Does Bitcoin Belong in Your Portfolio?

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While they are not well known to most investors and currently account for a minuscule share of the $24 trillion U.S. retirement and pension fund asset market, Bitcoins may be playing a larger role in your retirement future.

That’s because Bitcoins are considered one of those rare inventions that some experts believe can fundamentally change the ways we live and do business. 

Bitcoin is considered a transformational invention because it has two purposes: as a digital currency and as open-source software that can be used to facilitate financial operations and transaction processing.

In each of these roles, Bitcoin fans don’t hesitate to use superlatives. For example, “In an increasingly electronic financial system, digital currency (e.g. Bitcoin) offers investors an alternative: a scarce, global, apolitical, digital gold.”

As a digital currency, Bitcoin can be managed electronically from anywhere in the world. It also is becoming more widely accepted by banks and merchants.  In its other form as open-source software, the Bitcoin technology platform is being used by institutional traders and software developers to transform the operational and transactional sides of the financial industry. This is happening at a rapid pace and that should accelerate more changes, while also lowering costs.

All this should spell good news for investors, consumers, and anyone who does financial transactions.

Yet while institutional market users hail Bitcoin as the driving force capable of changing financial markets, average investors and most consumers are still scratching their heads over its importance. Other investors may have been attracted to Bitcoin publicity after its wild roller-coaster ride in the markets.

Many wonder about the causes of this volatility and why Bitcoin should mean anything to an average investor who wants to use it as an alternative investment in their retirement account?

The Bitcoin Basics

These are all good questions.  But they all have good answers.

First, individuals should know the basics about Bitcoins because it can make it easier to pay bills and transfer money across the city or to another nation.  It can also be done faster, cheaper anonymously, and also free of charge. Introduced in 2013, Bitcoin is a type of digital currency, printed in a fixed quantity: Only 21 million Bitcoins will ever be issued on a declining scale that will end in 2140. This currency is the first in the world that is created and managed electronically.

This means there are no banks or middlemen needed to handle transactions. This makes Bitcoin a very disruptive invention since it eliminates the need for credit cards or bank accounts. Money can be transferred instantly and free, so there could be no need of wire transfers or money orders.

While Bitcoins are electronic money (they are also called a “cryptocurrency”), they can be purchased at ATMs, from other Bitcoin owners, or online exchanges. Once the Bitcoins are purchased and entered into the system, they become totally usable, electronic, transferable, and anonymous. This means Bitcoins can be spent, sent, saved, or easily converted into any nation’s paper currency.

So once users recognized that Bitcoin is liquid, they attracted the attention of financial types who saw they could become an investable asset despite their very special qualities. One of those special qualities is that Bitcoin is considered property by the IRS in the United States. This means an investment structure cannot directly own Bitcoin, but it can hold Bitcoin as part of shares in an investment trust, which has purchased Bitcoins.

The other problem is that the financial, regulators, and the courts are not clear about how to classify Bitcoin. Recent rulings have found it to be a cash equivalent, a security, a commodity, and a foreign currency. This confusion explains why regulators are uncertain about their legal and regulatory jurisdiction.

Yet as the use of bitcoins expanded and people became more familiar with their characteristics and benefits, it was inevitable that they began to attract more attention in the asset management business. This is why accredited investors were allowed to invest in Bitcoin (through the Bitcoin Investment Trust) in self-directed IRA retirement accounts at Fidelity, but only for a short time, in 2013.

Bitcoin Gaining Acceptance

Accredited investors are eligible for special consideration from the U.S. Department of Labor, to hold a variety of alternative investments, such as physical real estate and managed futures, in their retirement accounts because they are considered sophisticated enough to understand the risks involved. To be considered an accredited investor, a person must have a net worth of over $1 million, not excluding their primary residence, or earned over $200,000 a year for the past two consecutive years.

But being an accredited investor is only part of the story. After Fidelity disallowed Bitcoins to be held in its IRA accounts, other companies jumped in to fill the void, such as Pensco Trust Company. As of April 2014, Pensco said it had more than $5 million held in tax-advantaged retirement accounts in a Bitcoin trust.

Another trust, the Grayscale Bitcoin Investment Trust (BIT), said it was the nation’s first to invest in Bitcoin shares as “the first publicly quoted security (ticker: GBTC) solely invested in and deriving value from the price of Bitcoin.”  According to Grayscale, the BIT allows investors to be exposed to price movements of Bitcoin through a simple investment vehicle, without having to buy, store, and safe-keep Bitcoins. And since investors use the trust as a security structure, shares in the BIT are eligible to be held in certain IRA, Roth IRA, and other brokerage and investor accounts, according to the company. 

In September 2015, the first Exchange Traded Fund (ETF) incorporating Bitcoin (through the shares of Grayscale’s Bitcoin Investment Trust) was launched in September 2015. Trading under the name ARK Web x.0, the ETF also holds very small positions in Bitcoin (0.3% of ARKW’s overall portfolio and is the smallest component of the ETF), as well as other high-tech and web-related ventures, such as Facebook, cloud computing and data mining companies, that have the potential to re-shape business.

