is tied to some unique blockchain. And so very similar to the way that before the Euro, every country in Europe had a different currency. Every different blockchain has a unique token associated with it. And that’s really where the idea of cryptocurrencies has come out of. Digital assets, you know, people tend to use that term to refer to things like non fungible tokens or NFTs, which I would say are more of a traditional asset and less of a currency. But in general, we’re not fully sold that cryptocurrencies are actually currencies. My background is in economics when I think about a currency, I think about it as a store of value, a medium of exchange. And the reality is I can’t go downtown where I live in Connecticut and buy my morning cup of coffee and pay for it using say Bitcoin, at least not yet. And so, you know, there are a number of other differences as well in terms of who secures the network, how does it derive its value? I think we’re going to get into a lot of that over the course of our conversation today. But to me, these are really all digital assets. The biggest difference between say, again, an NFT and a cryptocurrency or a crypto asset is really whether or not it is the unique token of a given of a given blockchain. Got it. Okay, well, that makes a lot of sense. And the one that people talk about the most is probably Bitcoin that has kind of come to be interchangeable with cryptocurrency. Let’s talk a little bit if we could about how many coins there are, how many of them really matter, how similar or different are they, for example, I know that Bitcoin has a finite supply, but that’s not maybe the case for all the other coins, right? That’s exactly the case.


00:05:04 – 00:10:01


So there are a plethora of cryptocurrencies out there in the current environment. Arguably too many for any individual to keep track of on a daily basis. The way that we think about it is, there’s obviously a very broad universe. We tend to focus on the more liquid tokens, the ones that are more heavily traded. And really just thinking about it as a share of the overall market capitalization. You have about 50% of crypto market cap split between Bitcoin and ether with either being the token tied to the Ethereum blockchain. You then have about another quarter, which is comprised of different tokens like Cardano, Solana, tether, Polkadot, XRP. I’m sure that means very little to a lot of our listeners, but it gives you a sense of how many different coins are actually out there. And importantly, when we think about the crypto universe, a lot of the names that I just mentioned are very different from things like Dogecoin. I think the way we split this up in our minds is we say, okay, you know, what if any real economic value can we tie these tokens to, you know? So in the case of something like ether, the Ethereum blockchain has the ability to run smart contracts, those are rules based applications for processing information. To me, it seems like there is real value in that type of technology. Again, you think about something like Dogecoin, which is based on the meme of a dog. You know, debatable, how much value that took and will have over time. But there are a lot of different cryptos out there and they each have their own unique set of fundamental traits. You mentioned Bitcoin and you mentioned the supply. There will only ever be 21 million Bitcoin in circulation once it all has been mined. That’s simply the way Take the application that the code was originally written and you juxtapose that with something like ether, where there’s effectively an infinite supply. The reward ebbs and flows depending on how much activity there is on the network. But over time, there’s just going to be more and more ether that is created and becomes available for people to use in order to have these transactions processed or to invest in, which is what we see a lot of in the current environment. And so to us, it’s there are a couple of things that we always try to focus on. What does the blockchain that this token is associated with really do? Does it create any real economic value and then obviously we look at some of the more technical aspects of these digital assets in terms of their trading turnover that gives us a sense of their liquidity. We’re obviously always looking at the price, but again, lots of moving parts here beneath the surface. Yeah, definitely. So let’s maybe take a step back before jumping forward. We’ve chatted a little bit about this already, but what is a cryptocurrency if you’re explaining it to somebody for the first time and what’s the blockchain technology? What are those things mean and how do they connect to each other? Absolutely. So I’m actually going to answer that question in reverse because I think that that’s a little bit easier way to wrap your head around the whole thing. So if we take a step back and think about what a blockchain is. A blockchain is nothing more than a database. And as we all know, a database is a collection of information that is stored electronically. Now, the biggest difference between a blockchain and a traditional database is simply in the way that the data is structured. And you think about a traditional database, say a workbook and Microsoft Excel, you’re going to have your data structured into rows and the columns. A blockchain, on the other hand, is going to have its data structured in the blocks. And so in the simplest sense, all blockchains are databases, but not all databases are blockchains. And in the current environment, blockchains are used as they’re primarily used to track cryptocurrency transactions. But there are a lot of real world applications here as well. And to come to mind, the first is an example actually the example of Walmart. So Walmart uses a blockchain for quality control and its produce business. Effectively, that allows it to track, say, a mango, from the point at which it is received from a farmer to the point at which it is sold in one of their stores around the world. And if we think about the various fiascos with contaminated food over time, these issues often take months to resolve if you were using a blockchain, it could be done over the course of an afternoon. Another example in New York State, there’s something called the excelsior app. This is where you upload your vaccination status and they scan it when you try to go into restaurants or bars, sporting events, so on and so forth. The excelsior app is actually based on a blockchain.


