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February 05, 2018 at 04:51 PM
Bitcoin is drawing attention and drama.
J.P. Morgan’s Jamie Dimon first saw it as another tulip bubble, but has since retreated from this assessment. Lloyd Blankfein, CEO of Goldman Sachs, reportedly is behind the start of a cryptocurrency desk. Blackrock’s Larry Fink thinks Bitcoin is “an index for money laundering,” while Peter Thiel’s Founders Fund has invested in it full throttle.
Brokerage firms like Charles Schwab and Fidelity have taken a wait-and-see view, while TD Ameritrade began a pilot project in which some retail clients can trade CBOE Global Markets’ Bitcoin futures. Kind of like the price of Bitcoin, the interest in it and other cryptocurrencies is all over the map.
Despite this range of acceptance and anxiety, cryptocurrencies have stormed the global stage, forcing investment professionals to, at the very least, explore what makes these products attractive beyond the speculative flurry and how they possibly could be used in investment portfolios.
There are only a few options today that provide financial advisors with the ability to invest in Bitcoin, but those may be out of their (and their clients’) comfort zone. Still, there’s also the investment that is attracting the “smart money”: the underlying blockchain technology.
“We see potential benefits [of blockchain] for more efficient check-out settlement in the markets we currently trade, but are really excited about opportunities to unlock new markets where current transaction processes are simply not efficient enough for us to trade reliably,” said Mike Harris, president of Baltimore-based investment management firm Campbell & Company.
“We think that’s one of the most promising aspects associated with the development of cryptocurrencies. I don’t know what will happen to Bitcoin in the future, but I’m optimistic something that looks like distributed ledger technology may be seen in our markets in the not too distant future,” Harris explained.
What Is Bitcoin?
The simplest description of Bitcoin is that it is one of more than 1,500 cryptocurrencies traded globally, and it has the advantage of being one of the first to be developed and — reportedly — one of the safest in preventing fraud. These products are “mined” by people — instead of a cartel that may have commodity production restraints; and production is limited by an algorithm.
That said, people do control the amount of Bitcoin available to traders and investors. For example, the theoretical universe of Bitcoin is 21 million, whereas to date 16 million have been mined.
It also should be noted that a country can crack down on cryptocurrency users. For example, South Korea recently announced a ban on anonymous cryptocurrency accounts. This news pushed down the price of Bitcoin, which had been above $20,000 in December, to below $10,000 in mid-January.
Of course, other news can affect its price. Right after the first of the year, when Thiel’s Founders Fund invested in Bitcoin, the price jumped above $16,000. But other than these types of events — believe it or not — there are relatively few fundamentals that determine (as of today) the true value of these products. What makes this area murkier is the unlimited number of cryptocurrencies, as well as their potential use on the dark web for drug and other illegal transactions.
Foliofn CEO Steve Wallman, a former commissioner with the Securities and Exchange Commission, questions what is behind the volatility of Bitcoin, stating that unlike orange juice, which has specific supply/demand fundamentals, or stocks that can be evaluated by a multitude of formulas on earnings, assets, etc., Bitcoin “is pegged to nothing.”
“There is no math with Bitcoin. People have tried to make the argument that there is a limited amount of Bitcoin that can be mined, therefore some threshold at which people should pay for Bitcoin because of limited supply, but the problem is, who cares? There’s a limited supply of sand in a sandbox, but you wouldn’t pay $12,000 for each grain,” Wallman explained.
He says that even if there is a theoretical value on Bitcoin, “the problem is there is no limit, theoretical or otherwise, on how many cryptocurrencies there can be….and therefore there is no inherent value of Bitcoin at all.” (See “1,500 and Counting.”)
Rules & Regulations
Along with all the excitement surrounding Bitcoin — and there is plenty — come the cautions, mainly from the regulators (examined further in “Be Careful Out There”). The Commodity Futures Trading Commission, which in late 2017 approved futures on these products for three exchanges it regulates, sees Bitcoin as a commodity and regulates it as such.
The SEC, which is led by Chairman Jay Clayton — who has been vocal about precautions investors should take and adamant about taking actions against bad actors — recently issued a report stating that the regulator sees tokens as securities and therefore does and will regulate them. The IRS has ruled that cryptocurrencies are property, and the U.S. Treasury sees these products as currencies and money.
Norm Champ, former SEC director and now with Kirkland & Ellis, recently told CNBC that the regulatory view is “as clear as mud.” He recommends regulators get together with practitioners to hammer out a single set of rules.
The issue of defining cryptocurrencies has even stumped Wall Street. “It doesn’t quite fall in a [specific] bucket,” said Ihor Dusaniwsky, managing director, prediction analytics, of S3 Partners, a New York-based financial analytics firm.
“I know of several firms that are sitting down and trying to figure out if this is a brand-new asset class, and [if so], creating an asset class they could refer clients to,” Dusaniwsky explained. That’s the first step in normalizing it as an investment vehicle.”
This may be easier said than done, especially with regulation. Wallman says the regulatory issue really is twofold. One aspect of it is that “all regulators have seen some value in blockchain technology,” he points out. The other “pure speculation” side is a problem that regulators and even countries have clamped down on, according to the former SEC commissioner.
“Some countries have already outlawed [Bitcoin and other cryptocurrencies] because they see it as a means to engage in the kinds of dark web activities or a way to evade currency transfer restrictions or a way to get around moving money out of country,” he said. “For those reasons, some countries have already shuttered use of cryptocurrencies.”
Time to Play?
With this much controversy swirling around Bitcoin and cryptocurrencies, should advisors pursue it as an investment for clients? Many don’t have this option as several broker-dealers aren’t allowing advisors to utilize the product at this point, such as Raymond James.
Merrill Lynch, for instance, stopped purchases of Greyscale Bitcoin Investment Trust on Dec. 8, stating in a memo, “The decision to close GBTC to new purchases is driven by concerns pertaining to suitability and eligibility standards of this product.” Morgan Stanley, Wells Fargo and UBS also have banned sales of the Bitcoin-related products.
