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The SEC’s approval on Jan. 10 of 11 spot Bitcoin exchange-traded funds (ETFs) has been met with enthusiasm by cryptocurrency fans, marking an important milestone in Bitcoin’s quest to become accepted as a legitimate “alternative asset” in investment portfolios. BlackRock, Fidelity, Franklin Templeton and Invesco—all pillars of the Wall Street establishment—led both the creation and marketing of Bitcoin ETFs.
Bitcoin ETFs provide investors a pathway to participate in crypto without necessitating direct ownership of digital assets. Purchasing Bitcoin (or any other cryptocurrency) requires navigating a crypto exchange and digital wallet. You then have to pray the crypto exchange doesn’t get hacked (Mt. Gox, 2014), isn’t fraudulent (FTX, 2022) or doesn’t file for bankruptcy protection (Celsius Network, 2022), with the coincident risk that your Bitcoin “deposit” is transformed into a claim against the exchange’s bankruptcy estate, giving you the opportunity to stand in line with all the exchange’s other depositors/creditors in hopes of an uncertain payoff somewhere in the distant future.
By contrast, Bitcoin ETFs enable individual and institutional investors (like mutual funds, pension plans and endowments) to purchase/sell shares through their brokerage, like any other security. The ETF then purchases/sells Bitcoin on an exchange (primarily Coinbase—currently involved in a legal battle with the SEC, which has charged it with operating an unauthorized exchange), which also acts as “custodian” for the Bitcoin (partially insured by the issuer of the ETF). Because the ETF holds only Bitcoin, the price of the ETF should closely track the price of Bitcoin.
We reiterate our long-standing warning that confusing speculating with investing is hazardous to your wealth. Unfortunately, Wall Street has both an insatiable appetite for fees and the unmatched ability to spot a hot “trend” and develop products designed to appeal to speculators wanting to jump on board. Indeed, Warren Buffett said in his latest letter to shareholders of Berkshire Hathaway, “One fact of financial life should never be forgotten. Wall Street—to use the term in its figurative sense—would like its customers to make money, but what truly causes its denizens’ juices to flow is feverish activity. At such times, whatever foolishness can be marketed will be vigorously marketed—not by everyone but always by someone.”
Notably, financial services behemoth Vanguard views crypto as a speculation, so will not allow crypto-related products on its brokerage platform.
ETFs have exploded in popularity by offering the ability to gain exposure to a broad or very narrow sector of the market quickly and efficiently. The SPDR S&P 500 Trust (SPY) launched in January 1993 as the first ETF. The “Spider” was the first S&P 500 index fund whose shares both fluctuated in price with the underlying securities and traded on an exchange during the day. It’s no coincidence the Invesco QQQ ETF (QQQ), which tracks the NASDAQ 100 index of “cutting edge” technology stocks, was born at the height of the dot-com bubble in 1999 (which burst in 2000). As the “Official ETF of the NCAA,” basketball fans will soon be inundated with TV commercials touting the $250 billion QQQ.
Moving to the purely speculative end of the ETF spectrum, thanks to product-development wizards at issuers like Direxion and ProShares, you can place a magnified bet (leveraged ETFs) on an index or sector, either up or down (inverse ETFs). Fantastic!
We don’t know where the new Bitcoin ETFs fall on the investment/speculation spectrum. We’re not experts in Bitcoin, cryptocurrencies or the “decentralized finance” (DeFi) ecosystem. We don’t want to dismiss Bitcoin entirely but look at George Washington on a $1 bill. You can use it to buy something (i.e., it’s a “medium of exchange”). You can deposit it in a bank (i.e., it’s a “store of value”). Finally, it’s a “unit of account” (i.e., how businesses price their product, account for income and expenses, and keep track of how much they owe/are owed).
Bitcoin traded at around $7,000 at the beginning of 2020, peaked at $67,800 in November 2021 and plunged to $15,600 a year later (down 77%). It seems this type of extreme price volatility disqualifies Bitcoin (or any of the other cryptocurrencies) as a replacement for the dollar bill. No buyer/seller is going to use/accept Bitcoin if it can rise/fall 30% tomorrow (as it has in the past). In addition, price volatility makes Bitcoin a poor store of value and unit of account.
Originating in the wake of the global financial crisis of 2007-2009, Bitcoin garnered momentum from a worldwide community intent on establishing a new global currency, unencumbered by governmental oversight or manipulation. We find it hugely ironic that today’s excitement about Bitcoin revolves around its being placed in a standardized, highly regulated financial product “box” to make it an accepted member of the traditional, centralized financial services ecosystem.
The SEC reluctantly approved the Bitcoin ETFs, with Chair Gary Gensler warning the SEC was not approving or endorsing Bitcoin because it is “primarily a speculative, volatile asset that’s also used for illicit activity including ransomware, money laundering, sanction evasion and terrorist financing.” Further, “investors should remain cautious about the myriad risks associated with Bitcoin and products whose value is tied to crypto.”•
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Kim and Lee are chief operating/compliance officer and director of research, respectively, for Columbus-based investment adviser Kirr Marbach & Co. They can be reached at 812-376-9444 or mickey@kirrmar.com and roger@kirrmar.com.
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