00:10:01 – 00:15:04


And that’s where they’re aggregating all of the information on who’s been vaccinated, who’s been boosted so on and so forth. And so when you start to think about blockchains in that sense, you realize that they are a pretty tremendous way of not just storing information, but processing information and processing transaction as well. Now, there are public blockchains and there are private blockchains or permissioned blockchains is really the industry term. A private blockchain, the token that’s associated with that. It’s debatable, whether it’s going to have any value, private blockchains or things that corporations build for processing data internally, you think about a public blockchain like the Bitcoin blockchain or the Ethereum blockchain. Well, you have all these miners out there who are processing these transactions, right? And trying to validate these transactions. They need to be compensated in order for doing so or in response for doing so. And so what happens here is the tokens that are associated with those public blockchains begin to have value. You know, again, I’d go back to the example I used earlier to meet each blockchain is like its own country. And it has a unique currency associated with it. So if you want to go and do something that only a specific blockchain can actually do, then there’s value to that transaction being processed. There’s therefore value to the currency. And that’s how we really try to hone in on where the fundamental value of these currencies may actually may actually lie, which there’s a ton of volatility. And I know we’re going to get to that. But as we try to look through the noise, that’s kind of how we think about thinking about doing so. How long have blockchains existed? So blockchain technology has been around since the early 2000s. Bitcoin really hit the ground and I believe 2009. And that’s when people really began to hone in on this, but actually at JPMorgan we’ve been investing in and leveraging blockchains again, since before the financial crisis and it’s something that has grown exponentially over time. But is actually been around for 15 or 20 years at this point. So it’s just getting more attention now with its connection to crypto and is there a difference in the technology and the power of one blockchain over the other that would cause you to think that the currency or the coin connected with it is more attractive or less attractive or are they all fairly comparable to each other? And from a technology standpoint? So from a basic technology standpoint, they’re all pretty much similar, right. You basically have these miners who are trying to validate the transactions by solving a very complicated equation or puzzle right crypto and cryptography and cryptocurrency. That’s kind of the link there. So from a purely technological standpoint, they’re all pretty similar. I think where the differences begin to arise is in what the blockchains almost specialize in. So coming back to some of the names that I mentioned earlier, you know, Solana is a blockchain that primarily operates in the decentralized finance space, right? So the way that that blockchain is built really caters to DeFi specifically. You think about something like Cardano on the other hand. And that really is aiming to provide a more secure scalable and efficient experience relative to other blockchains. You think about something like Polkadot, which is really meant to allow for the cross blockchain transfer of different digital assets. And so you begin to think about these individual use cases. That’s where we start trying to derive what the underlying value may be. But from a purely technological standpoint, all of these things effectively operate in the same way. The biggest difference is that you have some blockchains and historically blockchains have relied on proof of work where 51% of the users on the network need to verify that the answer to this equation is the right answer in order for the transactions to be processed. You’re seeing a movement away of that towards something called proof of stake where transactions are allocated based on a user’s stake in the network, which is oftentimes dependent on the amount of coin that they hold. That’s a much more efficient environmentally friendly way of processing transactions, but that’s really the biggest difference that we see in the current environment. And I know we’re going to start with what blockchain is and then jump to what is what is crypto. But we’ve mentioned, or you’ve mentioned a few times so far now, kind of mining and validating and that’s probably a complicated concept. This all sounds complicated, but that’s probably a complicated concept for the individual investor. What is Bitcoin or crypto mining? For sure. So let’s say that you have tickets to a football game. And I want to buy those tickets from you. And I want to pay you for those tickets using Bitcoin just to keep it simple.


