Should You Own A Bitcoin ETF?

By October 2019, the Securities and Exchange Commission is expected to decide whether to approve two bitcoin ETF applications.

Filed by Bitwise Asset Management and VanEck, these ETFs would give investors a simpler way to gain exposure to bitcoin cryptocurrency. Approval doesn’t mean immediate launch—that could take time. But if approved and launched, should you invest in it?

Background

I first wrote about Bitcoin nearly two years ago. Though I expected to slam it, I walked away with far more respect for this cryptocurrency than anticipated. Why? The blockchain technology behind bitcoin drastically lowers transaction costs by disintermediating traditional financial institutions.

For example, when buying something from Amazon, the largest retailer on the planet, my credit card gives me 2% cash back, so I assume Amazon is paying more than this amount to the credit card company. By comparison, a bitcoin transaction would cost less than a dime.

What’s New?

Last year, the SEC rejected a bitcoin ETF application, filed by the Winklevoss twins of Facebook fame. At the time, the SEC said the proposed ETF had not met the commission’s requirements to prevent fraudulent and manipulative acts and practices.

But the SEC also stated that its rejection did not hinge on whether cryptocurrencies or blockchain technology have value as an innovation or investment.

I wanted to learn more, so I spoke to Matt Hougan, who is global head of research at Bitwise Asset Management

Cracking The SEC Nut

Hougan says that Bitwise believes it has solved the problems noted by the SEC in the Winklevoss rejection, in part, by using a regulated, insured, third-party custodian to store its bitcoin.

I asked Hougan why not just buy bitcoin through an exchange rather than using the ETF wrapper with an ongoing expense ratio? Hougan responded that there were several advantages, including:

• Custodial safety (if you lose your bitcoin private key bought directly, the bitcoin is forever lost)
• Ease of trading execution and far lower transaction fees than on the retail market
• Automated tax reporting
• It’s far easier, and can be used by financial advisors using traditional custodians

Hougan did not disclose a target expense ratio for the proposed ETF, but says he hopes it would be equal to or lower than its current non-ETF offerings, which are 1.5% annually for less than $1 million invested, and 1.0% for more than $1 million.

Should Bitcoin Be Part Of Your Portfolio?

Bitcoin is interesting, and also full of risk. From a behavioral perspective, people chase performance, particularly when there is volatility. And bitcoin volatility makes the stock market look boring.

Consider that I study and teach behavioral finance, yet I was fascinated by my own greed instincts after buying a little bitcoin. I wrote about that experience on “my brain on bitcoin.”

Cautionary tales aside, Bitwise’s white paper on the role of crypto in portfolios offer some interesting insights, and it says cryptos should not be more than 2% of one’s portfolio. Remember: Past performance is not indicative of future performance.

Hougan told me his views on bitcoin:

• There’s a good likelihood it will emerge as a significant nonsovereign digital store of value, akin to or in rivalry with gold 
• There’s a small likelihood (like a cheap, out-of-the-money call option) that it becomes the transactional backbone for Finance 2.0
• There’s a low or zero likelihood that it's used as a currency to buy things like coffee or lunch

I tend to agree. Like most out-of-the-money call options on stocks, there is a strong probability bitcoin will be worthless a decade from now. But there is also a significant possibility of huge returns.

If you are going to own a little, think very long term—as in a decade or more. Consider selling some in an up market to maintain a position of no more than 1% of your portfolio.

Be very cautious about rebalancing and buying more in a down market, because if bitcoin becomes worthless, you don’t want to keep sinking more money into it.

Allan Roth is the founder of Wealth Logic LLC, an hourly based financial planning firm. He has been a nonpaid panelist at one of NGPF's conferences for high-school teachers, but is not part of its organization. He is required by law to note that his columns are not meant as specific investment advice. Roth also writes for the Wall Street Journal, AARP and Financial Planning magazine. You can reach him at [email protected], or follow him on Twitter at Allan Roth (@Dull_Investing) · Twitter.