Our opinion about cryptocurrency hasn’t changed despite the recent regulatory approval of Bitcoin ETFs.
This asset class is still in its infancy. Plenty of risk, volatility, and regulatory uncertainty remains.
If still interested, understand that crypto is extremely high risk. Don’t allocate more than 5% of your portfolio to this asset class.
Earlier this month, the U.S. Securities and Exchange Commission (SEC) approved 11 Bitcoin ETFs for retail investors. As expected, the long-awaited decision led to increased institutional and retail investor participation in the cryptocurrency market. Consequently, we’ve received several inquiries from clients about allocating a portion of their portfolios to this alternative asset class. More on that in a minute.
JP Morgan and Blackrock are among the institutions now offering Bitcoin ETFs to account holders. Rather than setting up a complex account on a crypto exchange, retail investors can now purchase Bitcoin in ETF form in their brokerage accounts. It’s just like buying mutual funds, ETFs, or stocks. And expense ratios for Bitcoin ETFs are very low.
What Are Bitcoin ETFs?
Bitcoin ETFs are just like any other exchange-traded fund, except they directly track the price of Bitcoin, not stocks, bonds, or a real estate portfolio. This is a big step up from previous Bitcoin ETFs which just tracked Bitcoin futures contracts.
Benefits Of Bitcoin ETFs
Accessibility. Bitcoin ETFs are very easily accessible. So, any investor with a retail account or institutional account can type in one of the 11 ticker symbols and purchase it just like they would any other ETF, and there are no trade fees with certain custodians. Again, since you don’t have to set up a complex account on an anonymous cryptocurrency exchange, this makes it much easier to gain some exposure to the crypto sector.
Diversification. Bitcoin ETFs are technically an alternative asset class, so they provide diversification for investors. Cryptocurrency, including Bitcoin, doesn’t track (i.e., correlate to) the stock or bond markets so it can theoretically be a hedge when traditional asset classes are underperforming. Again, the keyword is “theoretical” since it so far hasn’t protected investors' downside during recent recessions or bear markets in stocks and bonds.
Regulatory oversight. Bitcoin ETFs are now subject to the regulatory standards that traditional asset classes face. This provides a layer of security and legitimacy that has long been lacking from the crypto exchanges. One of my friends – a sophisticated investor – had his Coinbase digital wallet hacked and subsequently, $50,000 worth of cryptocurrency was stolen from his account. He’s hired a lawyer and is still trying to recover the money. Owning Bitcoin in an ETF may reduce this threat.
Risks Of Bitcoin ETFs
Volatility. As with all crypto, Bitcoin is a very volatile asset class with significant fluctuations. See year-over-year returns since 2018 below. To put this into context, 2022 was one of the worst years on record for U.S. stocks and bonds combined and those returns were approximately -20% and -16% respectively – only one-third as disappointing as Bitcoin’s. So much for hedging.
Regulatory and tax uncertainty. The crypto market is still in its infancy. Future government regulations could impact its performance and even its legality. As the government gets closer to launching its central bank digital currencies, it may not want Bitcoin to interfere as a black-market tool. The government could decide to prevent other cryptocurrencies from being used in domestic commerce, or it could heavily tax Bitcoin to the point that no one wants it. Currently, gains and losses on Bitcoin investments are taxed at the same short-term and long-term rates that your other investments are taxed.
Stability and security. ETFs will help mitigate cyber threats and other risks associated with holding directly (as my friend learned the hard way). But if something happens to the Bitcoin world at large, Bitcoin ETFs could be heavily impacted.
Is A Bitcoin ETF Right For Me?
When evaluating client portfolios and considering new asset classes for diversification purposes, we need to make sure those assets align with a client’s financial goals, risk tolerance, and time horizon. Cryptocurrency doesn’t check any of these boxes. Sure, Bitcoin and other alternatives have the potential for higher returns, but there's also the potential for significant losses.
If someone wants to add a Bitcoin ETF to their portfolio on their own, we just recommend that they allocate no more than 5% of their total portfolio to the asset class, understanding its volatility risks. For now, we put Bitcoin in the same category as gambling, speculation, or taking a stake in a movie or thoroughbred horse; it’s not investing.
Like traditional alternatives such as gold or real estate, Bitcoin has little correlation to the stock and bond market. That can be good during volatile times, but gold and real estate are still impacted by the economy, interest rates, and supply and demand. Their value has some basis in reality. Bitcoin is not based on reality. Bitcoin proponents call it a currency, but it doesn’t fulfill the fundamental requirements of a currency -- utility and stability. For those reasons, it's based on the overall feeling of the crypto investor market, which is pure speculation, like gambling. Even in unstable third-world countries, you would never see the currency of a country, go through the extreme ups and downs that Bitcoin has. And for those reasons, there's nothing to stop it from going to zero. And there's also nothing that would stop it from going to a million; just like the jackpot on a slot machine.
Granted, the blockchain technology behind Bitcoin is very good, but the value of the coins themselves is not based on anything other than what the next person is willing to pay for them. The price doesn’t go up or down because of any underlying reason based on economic conditions or a company’s prospects. So, at best, Bitcoin is still a work in progress and best suited for those with a high tolerance for risk and plenty of disposable income to absorb losses.
People look at the recent SEC ruling as giving legitimacy to Bitcoin. But, as with other speculative investments, legitimacy does not guarantee long-term growth.
If I haven't convinced you otherwise, go ahead and experiment with it for fun if you have a high-risk tolerance and can afford to lose your entire investment. Just don’t include it in your financial plan, retirement plan, or college savings plan. While still in infancy, bitcoin is risky and volatile. If you or someone close to you is interested in adding Bitcoin ETFs to your portfolio and creating a pragmatic approach to cryptocurrencies, reach out any time. I’m happy to assist.
DAN SATZ MS, CFP® is a Wealth Manager at Novi Wealth