On January 10, the Securities and Exchange Commission took a major step by approving a way for investors to buy and sell Bitcoin like stocks without going through a specialized cryptocurrency exchange. The SEC has approved applications for 11 new exchange-traded funds that can hold Bitcoin directly and buy and sell it in brokerage accounts, including IRAs.
While proponents have welcomed the decision and are predicting a flood of capital inflows that could send Bitcoin prices skyrocketing, many advisors are warning that individuals investing in the little-understood and highly speculative asset class will Investors are urged to exercise caution as there are significant risks. Investors always warn us that “buyer or seller beware,” but this lesson is rarely applied so well.
The SEC's action marks the culmination of a decade-long campaign to bring digital currencies mainstream through publicly traded securities. In 2013, twin brothers and cryptocurrency promoters Cameron and Tyler Winkelboss filed the first application for a Bitcoin exchange-traded fund, structurally similar to existing gold funds. The value of an exchange-traded fund is determined by the real-time or “spot” price of Bitcoin, minus fees and expenses. After numerous iterations, the SEC rejected the application in 2017, citing an insufficiently mature market and an undeveloped regulatory environment.
Also in 2013, Grayscale Investments established a private trust to hold Bitcoin and converted it into an open-end fund in 2020, making it the first successful cryptocurrency fund to go public in the United States.
Meanwhile, in 2021, the SEC approved a Bitcoin exchange-traded fund from investment firm ProShares that uses futures contracts without directly holding cryptocurrencies. Futures are contracts to buy or sell a commodity at a specific future price and are widely used in agricultural, energy, materials, and financial markets.
In the same year as the ProShares fund's launch, Grayscale filed an application to convert its existing open-end fund to a spot exchange-traded fund structure, which was denied by the SEC the following year. Sensing the time was right, Grayscale filed suit and ultimately won in August 2023, but the SEC chose not to appeal. The result was a negative vote, making Grayscale one of 11 investment firms, including large corporations, to be given the green light to offer a spot Bitcoin exchange-traded fund.
The launch of a Bitcoin exchange-traded fund and the hype surrounding it is particularly ironic in that it further erodes two of the digital currency's fundamental rationales in the minds of its supporters. .
Bitcoin and its cousins were promoted as a more convenient and efficient alternative to sovereign currencies. In fact, other than hiding illegal activities, the myth of Bitcoin as an alternative to dollars to buy pizza was already fading due to its extreme volatility and high cost. Now, if you think about why you would want to hold US dollars in an exchange-traded fund that doesn't charge interest or fees, you'll see why the idea of a fund is incompatible with existing exchange methods.
Interestingly, some of the most ardent Bitcoin evangelists dislike the concept of Bitcoin funds. Because it goes completely against their vision of a decentralized medium of exchange outside the traditional financial system, exempt from central bank control and independent of Wall Street. BlackRock, Fidelity, and Invesco are among the giants backing new exchange-traded funds.
Another rationale for adopting cryptocurrencies was the promise of a secure store of value, often likened to digital gold. That has not been the case historically for cryptocurrencies, which have fluctuated widely in value, are more closely correlated with risky tech stocks than gold, and have fallen particularly hard during crises. Placing Bitcoin (and soon the second-largest cryptocurrency, known as Ether) in an easily traded exchange-traded fund is likely to accentuate rather than dampen its volatility. In fact, for speculators, the potential for wild price movements is what makes them so attractive. As the Wall Street Journal puts it, Bitcoin “isn't just a store of value; it's also a store of volatility.”
Part of the enthusiasm for crypto funds is the idea that now that digital assets can be traded as easily as the S&P 500 index, financial advisors will feel more comfortable incorporating them into their clients' portfolios. It's rooted. But wealth managers, especially financial advisors who act as fiduciaries, such as registered investment advisors, should enter this space with extreme caution.
Fiduciary advisors have a duty to act in the best interests of their clients. Its obligations include the obligation to conduct thorough due diligence examining Bitcoin's market dynamics, correlation with other assets, valuation methods, and underlying technology. At present, few advisors can clearly explain how Bitcoin is created, much less provide a convincing methodology for estimating its intrinsic value, or whether it actually has any value. Very few people can explain it. Additionally, the SEC warned that digital asset recommendations by advisors will be a top priority in its 2024 review program. There is no doubt that securities litigators are looking forward to the next crash.
Bitcoin's price had soared 60% in the past few months as the SEC's decision became more likely, but it fell nearly 9% in the two days after the incident, a classic “buy the rumor, sell the news” It became a case. Investors would be wise to approach such speculative funds with an extremely skeptical attitude. All tulip bulbs and Beanie Babies have been digitized.
Chris Hopkins is a Chartered Financial Analyst and co-founder of Apogee Wealth Advisors.