00:15:04 – 00:20:01


So the way that this all works is we start by broadcasting the transaction to the network of computers that are running the Bitcoin code. So David wants to buy patriots tickets from Sammy for X number of Bitcoin. What then happens is our transaction gets bundled up with other transactions and these miners then work to solve very complicated equations that effectively produce a unique string of digits and letters that is unique to that collection of transactions. Once they think they have the answer, again, this is where proof of work comes in. They need the rest of the network to agree. So it’s very democratic on and you need consensus in order for those transactions to be validated. And then once the transactions are validated once everybody’s in agreement that the answer is the answer that block gets chained onto the existing blockchain, the miner is rewarded with, in the case of Bitcoin, 6 and a quarter Bitcoin for every block that they mine. And then the whole process starts itself over again. And so back to what I said earlier, part of the reason why there is value in these cryptocurrencies are the market has decided that there’s value in these cryptocurrencies is because effectively the blockchain is providing a service and these people that are providing that service need to be compensated for what they’re for what they’re doing. And how long does that validation process take? And I forgot your example if I was buying tickets or selling them, but how long does the seller wait until they’ve received their validation and their currency? So the answer is that it depends. And it depends on how much activity there is on the network at any given point in time. Not only is there the reward of the minor receiving crypto for validating the transaction. But there are also a number of other fees that oftentimes get layered in there. To the overall to the overall process. But what I would say is that the transaction time does vary when the network is busy, it tends to take longer. And this is actually a perfect kind of way to circle back to my point earlier. These are very much assets and not necessarily currencies. These numbers are going to be precisely wrong, but Visa process is something like 4000 transactions per second and Bitcoin processes four. So there is scale here. It’s completely different. That said, it can become a self-fulfilling prophecy and the more people you get mining and verifying and participating arguably the more transactions that are able to be processed. But this is one of the things that has caught the attention of the regulators because the system can get kind of clogged up, if you will. When there is a lot of activity on the network. Understood. And so is your sense and maybe this is still too opaque or vague that people are using it as an investment or are they using it as a currency? So I think it’s a little bit of both. I do think that you have a group of individuals who like the idea of a decentralized network. An anonymous network. They like kind of all of the very secure network. They like all of the things. There are a lot of things I should say. They crypto brings to the table. That said, you do have people that are purely viewing these as investments and that’s particularly true. In the institutional investor community, you know, hedge funds will trade anything with volatility. And over the past ten years, Bitcoin has had an average annualized volatility of more than 250%. And so you just really have to take a directional view on these assets. If you’re a speculator or an investor and that has led an increasing number of players to come in, particularly from the hedge fund community. And not only trade the underlying digital tokens, but now we’re seeing more and more activity actually in the private equity and the venture capital world in terms of funding a lot of these companies that are building the underlying blockchains, which as we discussed earlier have had very different use cases depending on the way that they are depending on the way that they’re constructed. Yeah, and I’m glad you brought that up because I did want to touch on the value and the volatility. I think that obviously as you pointed out, and I think we’re defaulting a little bit to Bitcoin as just an easier example, but I think applies across the board. I did see something saying that, you know, it was 5 times as volatile as gold four times as volatile as the S&P 500. What gives any given coin it’s value and why has it been so volatile? So I think that this is where the thinking cap really needs to get put on. Because in the most fundamental sense, I mean, these are their commodities, right? Their prices are based on supply and demand.


