Bitcoin, the first and most well-known cryptocurrency, continues to move towards the mainstream. From ATMs in Manhattan bodegas, to Overstock.com, slowly bitcoins are appearing in our daily lives. Ever since Bitcoin launched, speculators have been able to buy and hold this cryptocurrency in search of profit from changes in its value over time. Using a variety of online services or software applications, technologically sophisticated individuals can easily convert bitcoins to US dollars (or other currencies) and back again.
A 2014 article in this journal predicted an emerging “demand for Bitcoin-related financial instruments.” This demand has led to more to the development of more formal means of investing in Bitcoin. For example, The Bitcoin Investment Trust is a private trust that holds bitcoins for investment. Interests in the fund are now publicly quoted on OTCQX, an over the counter quoting service, under the symbol GBTC. While this fund has opened Bitcoin to more people, pending before the SEC is a proposal to bring Bitcoin investing mainstream with a public listing on the BATS exchange.
The Winklevoss twins (of Facebook fame) are sponsoring the Winklevoss Bitcoin Trust for listing on BATS. This trust will be traded as an Exchange Traded Fund or ETF. Investors purchasing the ETF will not be buying bitcoins directly, instead, they will purchase shares of a fund that will purchase and hold the bitcoins on their behalf. This type of investment avoids the risk and technical complexity that comes with one purchasing and holding bitcoins on their own.
If approved, the public listing will allow for nearly any investor to participate in a highly liquid and dynamic market for bitcoins. The SEC has yet to rule on a necessary change to BATS rules that will allow trading to begin. The SEC has only until March 11, 2017, to decide whether to approve the change.
As of the time of writing, on the BitMex prediction market, speculators give the rule just shy a 50% chance of approval. While the SEC has not indicated how they will ultimately rule on the BATS’ proposal, they have released a series of questions for public comment. Reviewing these questions reveals some of the concerns the SEC has. For example, the SEC specifically questioned the appropriateness of a fund backed by assets that are not physical commodities (like livestock or oil) nor are traditional registered securities (like the stock of Apple or GE), the accuracy of the fund’s pricing methodology, and the security procedures employed.
Many public comments present contrasting viewpoints on the proposal. One particularly interesting comment written by a Brazilian computer scientist expresses concern about the threat of theft. He points out that bitcoins can be stolen simply by stealing the private keys of bitcoin holders, including the fund.
Commenters have also raised concerns about how the ETF will handle a “hard fork”. Bitcoin relies on a decentralised register of transactions called the blockchain. Under certain circumstances, disagreements about the management of the blockchain can result in two blockchains being formed, a so-called “hard fork.” After a “hard fork” there may be uncertainty about which blockchain should be considered authoritative, effectively creating rival claims of bitcoin ownership. This scenario occurred in the blockchain of a decentralised computing platform called Ethereum. It is hard to imagine a similar scenario occurring in the context of a more traditional asset underlying a security like a commodity or a stock.
As of the time of this writing, bitcoins are trading close to their all-time high against the US Dollar, partly responding to speculation that the ETF will be approved. If approved, the ETF will allow millions of people an easy way to invest in Bitcoin, increasing demand and potentially driving up the price of bitcoins. Other reasons given for the recent rise in bitcoin prices include: uncertainty regarding public policy under President Donald Trump, and concern about foreign currencies, including the Indian Rupee.
Approval by the SEC of the ETF may lead to a variety of other similar investment products following close behind, including public registration of the BitCoin Investment Trust and the Solid X Bitcoin Trust.
In general, I support the broadening of public access to investment opportunities. Many types of investments with high upside potential are limited to investors with high levels of income or financial or technical sophistication. When investment opportunities, like the Winklevoss ETF, are made available on the public markets, these investments become available to a more diverse investing public. Investors also benefit from the additional transparency that follows from registered securities. On the other hand, like any investment, an investment in bitcoins comes with substantial risks that registration will not eliminate. Unfortunately, I fear that easy investment in Bitcoin creates pitfalls that are not necessarily present with traditional investments.
Investing in Bitcoin is in some ways comparable to an investment in gold, or other precious metals. Both Bitcoin and gold exist outside the traditional monetary domain of governments and, therefore, are not directly affected by prevailing fiscal conditions. Understandably, these investments can seem attractive during times of uncertainty. Few readers will have escaped the barrage of ads for gold investments run on radio and cable news stations during the years following the financial collapse. These advertisements promoted gold as a hedge against the fear of inflation or economic weakness. Unfortunately, these ads often targeted individuals with little knowledge of the markets and may have driven viewers into making ill-advised investment choices.
I fear, without oversight and scrutiny, that easy access to Bitcoin investments may present similar risks. Unscrupulous companies may draw upon the political anxiety people feel to promote investing in Bitcoin and other cryptocurrencies as a hedge against government policy. While combating this marketing will be difficult, it is incumbent upon ethical investment advisors and the promoters of these ETFs to counsel potential investors on the high risk and volatility inherent in a cryptocurrency investment and to support concerted efforts at public education about these investments.