Close Close
ThinkAdvisor

Portfolio > Alternative Investments > Cryptocurrencies

Michael Kitces: The Problems With Crypto for Financial Advisors

X
Your article was successfully shared with the contacts you provided.

What You Need to Know

  • Kitces' concerns include a questionable investment thesis, holding and storage difficulties and liability risks.
  • He also noted questions about costs and billing and the time needed for advisors to get educated about crypto.
  • He's not “sold” on crypto yet but keeps an open mind.

Despite a $2 trillion market capitalization and a growing number of cryptocurrencies and digital tokens, most financial advisors remain wary of crypto assets, often for very practical reasons, according to financial planner and blogger Michael Kitces.

In a conversation with Tyrone Ross, the CEO of Onramp Invest, which provides RIAs direct access to crypto assets as well as educational materials, Kitces laid out some of the “blocking points” and other concerns that make advisors including himself wary of engaging in the crypto market.

Kitces and Ross also discussed why advisors need to get educated about crypto. The conversation was part of the 2021 Bitcoin for Advisors online conference sponsored by CoinDesk, which is owned by the Digital Currency Group, the parent company of Grayscale Investments.

A Questionable Investment Thesis

Kitces said he hasn’t yet found why crypto assets have economic value in the long run beyond the idea that they will be worth more because everyone else is buying them too. That worked during the dot-com rally in early 2000 and a few years later during the real estate boom — until it didn’t, he explained.

Kitces also questioned the long-run fundamental investment thesis for cryptocurrency coins,  which are “infinitely splittable and infinitely forkable,” meaning there is no fixed limit to them because anyone can launch one and attract assets away from existing cryptocurrencies. Dogecoin, which started as a joke based on a meme of a Shiba Inu dog, is an example of such a launch. Its market market cap skyrocketed to over $70 billion earlier this year but is now about half that.

The Difficult Mechanics of Holding and Storing Crypto

“All of the dynamics of what it takes to own and hold cryptocurrencies” are difficult for advisors, Kitces said. It usually involves going off platform and different individual wallets for different clients, many worried about whether their money is safe.

“We don’t even like changing custodians because we might have to ask clients to go from a Schwab login to a Fidelity login. We would rather have a whole relationship with a second custodian.”

Kitces acknowledged that some of these concerns are being addressed now with platforms such as Coinbase being built and solutions from firms such as Onramp, but the difficulties have not yet been resolved. In the meantime, clients are concerned about whether their money is safe and, according to a Fidelity study cited by Kitces, 58% of clients surveyed said they would drop their advisor if there were a security breach in any client account at their advisor’s firm.

Fear of Lawsuits Due to Extreme Volatility

Kitces said there was “a very real liability risk” for advisors whose clients’ assets are invested in an extremely volatile market like the crypto coin market, which can plummet 50%, 60%, even 70% in a year, a month or less. “Every time there’s a bear market, lawsuits against advisors spike … and that’s for markets that go down 30% a year,” Kitces said.

Going through the due diligence of providing clients a validated risk tolerance questionnaire doesn’t prevent lawsuits from which advisors must defend themselves, according to Kitces.

Costs

The transaction costs in crypto coins and in current crypto wrapper producers is a “whole other level of costs” for advisors, Kitces said. Those costs can potentially erase higher returns when computing net returns.

He later tweeted that even when asset managers release SMA or ETF products based on crypto — the SEC still hasn’t yet approved any crypto ETF — he’s “very concerned about how they’ll be priced, both in upfront fees and underlying costs structure to gain exposures. “

Billing

Another problem for advisors dealing with crypto assets is how to bill clients, especially if those assets are in an account not managed by their advisor, which is often the case. Advisors then can’t charge the usual assets under management fee, Ross said.

But assets under administration pose challenges for advisors too. AUA is still advising, which raises fiduciary responsibilities, according to Kitces.

Why Advisors Can’t Ignore Crypto

Despite these concerns, advisors can’t afford to ignore crypto assets — if only because, according to Kitces and Ross, their clients or potential clients may already be investing in crypto assets.

Advisors “risk coming across as out of touch” if they can’t discuss those assets with clients, Kitces said. “It’s a good door to open with clients to know if they hold it.“ He added that in general, advisors should check in with clients about any investment topic that is active in the news cycle, including volatility.

The Need for Education About Crypto

Both Kitces and Ross acknowledged the need for advisors to get educated about crypto.

“It’s not our language, it’s not our space,” Kitces said. “We can learn it  We have and have an obligation to get there … but we have to acknowledge the education bar is really high on crypto. That It creates very real and practical constraints for advisors. … [who would] spend 300 hours in the next year [learning about crypto] to make a 1% allocation to a client’s portfolio … or a 2% allocation in a non-managed account.”

Kitces suggested a “structured learning” module around crypto that provides a certificate to advisors rather than a certification, which usually requires years of study and employment.

After the session, Kitces tweeted that he’s not “sold” on crypto yet for financial advisors but “maintains an open mind as the crypto space itself evolves.”