9 December 2020
Ever since Satoshi Nakamoto created Bitcoin in 2009 the debate has raged over what it is, and what value it has to the world.
Bitcoin has surged in both price and popularity again recently, but is prone to spectacular crashes…timing is certainly of the essence. If an investor has a short time horizon, it may be best to steer clear, but for longer term investors it is reasonable to ask the question: will Bitcoin ever form part of a long-term portfolio?
Bitcoin price since 2010
The volatility alone has kept some investors at bay; but Bitcoin bulls would point to the possibility of high returns in a low yield environment. Bitcoin is also becoming more mainstream – Paypal announced in October it would begin to allow customers to use Bitcoin, and other well-known companies that accept it as a form of payment include Microsoft and Burger King.
How big is it now?
Bitcoin is the most well-known cryptocurrency, though there are around 2000 of them in circulation. The total value of the cryptocurrency market is over $500bn – a massive increase from $18bn only 3 years ago, and it was considered symbolic when the total value of all Bitcoins exceeded the market capitalisation of JP Morgan, the world’s largest bank (with a market cap of c$330bn). However, as an asset class, cryptocurrencies are still pretty tiny – gold for example has a total market cap of around $9 trillion.
Should Bitcoin be included in investment portfolios?
We think there are two key questions investors should ask in trying to assess whether Bitcoin should be considered for portfolios.
1. Is Bitcoin a financial asset?
Let’s look at the evidence, it has:
- No income
- No contractual claim to crystalise value – like, for example, a loan has
- No inherent value – such as an industrial commodity has
- It is also unregulated and potentially more susceptible to fraud and theft than other assets
To us, Bitcoin seems to fill no criteria for being a financial asset. But if it isn’t a financial asset, then perhaps it qualifies as a currency.
2. Is Bitcoin a currency?
Again, looking at the evidence we offer the following observations:
- You can’t pay your taxes with it – which would make it convenient to pay most people’s largest annual liability
- It still isn’t widely accepted for transactions (yet)
- It is not (as some would argue) a store of value – it is difficult to argue that something whose value rises and falls by 20%+ in very short spaces of time is a store of value. This may eventually stabilise though
Even if the answers to either of these questions was yes, we’d still have to subject it to the same standards of any other asset: we’d need to be satisfied that it had credible expectations of returns, and made sense from a risk and correlation perspective before considering including it in client portfolios. Even if we did get comfortable with question 2 that Bitcoin was a currency, we still might not suggest an allocation – most portfolios don’t include an allocation to basket of small, non-domestic currencies.
One argument for holding cryptocurrencies is as a hedge against inflation. Some investors are concerned that inflation could reduce the real value of currencies globally – and the modern monetary system, with no backing of those currencies with gold, makes it fairly easy for governments to devalue their currencies. Certain cryptocurrencies are structured so that the amount of issuance is limited and so should, the argument goes, protect against inflation.
But to us, it’s a pretty firm “not for now” when it comes to considering Bitcoin for portfolios. But not everyone has taken that view and there is a considerable global appetite for vehicles that allow investors to gain access to Bitcoin.
How could you invest in Bitcoin?
Despite a number of attempts over the last seven years (described in more detail here), Bitcoin Exchange Traded Funds (ETFs) have failed to get full authorisation from the SEC in the US, however, Germany has been more accommodating of cryptocurrencies generally and an ETF was recently launched there trading on XETRA (a well-known exchange). Units of this fund give holders a claim on a defined number of Bitcoins, ie it is physically backed by Bitcoin, which is an important point. There are several other listed products in Europe that trade on exchanges via certificates or notes backed by Bitcoin.
One of the larger funds, launched in 2013 provides access to Bitcoin via an investment trust structure, it remains unregulated, trading on a niche market. It has a sizeable $9bn under management and is a popular investment on the Robinhood trading platform. Fees for these funds are hefty, at around 2% pa.
There is also a Bitcoin future contract that trades on the Chicago Mercantile Exchange (CME).
Other ways that some investors have chosen to gain exposure is through backing Venture Capital investments of companies in this area, with notable headlines surrounding the Yale endowment’s involvement. Investments in companies pursuing the promising Blockchain technology applications (that also supports Bitcoin) are a whole other investment universe of course, which will include some venture capital investments plus projects inside publicly listed technology firms.
We are aware of at least one institutional manager currently investing clients’ assets in Bitcoin as part of an alternatives fund, others may be restricted by regulations on what they can hold in pooled funds. The devil is in the detail of the fund rules here. Cayman based fund types allow Bitcoin whereas UCITS funds do not.
Finally, you could buy Bitcoin in the spot market but then your issue is how to store it safely – you need a custodian. Some custodians even allow US investors to hold Bitcoin in their retirement accounts.
While we don’t expect to be considering Bitcoin allocations for our clients anytime soon, many other investors have taken the plunge and are clearly prepared to pay high fees to invest in products to get access to this new form of investment.
We’ll keep putting Bitcoin and other cryptocurrencies against our tests identified above as a yardstick for determining whether this could play a role in portfolios. Although for now, the answer remains no, cryptocurrencies are definitely one to watch. A change to the regulatory status could mean they become eligible for inclusion in a wider range of investment vehicles, and we could see managers starting to make more use of them where they see a case.