Crypto and Bitcoin ETF Frequently Asked Questions
Summary
Here are answers to some common questions now that several Bitcoin ETFs have received regulatory approval.
After the recent regulatory approval of the first exchange-traded funds (ETFs) that hold Bitcoin, we’re getting many questions about whether digital assets make sense as part of an investor’s portfolio and financial plan. Thousands of cryptocurrencies have been trading on unregulated exchanges for several years, and regulators have already approved a few other ETFs linked to Bitcoin futures. But these SEC-approved spot Bitcoin ETFs listed on established, regulated exchanges could present an opportunity for investors to gain exposure to Bitcoin without holding actual Bitcoin. Crypto is still crypto, however. These assets are very different from traditional investments such as stocks and bonds, and investors should be fully aware of the unique risks they pose. Here are answers to some of the most frequently asked questions we’ve received now that Bitcoin ETFs have hit the broader investment landscape.
What’s the difference between Bitcoin, blockchain, and digital assets?
Digital assets include cryptocurrencies, stable coins, non-fungible tokens (NFTs), and almost anything that’s based on blockchain technology. Blockchain is a database of transactions. Lists of transactions are called blocks, and the transactions are linked in a specific order called a chain. The typical blockchain is also distributed and shared by many users or nodes in a network. Today, blockchain is used in a wide variety of settings, including banking, recordkeeping, voting systems, supply-chain management, cross-border payments, and real estate transactions.
Digital assets that are issued using blockchain and cryptography are called crypto assets. A digital ledger on a peer-to-peer network allows users to validate or verify the transactions posted to the ledger. The validation process records each transaction and limits the generation of new units.
Bitcoin is currently the most popular cryptocurrency. A still-unknown person (or persons) using the pseudonym Satoshi Nakamoto created Bitcoin in 2009. It was designed to be a decentralized currency for peer-to-peer transactions that would be recorded in a public ledger. This allowed transactions to be completed, verified, and recorded without a financial intermediary or middleperson.
What are the benefits of decentralization?
Arguably, security is one of the biggest benefits of Bitcoin decentralization. Because changes to the blockchain and the recording of transactions must be validated across a network of users, some view it as a more secure model. But centralization also has its benefits. A financial intermediary, acting as an independent third party, is often essential to establishing trust in a transaction. For instance, when an escrow company holds funds during a real estate transaction, it provides peace of mind to both the buyer and seller. I’m not sure that a theoretically secure network of anonymous users validating transactions can do the same.
Is Bitcoin secure?
A common argument in favor of Bitcoin investing is that blockchain is very secure, which may be true. Nevertheless, there have been some high-profile hacks since Bitcoin was created. According to data released in December 2023, North Korean hackers stole roughly $3 billion in cryptocurrency over the previous six years. More broadly, there have been more than 800 reported thefts of Bitcoin since July 2011, totaling $50 billion in value, or 6% of all Bitcoin in existence. The problem often isn’t blockchain but rather a third-party application, such as a digital wallet, that’s used to manage Bitcoin holdings. Even so, it’s difficult to fathom investing in anything that has such a high rate of loss due to theft or fraud.
When a Bitcoin owner is the victim of fraud, they often have little recourse. Unlike many traditional assets, there’s no insurance for Bitcoin holdings. For money in a bank, the Federal Deposit Insurance Corporation (FDIC) protects up to $250,000 per account per bank per ownership category. Many of the large brokerage firms and custodians (those that house assets) have insurance to protect investment accounts and retirement plans. But if a crypto broker or exchange goes under, there are no similar protections in place to help a consumer get their money back.
Is Bitcoin an alternative to currency such as the U.S. dollar?
In economics, an asset must meet many requirements to be considered a currency. The most obvious is being a medium of exchange—in other words, usable for settling transactions. Bitcoin increasingly meets this requirement, as more and more goods and services can be paid for today using Bitcoin. But another requirement of a currency is that it must function as a store of value. This does not mean the currency must maintain all of its value over time. For example, the U.S. dollar devalues due to inflation—as a result, $1 today buys fewer goods and services than it did decades ago. The rate of inflation has been mostly steady during the last 30 years, averaging 2.5% annually.1 Bitcoin, however, has been much more volatile, and investors have experienced declines in value of as much as 70%. It’s difficult to make a case that an asset is a store of value when it has seen such dramatic fluctuations.
There are costs to consider, too. Bitcoin and other cryptocurrencies are often subject to significant transaction fees, with some platforms charging 3% or more to exchange Bitcoin for U.S. dollars and vice versa. In addition, when a U.S. taxpayer converts a cryptocurrency holding to U.S. dollars, they’re subject to capital gains tax, which can be significant depending on their tax situation.
Should I invest in Bitcoin?
As part of an investment portfolio, Bitcoin requires a rationale. How large should the position be? If you view all of Bitcoin like an individual stock, it would have roughly the same market value as Tesla. Therefore, an investor could perhaps justify a 1.5% allocation in a U.S.-only portfolio, or a 0.75% allocation in a global portfolio. The bigger challenge in formulating an investment rationale is deciding what a fair price is for one bitcoin (or any other cryptocurrency). Is it the current value of more than $50,000? Or was it a year ago when the price was $25,000? There’s no way to determine the value based on fundamental analyses because there are no details about revenue and earnings available in quarterly reports. With Bitcoin, there’s not even a management team to talk with.
Mercer Advisors is a fiduciary that’s required to put clients’ interests first while serving as trusted guardians of their wealth and financial plans. This responsibility demands that our investment recommendations meet a high standard. Bitcoin does not satisfy even the basic needs for sound investment rationale and ironclad ownership that can be defended in court. Therefore, it does not meet our standard for suitable investing.
For more information about cryptocurrency, listen to this recent Market Perspectives podcast.
1Bloomberg data.
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