Bitcoin ETFs: What they are and what we think

The risks and potential of cryptocurrency.

Article published: April 03, 2024

 

In this article:

  • Spot bitcoin exchange-traded funds received a lot of attention following their SEC approval.
  • Bitcoin’s value is extremely volatile and as an investment, it should be considered speculative.
  • You don’t need to invest directly in cryptocurrency to have exposure to emerging technologies and the digital asset space.
  • We believe the most important implication of this new asset class is the development of blockchain technology.

 


In early 2024, the SEC approved spot bitcoin exchange-traded funds for the first time. Within three weeks, amid a blitz of media attention, more than $10 billion poured into the 11 approved ETFs.

Bitcoin’s value is notoriously volatile – one particularly rough day, it dropped more than 30%. The losses can extend much longer than one day, too. Between April and June of 2022, the price of bitcoin fell more than 55%.

However, bitcoin, cryptocurrency and other digital assets continue to gain attention as alternative investments. We’re here to help you understand the excitement around spot bitcoin ETFs and our stance on owning them.

Just keep in mind that investments in cryptocurrency, including bitcoin securities, can be exceptionally volatile and speculative, and the risk of loss remains significant.

 

What’s bitcoin?

Bitcoin is the most common cryptocurrency, also known as digital currency or virtual currency. Like other digital assets, it’s created and stored using a decentralized system called a blockchain, where records of all transactions are tracked.

Bitcoin, digital assets and blockchain technology can get very complex quickly. But bitcoin’s gotten a lot of attention because of how quickly its value has risen. From its creation 15 years ago (when it was worth nothing), the value of one bitcoin has reached nearly $70,000 at times. So rather than using it to pay for goods and services – its original intended function – many people have purchased bitcoin as an investment.

 

What’s a spot ETF?

With a spot ETF, the sponsor of the ETF (for example, Fidelity or iShares) buys a commodity or currency (in this case, bitcoin) and then sells shares of the portfolio to investors. The ETF owns the bitcoin; you own part of the ETF.

Investing in a spot ETF is a way to gain direct exposure to an asset without having to actually buy it and store it yourself, which can get complicated. (Most people would rather own a spot gold ETF than keep bars of gold in their basement!)

Before 2024, all bitcoin ETFs were strategy ETFs, which don’t actually own bitcoin. They may own bitcoin futures, or companies involved in the creation of new bitcoin (called mining). While you can expect the share prices of strategy ETFs to generally rise and fall based on the overall fortunes of bitcoin, they don’t track it directly and can deviate substantially. This can make spot ETFs a better match for bitcoin’s price changes.

 

How does someone buy bitcoin?

Before the approval and launch of spot bitcoin ETFs, you’d have to buy bitcoin via a cryptocurrency exchange and hold it in a virtual wallet.

Spot bitcoin ETFs have gotten so much attention because they give you an alternate way to own bitcoin via fractional ownership of the fund. Per its objective, the ETF’s share price is intended to track the movements of bitcoin itself (although there will be fees charged by the fund). You can’t use a bitcoin ETF for payment the way you could if you held bitcoin directly in a virtual wallet, but you can have exposure to the same value increases and declines.

Spot bitcoin ETFs can provide other potential benefits over direct ownership. You don’t need a virtual wallet, the ETF will generate tax forms (potentially making reporting easier), you may be better protected from fraud since ETFs are more tightly regulated than cryptocurrency exchanges and expense ratios for ETFs may be cheaper than paying fees on an exchange.

 

Since 2020, changes in bitcoin’s value have been positively correlated with those of overall stock prices, potentially indicating that any diversification benefits may be reduced over time.

 

 

What are the risks of investing in bitcoin?

As noted above, there’s a substantial risk of loss when investing in bitcoin and other digital assets. Any investment should be considered speculative, meaning you should be prepared to lose it completely. Bitcoin’s value depends on what people are willing to pay for it – there’s nothing else behind it. In contrast, traditional assets like bonds and stocks have value because they either produce cash flows like interest or dividends, or they are based on future profits.

Because of that, bitcoin prices are also extremely volatile, having experienced a number of boom-and-bust cycles over the last 15 years.

Bitcoin can be subject to the uncertain tax and regulatory environment that comes with a new type of investment. For example, investments in bitcoin have not previously been subject to the wash sale rule (which comes into play during tax-loss harvesting) because they’re not considered securities. However, because spot ETFs are registered with the SEC, the wash sale rule could apply to them.

Some bitcoin ETFs have an additional risk as well; eight out of the 11 ETFs that were approved by the SEC in January hold their bitcoin at the same custodian – Coinbase. If there were to be an event like a cyberattack directed at Coinbase, the security of all these assets could be at risk.

 

Which investors are a good match for bitcoin?

We believe that anyone who invests in Bitcoin or other digital assets should:

  • Have an extremely high risk tolerance and be willing to lose the investment.
  • Have a high net worth and be able to afford losing the investment – you shouldn’t invest money that you need to fund an important goal like retirement.
  • Have tax-advantaged accounts to hold the investment or be willing to potentially pay higher or more unpredictable taxes.

Remember that you don’t have to invest in cryptocurrency to get the potential benefits of this new asset class. Virtually all our clients have some exposure to the digital asset space because:

  • Blockchain technology has numerous potential applications and is likely to impact many of the companies we hold in our portfolios and those you interact with in your daily life. The wider adoption of digital currency will also eventually have implications across the investable universe.
  • Most client portfolios incorporate an allocation to companies involved in emerging or transformative technologies – which can include the cryptocurrency industry but also companies like Tesla, Nvidia, Oracle or Microsoft, for example. In fact, direct and indirect exposure to digital assets in our portfolios can be as much as 10%.

We believe the greatest benefit of this new asset class will be the long-term exponential development of blockchain technology, not the short-term speculation of digital assets.

 

 

Does Edelman Financial Engines offer the option of investing in cryptocurrency?

Direct investment in cryptocurrency isn’t currently part of our standard portfolios. That said, we constantly evaluate the universe of investment options to identify those that may add value for our clients, and we incorporate new types of investments when we believe the diversification benefits could outweigh potential risks.

If you’re interested in having direct exposure to cryptocurrency, talk to your planner so we can review your personal situation and help you weigh the significant risks and potential benefits.

 

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This information is not intended as and does not constitute an offer to sell or solicit any person to purchase securities. Investment decisions should not be made based on this information. Investors should carefully consider the investment objectives, risks, charges and expenses of any investment prior to investing.

 

Investments involving crypto or digital assets, including bitcoin securities, can be exceptionally volatile and speculative and the risk of loss for investors remains significant.



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