The Securities and Exchange Commission took a big step on January 10, approving a vehicle that allows investors to buy and sell bitcoin just like stocks rather than through a specialized cryptocurrency exchange. The SEC granted applications for 11 new exchange traded funds or ETFs that directly hold bitcoin and can be purchased or sold in brokerage accounts, including IRAs.
Boosters hailed the decision, predicting a deluge of capital inflows that could send the price of bitcoin soaring, while many advisors urge caution due to the substantial risks assumed by individual investors plowing into a little-understood and highly speculative asset class. Caveat emptor or buyer beware should always be the investor’s creed, but seldom has this precept applied more aptly.
The SEC action marks the culmination of a decade-long campaign to bring digital currencies into the mainstream through exchange traded securities. In 2013, twin brothers and cryptocurrency promoters Cameron and Tyler Winkelvoss filed the first application for a bitcoin ETF, structurally similar to existing gold funds. The value of the ETF would be determined by the real-time or “spot” price of bitcoin, less fees and expenses. After numerous iterations, the SEC rejected the application in 2017 on the grounds that the market was not sufficiently mature and the regulatory environment was underdeveloped.
Also in 2013, Greyscale Investments created a private trust to hold bitcoin, which it converted into an open-end fund in 2020, the first successful US public offering of a crypto fund.
Meanwhile, the SEC approved a bitcoin ETF from investment company ProShares in 2021 that did not hold the cryptocurrency directly but utilized futures contracts. Futures are agreements to buy or sell a commodity at a specific future date price and are widely employed in agricultural commodities, energy, materials, and financial markets.
The same year the ProShares fund launched, Greyscale filed an application to convert its existing open-end fund into a spot ETF structure, which was rejected by the SEC the following year. Sensing the time was right, Greyscale filed suit and ultimately prevailed in August of 2023, a verdict which the SEC chose not to appeal. The writing was on the wall, and Greyscale became one of the 11 investment firms, including some of the biggest players, that were greenlighted to offer spot bitcoin ETFs.
The launch of bitcoin ETFs and the hype surrounding them is particularly ironic in that it further erodes two of the foundational rationales for digital currencies in the minds of their proponents.
Bitcoin and its ilk were touted as alternatives to sovereign currencies as a more convenient and efficient method of exchange. If fact, other than for concealing illicit activity, the myth of bitcoin as a dollar substitute for buying a pizza was fading already due to its extreme volatility and high costs. Now ponder why one might want to hold their US Dollars in an ETF that pays no interest and charges fees, and you can see why the idea of a fund is incompatible with a ready method of exchange.
Interestingly, some of the most zealous bitcoin evangelists abhor the notion of a bitcoin fund, as it runs completely counter to their vision of a decentralized means of exchange outside of the traditional financial system, exempt from central bank control, and independent of Wall Street. Blackrock, Fidelity, and Invesco are among the behemoths backing the new ETFs.
Another rationale for embracing cryptocurrencies was the promise of a safe haven store of value, often analogized as digital gold. The historical behavior of crypto has proven to be anything but, swinging wildly in value and correlated much more closely with riskier tech stocks than with gold, falling especially hard during times of crisis. Putting bitcoin (and soon the number two cryptocurrency called ether) into an ETF that’s easier to trade is likely to accentuate not attenuate its volatility. In fact, the prospect of sharp price movements is exactly the attraction for speculators. As the Wall Street Journal put it, “far from being a store of value, bitcoin’s been a store of volatility.”
Some of the enthusiasm for crypto funds is rooted in a belief that financial advisors will feel more comfortable including digital assets in their clients’ portfolios now that they can be traded as easily as an S&P 500 index. But money managers, especially financial advisors acting as fiduciaries like Registered Investment Advisors, should enter the arena with extreme caution.
Fiduciary advisors have a duty to act in the best interest of their clients. That duty includes an obligation to conduct thorough due diligence, examining market dynamics of bitcoin, its correlation with other assets, methods of valuation, and the underlying technology. At this point, few advisors can articulate just how bitcoins are created, much less a compelling methodology for estimating their intrinsic value, or if indeed they have any. Furthermore, the SEC has warned that advisors’ recommendation of digital assets will be a top priority in its 2024 examination program. Securities litigators are no doubt licking their chops in anticipation of the next crash.
The price of bitcoin surged 60% over the past few months as the SEC’s decision appeared increasingly likely but dropped by nearly 9% in the 2 days after the event, a classic case of “buy the rumor sell the news.” Investors would be wise to approach these speculative funds with a high degree of skepticism. Tulip bulbs and Beanie Babies are all digital now.