The Importance of Bitcoin

This once esoteric invention has now attracted the attention of some of the world’s largest institutions, government agencies, and institutional investors. But it has remained under the radar of most average citizens because its primary appeal thus far is that it may fundamentally change the global financial infrastructure. This includes areas in which Bitcoin-oriented technologies can make a huge impact, such as the: $2 trillion annual market for electronic payments; $1 trillion annual e-commerce market; $514 billion annual remittance market; $2.3 trillion hedge fund market; $7 trillion gold market; $4.5 trillion cash market; and the $16.7 trillion offshore deposit market.

Bitcoin’s core feature is that “for the first time in history, it is possible to have a decentralized “asset ledger,” the “blockchain” that is currently distributed across 250,000 computers worldwide,” according to a paper published by the Practicing Law Institute.

This same paper names the key elements that make Bitcoin very attractive to global financial institutions:

  • It is fairly invulnerable to being shut down because there is no central clearinghouse. This is because there are currently hundreds of thousands of computers that support the blockchain.
  • It is infinitely divisible.
  • It is 100% digital; this makes it is the first form of money that is extremely well-designed for the internet era.
  • It is extremely secure cryptographically, built on 40 years of public key-private key cryptographic research.
  • It is programmable, meaning that advanced financial instruments, such as derivatives or other financial contracts (e.g. escrow services) can be built using the bitcoin scripting language.

The Investment Caveats of Bitcoin

Like anything new, people often overlook any investment’s essential features. One of the caveats of owning Bitcoin in any investment account is that investors have to know what drives their value, especially since it is so new in the marketplace.

“Bitcoin is an interesting piece of news to follow, but it’s certainly not something I’d recommend including in a long-term investment portfolio, especially with an IRA,” according to Elle Kaplan, the CEO of LexION Capital Management, New York. “I always stress a long-term investment approach – particularly for your Golden Years and Bitcoin definitely does not fit in that picture.

“Bitcoin is not a stock, not a bond, and not a recognized currency that any government issues or supports. It’s also completely unregulated and completely uninsured. While the stories of Bitcoin’s dramatic rise in value, from pennies to hundreds of dollars each, may seem appealing in the short-run, the majority of its value could disappear in a split second. Bitcoin is something that could disappear in a year. It is not something to depend on in a decade,” Kaplan said.

Since Bitcoin is an electronic currency, merchants who are paid in it cash it in at its face value to pay salaries, bills, or take it home as profit.  In almost all cases, Bitcoin is spent immediately. As a result, it trades at, or often less than, its face value, according to futurist and writer Giulio Prisco.

“In fact, the price of Bitcoin doesn’t grow with adoption – if anything, it goes down. A reason is that Bitcoin is not only a speculative investment, but also a currency that is increasingly used to pay for goods and services – you can’t buy a beer with Facebook’s stock, but you can buy a beer with Bitcoin. Usually, merchants that accept Bitcoin sell it for fiat immediately, which brings the Bitcoin price down,” Prisco said. This makes it very difficult to achieve price appreciation, at least in this phase of its existence.

Then, there is also the issue of volatility. “Bitcoin is a very risky investment because its valuation is mostly driven by speculation. People who use the Bitcoin network for transferring value generally don’t care about the exchange rate because they enter and exit the system fast enough to avoid being exposed to much volatility,” according to Jameson Lopp, an engineer at a Bitcoin startup in Durham, North Carolina. This may help explain why the price of Bitcoin dropped 60% from January 2014 to December 2014, according to the Coindesk Bitcoin Price Index. Similarly, the average daily price change of BTC vs. the U.S. Dollar between July 2010 and August 2013 was 0.7%, which “is quite a lot compared to other assets,” according to Bitcoin Magazine.

Even Bitcoin’s own magazine warns users about price volatility.  On their site, the magazine says: “The price of a bitcoin can unpredictably increase or decrease over a short period of time due to its young economy, novel nature, and sometimes illiquid markets. Consequently, keeping your savings with Bitcoin is not recommended at this point. Bitcoin should be seen as a high-risk asset, and you should never store money that you cannot afford to lose with Bitcoin.”

Then, there are also operational hurdles. “As of right now, major IRA custodians won’t accept Bitcoin investments in a tax-advantaged account.  So at this point, if you want to invest in Bitcoins, the simplest way is to outright buy them,” according to Andy Brantner, a Certified Financial Planner and investment blogger at www.startinvestingonline.com.

 

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Chuck Epstein has managed marketing communications and public relations departments for major global financial institutions and participated in the launch of industry-changing financial products. He also has written by-lined articles for over 50 publications, five books and served as editor and publisher of nation’s first newsletter on the topic of using the PC for personal investing and trading. (“Investing Online, 1994-1999). He also is a marketing consultant, writer and speaker on topics related to investor protection and opportunities in the very dynamic cannabis industry. He has held senior-level marketing, PR and communications positions at the New York Futures Exchange, Chicago Mercantile Exchange, Lind-Waldock, Zacks Investment Research, Russell Investments and Principal Financial. He has won national awards from the Mutual Fund Education Alliance (MFEA) and his web site, www.mutualfundreform.com, was named best small blog in 2009 by the Society of American Business Editors and Writers (SABEW).

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