00:20:01 – 00:25:00


A Bitcoin is worth what somebody will give you for it at a given point in time. And the way that we’ve started to think about this as we’ve seen more and more growth in blockchain and as a result of that growth in the number of digital tokens that are available for investment is can we tie what this blockchain is doing to some sort of income stream in the real economy because if you can tie these things to cash flow, now you can begin to value them very similar to the way that you would run in DCF analysis to value to value equities. And so there are more and more ways of coming up with an intrinsic value for these assets, particularly the ones that operate on blockchains, which are able to be tied to the real economy. I’ve seen some speculation as to what the long-term value of Bitcoin should be, kind of comparing it to gold, looking at the stock of Bitcoin versus the stock of gold, making a whole bunch of assumptions to me, that’s the ultimate hand waving exercise. I like it much more if I can tie it to a cash flow and then figure out what those cash flows are going to be worth in the future. Understood and that is kind of getting into the investment case or the difficulty of an investment case. That’s been the challenge so far, you know, I think we’ve chatted about this briefly. You can really invest unless you’re speculating, you can really invest in a couple of main ways and one is just do individual price discovery, figure out what a security should be worth and decide whether you have an attractive entry point or not. The other way to do it is if you’re going to take more of an asset allocation approach and try to forecast the long-term return of something, how correlated it will be to other investments that will be in your portfolio and what return expectation you could attach to it going forward. Both of those are still extremely difficult to do with crypto and digital assets. Yes, or no, I guess your thoughts on that and is it still kind of in that speculative realm because of that? So the answer to your question is yes. Sizing the position is next to impossible because as you noted, if you think about portfolio construction and mean variance optimization framework, basically what you need as inputs are an expected return, an expected correlation and an expected volatility. Very difficult to forecast things where the volatility is wildly unstable and as you said, multiple times that of the S&P, very difficult to forecast the correlation when the correlations are equally unstable over time. And again, you know, from a return perspective, I could come up with an expected return, but if the market decides that they don’t like Bitcoin, supply and demand are going to win out. Instead actually, as just kind of a thought exercise said, well, instead of trying to predict the future, let’s just use the past. And so we ran kind of an optimization analysis using look back windows and historical data. And what we found is that if you use the three year look back window versus a 5 year look back window versus a ten year look back window, you ended up with wildly different recommended allocations because the numbers have changed so drastically over all those periods of time. And so for that reason, I do think that it’s still somewhat speculative. We see people using it in portfolios. And again, we’re not saying that this is a bad thing. But to me, the kind of overarching principle, if you will, is that if you’re going to invest in these assets, you need to be okay with the value going to zero. Because there is a chance that some day everyone wakes up and they say, you know what? This just isn’t worth anything. I’m walking away. And if everybody walks away, well, you know, then the value again could theoretically fall to zero. Not our base case scenario, but if you can’t stomach the loss, the bottom line is that this is not the right asset class for you. No, and I think that makes a ton of sense and that’s why I feel really fortunate that you’re joining us today for this podcast because you’re taking a very thoughtful approach. There are crypto evangelists who no matter what they think, you know, you’ve got to be there, then there’s people brilliant people who are dead set against it will never touch it. And then there’s people in the middle who are trying to learn and keep an open mind, but not take on too much risk while they’re doing so. So that’s a very beneficial approach for our listeners. You talked a little bit about going to zero and you mentioned one reason. What are some of the other reasons that could hurt a specific cryptocurrency or digital asset or that category in general? So a couple of thoughts there. If everybody walks away, then the price goes all the way down to zero.


00:25:01 – 00:30:08


The other thing that you could potentially see are coins just become somewhat obsolete. So you think about the continuous development of blockchains. It’s like version one versus version two. If you get the new shiny object and it’s better than the one you used to have, well, maybe you walk away from that and again, if everybody walks away, then the value declines to zero. You know, I do think it’s important to recognize that liquidity has played a role in the price action we’ve seen, particularly over the past couple of years. And I’m not saying that quantitative tightening is coming. I’m not saying that the fed is going to move as aggressively as what the market is pricing. But what I will say is that I think policy is going to get less easy going forward. And you could very well see some of these more speculative digital assets come under pressure as monetary policy gradually begins to tighten here. And so we’ve really been looking at kind of a confluence of factors when it comes to what could push the value of these various assets down to zero. And it feels like it would be more idiosyncratic as opposed to macro in the sense of individual coins kind of falling by the wayside rather than the entire asset class imploding. At a given point in time. Got it. Understood, and that makes a lot of sense. You know, I’ve heard or R ay Dalio say that this is the modern day gold. Do you buy into that? Do you see the analogy or do you think it’s too simplistic? I think it’s a little bit too simplistic. You know, the first point I would make is that it’s not really correlated to gold. So tough to see how it can be the new gold. But I understand why people will draw this comparison. You know, limited supply, kind of a currency type instrument. I think that there are a lot of nuances and again, you know, we believe that the real value is in the blockchain. And so you begin to look at some of these other tokens and something like ether where the supply isn’t capped while now I’m struggling more with why t hat would be like digital gold. I sort of understand, again, the Bitcoin comparison. But I think it’s much more than that, you know, to me, this is another sleeve that has been created within the commodity complex more broadly. And I do believe, you know, pretty adamantly that over the course of the coming years, people are going to be talking about investing in crypto right alongside their conversations about investing in things like copper and other traditional commodities. That’s fascinating. In a recent blog post up on heritagefinancial.net, we noted that some money managers are tracking the price of Bitcoin as a way to gauge how speculative the market is, one of those kind of speculation indicators, are you seeing that and does that tell investors something in general about Bitcoin and crypto? So I do think I would replace speculation with sentiment. I think it tells you a lot about the tone of the market. And you look at what’s going on here over the course of the past couple of weeks, you know, stocks and bonds, both down to start the year. Speculative growth names down more than their value counterparts, Bitcoin finding its footing but still down significantly relative to where it stood closer to the end of last year. And so to me it kind of tells me about the tone of the market and the sentiment in the market. Rather than being a direct indicator of speculation. I think there are certain parts of the crypto complex. The ones the tokens that don’t really seem tied to blockchains that could create any real economic value. The more speculative parts of the crypto universe may give a sense of speculation overall, but I think if you’re looking at the price of Bitcoin or ether or some of the other ones that we’ve mentioned today, it’s going to tell you more about the way people are feeling when it comes to taking on risk in general. Than it is an indicator that the pot is boiling over and things are about to get really nasty. Got it. No, that makes a lot of sense. Is there anything else because I know I probably jumped around a little bit on you? Is there anything else that you wanted to share about crypto or the blockchain that we haven’t gotten to yet? I would just kind of encourage everybody, you know, go out and do your own research. You know, Sammy, you made the point that everybody’s got their own view and then some people are die hard believers and, you know, some people are like, no way, this is complete nonsense. There’s a lot of really good information out there. And I think what we all need to do is just improve our understanding of what’s actually going on because I can tell you that when I started my foray into the crypto world, I was much more skeptical than I am today and in the process of talking to people who work in the industry reading academic research on it, reading investment research on it.


