Bitcoin is the best performing asset since the global financial crisis of 2007-2008. While some believe that Blockchain is an investible theme, others have successfully understood the inextricable linkage of the currency embedded in the protocol. This embedded currency is called bitcoin.
While this topic comes with a steep learning curve, as Bitcoin is very different from what investment professionals have seen before, it is a new asset class that has been embraced by an increasing number of institutional investors and high-net-worth individuals.
Several Exchange Traded Fund (ETF) providers in Canada and the US are attempting to launch a publicly traded bitcoin related investment product. Let’s review some pros and cons to a bitcoin ETF.
The pros of a Bitcoin ETF
First, an investment structure alleviates barriers such as the logistics of buying and selling the underlying asset and solves for custodial considerations because asset managers can’t self-custody on behalf of their clients.
Some investment structures already invest in bitcoin but are only available to accredited investors. A bitcoin ETF would ensure fair access, since all types of investors could invest in it. If high-net-worth Bob can invest 1% of his portfolio in it, why can’t saving-for-retirement Alice do the same?
Secondly, from a portfolio construction point of view, bitcoin can be used as a trading tool to generate alpha or as a portfolio diversifier for asset allocators in search of low correlation to traditional assets.
To appreciate bitcoin for its uniqueness and asymmetric risk payoff profile, it first must be understood. It can be viewed as an option on digital gold and therefore as a flight-to-quality asset in certain market conditions.
Lastly, from a regulatory point of view, a publicly listed investment structure ensures proper disclosure of all risk factors.
Investment professionals are best qualified at handling questions pertaining to the suitability of the investment in the context of the overall financial portrait of the end investor. And, since investment dealers already deal with KYC/AML considerations, investors would not need to go through the process with another provider.
The case against a Bitcoin ETF
There is however a paradox in wanting to support a decentralized network, if only to put in back into a centralized structure such as an investment funds.
Bitcoin is a digital bearer instrument. Trapping it in a fund structure limits its usability to just an investment theme. The peer-to-peer nature of the network is lost when the asset sits in a fund structure. For example, the investor in a bitcoin ETF would not be able to use his asset to tip online or to buy goods and services with it.
Special considerations must be taken for audit, custody and insurance, because such investment funds represent honey pots that can (and will) attract hackers. Furthermore, securities lending and fork policies must receive heightened scrutiny for anyone in charge of product selection and due diligence.
In the end, a bitcoin ETF is not fundamentally required, since anybody can buy some bitcoin directly and without any custodial financial intermediaries. However, for investment professionals to use it in portfolio management and to get paid for their recommendations, they need a wrapper around the asset.
Although unnecessary, I think a bitcoin ETF is inevitable. The question is, who goes first, USA or Canada?
A retail perspective
From a retail point of view, the question then becomes, how will the compliance departments of investment dealers classify a bitcoin ETF within their internal risk parameters?
Due to the historical price volatility, they would most likely put it in the high-risk product bucket. However, this would fail to account for the flight-to-quality and hedging characteristics this asset can offer in certain market circumstances.
One way to solve this accountability conundrum is to assess the portfolios on an overall basis, rather than on a per product basis. This would not only be more aligned with the way institutional managers are assessed, but would also increase the accountability of portfolio results to end investors.
Elisabeth Préfontaine, CFA, is the founder of Octonomics, an independent research and consultation firm.
In 25 years of financial service experience, Elisabeth has witnessed a broad spectrum of transformations in financial technologies. In fact, she is one of the few who can claim to have both traded a physical coupon bond in a bank branch and also bitcoin.
