Investors: Add cryptocurrency to your portfolio, but 'handle it with caution.'

Bitcoin and other cryptocurrencies are volatile and have been viewed as risky by skeptics within Wall Street ranks and veteran investors.

And yet, more are warming up to the notion of crypto as part of a diversified portfolio, given what’s being viewed as its technological staying power. Amy Arnott, a portfolio strategist for Morningstar, says cryptocurrencies can be a part of a diversified portfolio.

“Crypto is definitely becoming more established as a separate asset class and moving more into the investment mainstream,” she told Yahoo Finance’s All Markets Summit this week, as part of a crypto panel discussion. “It's definitely something that long-term investors should consider if they're more risk tolerant.”

However, Arnott recommended keeping crypto to a smaller allocation of an overall portfolio, noting that 1%-2% can go a long way. “I would definitely handle it with care, because the volatility has been so high. Even a very small percentage of cryptocurrency can really spike up your portfolio's risk profile,” Arnott added.

The global cryptocurrency market is now worth over $2.6 trillion and growing. Bitcoin is notoriously volatile, but in some instances has demonstrated a lower correlation with mainstream asset classes like stocks and bonds, and sold off less with other risk assets when markets drop.

If you're looking to add crypto exposure to your portfolio, you're probably better off buying it directly through a crypto exchange or platform.

Isaiah Jackson, the best-selling author of “Bitcoin & Black America,” says bitcoin is a long-term asset and will remain that way.

“If you want to be a part of it, you have to think long-term,” he told Yahoo Finance this week.

“In any new market you will have volatility. You're not going to get rich just because you entered the market. You do have to have patience. But if you invest long-term the volatility does not matter,” he added.

Arnott said investing in crypto can be thought of as investing in the Internet in the late 1990s. “I think you have a lot of the same kind of growth trajectories,” she said.

“Consider it a growth asset and really a play on the long-term shift toward digital money and the ongoing revolution in the financial technology landscape,” Arnott explained. “You're not directly investing in the underlying technology, but you are getting indirect exposure to it.”

The strategist pointed to developments in payment processing, smart contracts, blockchain, NFTs (non-fungible tokens) and gift cards as examples. In the payments space, cryptocurrency exchange Bakkt (BKKT) announced this week that it’s partnering with Mastercard (MA) to offer crypto debit and credit cards, making it easier for consumers to pay using cryptocurrencies.

The companies will also offer the ability to earn rewards in cryptocurrency through their card spending.

“We want to be able to provide the ability to be able to use cryptocurrency in an everyday transaction,” Bakkt CEO Gavin Michael told Yahoo Finance.

“The Mastercard partnership includes the ability for us to be able to deliver crypto rewards, another way to gain an asset holding in this space in a fairly easy way.”

ETFs vs exchanges

The ability to gain exposure to bitcoin has become easier after the Securities & Exchange Commission last week greenlighted the first bitcoin futures exchange-traded fund (ETF). But while that’s made it easier for investors to gain exposure, it may not necessarily be the best way to invest.

Arnott says the ETFs offer more transparency, and are easier to buy through an existing brokerage account — but they may not track the price of Bitcoin exactly, leading investors to miss out on the full gains of the underlying digital asset.

The ETFs are buying the front-month futures contract. As those contracts roll over, funds may have to purchase the futures at a higher price. Arnott estimates gains could be off 5% or 10% each year. That makes purchasing the actual cryptocurrencies through crypto exchanges the better bet.

“I think we will eventually see a crypto ETF that tracks the spot price,” says Arnott. “But at this point, if you're looking to add crypto exposure to your portfolio, you're probably better off buying it directly through a crypto exchange or platform.”

Bakkt has allowed trading in bitcoin futures before ETFs were available. Michael also believes ETFs will eventually be allowed to invest in the actual cryptocurrency, instead of just the futures contracts. He says he thinks the bitcoin futures ETFs will actually help smooth out volatility over time, since it will allow more investors to participate.

“We expect evolution in this space to move away from cash-settled prices through the futures contracts into physically delivered contracts, as has been the norm for other ETFs that have tracked based on a commodity,” he said.