00:30:08 – 00:34:19


I feel like I’ve begun to build an understanding of how this piece fits into the broader pie. And so my only ask of all of our listeners, all of your listeners, I should say, is that don’t dismiss it without doing your homework. If you go and you learn about it, you say, you know what? This is still kind of crazy. It’s not for me. That’s fine. You have an informed opinion. What drives me nuts are people that are very adamant in their view and there isn’t a whole lot of substance standing behind it. Yeah, I think that makes a lot of sense, and I love the way that you present that in terms of in terms of making an informed decision. And I think that that’s key, you shouldn’t invest in it because your experiencing fomo or you’re hearing about it at Thanksgiving or you know who’s making a killing on it. That to me is one of the worst reasons and probably a few start position for those reasons. It’s likely not going to work out because you’ll be rattled out of it with some volatility, which as we’ve talked about is definitely present in this investment type. So I think people should do their research and I think this podcast and the information that you share David gets them started on that. And so, you know, I thank you for sharing your insight. I know we can go on for a lot longer on this topic, but it’s been a great dialog thus far. And I definitely appreciate you sharing your insight with our audience. What’s one thing you want people to take away about crypto as it relates to their personal wealth? So the one thing I would want people to take away about crypto is that there is no way to get rich quick regardless of the asset class that we’re talking about. As you were just talking now, Sammy, something jumped into my mind, something that was said to me very early on in my career, which is the bulls get rich the bears get rich, but the pigs get slaughtered. And I think that that should really be the guiding light when it comes to investing in these crypto assets. You like them, express your view. You don’t like them, express your view. But if you start to get greedy, that’s probably going to be when you get hurt. meet your downfall. And so again, you know, basing any investment decision on fundamentals rather than on opinions. I think it’s the key to success, not just with respect to crypto, but with respect to investing, particularly over the course of the longer term. Great advice and along those lines, David, what’s the best piece of money advice you ever received? So the best piece of advice I’ve ever received was start early. The most powerful force in the finance universe is compounding. And if you can put your money to work sooner rather than later, you can get that money working for you. And that’s why I opened my daughter’s 529 account before she was even born. You know, now she’s three. We’ve got a couple of years ahead, but let time be on your side when it comes to investing because if you can be patient, you will enjoy more success, particularly in the long run. That’s great stuff. Awesome. Thank you very much, David for joining me today and thank you for sharing your insight. My pleasure. Thanks again for having me.

Thank you for listening to wealthy behavior. If you found the conversation useful, please consider leaving us a review wherever you listen to your podcasts and sharing this episode so those around you can live a rich life too. For more insights, subscribe to our weekly blog at heritagefinancial.net and follow heritage financial on Facebook, Twitter and LinkedIn. Check out my personal finance blog at the Bostonadviser.com and follow me on Twitter at Sam Azzouz.

This educational podcast is brought to you by heritage financial services LLC located in the greater Boston area. The views and opinions expressed in this podcast are that of the speaker, are subject to change and do not constitute investment advice or a recommendation regarding any specific product or security. There is no guarantee that any investment or strategy discussed will be successful or will achieve any particular level of results. Investing involves risks including the potential loss of principal.


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About Wealthy Behavior: Heritage Financial Services

Wealthy Behavior digs into the topics, strategies, and behaviors that are key to building and protecting personal wealth and living a rich life. We’re Boston Massachusetts-based wealth managers who have been helping busy, successful people pursue their financial goals for more than 25 years. Hosted by Sammy Azzouz, President of Heritage Financial, Wealthy Behavior digs into the topics, strategies, and behaviors that are key to building and protecting personal wealth and living a rich life.