Bitcoin reached a new milestone this week, surging past $60,000 for the first time since November 2021. The demand for digital currency was so high that it caused the popular crypto-trading platform Coinbase to crash on Wednesday.
Following the tough “crypto winter” that began in 2022, bitcoin is on track to break its previous records as investors are pouring money into newly created bitcoin spot ETFs (exchange-traded funds). The price of ether, the native token of the ethereum network, also rose above $3,300, reaching levels not seen since April 2022. Investors are speculating that ethereum ETFs will eventually be approved by the U.S. Securities and Exchange Commission (SEC).
With billions of dollars being invested in bitcoin ETFs daily, many are wondering if it’s time to join the party. However, it’s important to proceed with caution.
What’s the significance of these new bitcoin ETFs?
A survey by the Pew Research Center showed that less than a year ago, 75% of Americans who were aware of cryptocurrency did not trust its safety or reliability. However, the price of the world’s largest cryptocurrency started rising again in late 2023 after a federal appeals court ruled that the SEC had wrongly rejected an application from Grayscale Investments to convert its Grayscale Bitcoin Trust into a spot bitcoin ETF. The SEC announced in October that it would not be appealing the court’s decision.
In January, the SEC gave the green light to nearly a dozen new exchange-traded funds known as spot bitcoin ETFs. These ETFs directly own the underlying asset and closely track its price, minus any trading costs or fees.
Ric Edelman, founder of the Digital Assets Council of Financial Professionals, stated that “There have not been any ETFs like this before.” He explained that while there are ETFs that invest in stocks of companies in the crypto industry and ETFs that trade bitcoin futures, there have not been any ETFs until now that directly invest in and own bitcoin.
The SEC’s approval allows investors to gain direct exposure to bitcoin without having to go through a cryptocurrency exchange or deal with storage or security concerns. Instead, investors can easily gain bitcoin exposure by owning shares in their brokerage accounts, including their individual retirement accounts (IRAs).
Edelman also stressed that these new spot bitcoin ETFs are considered safer from a custody perspective since they are regulated by the SEC, and the ETFs handle the safeguarding of the bitcoin for investors.
Should bitcoin be a part of your investment portfolio?
With all the hype surrounding bitcoin, it’s natural to be tempted to invest in it. However, there are important factors to consider before trying to profit from its skyrocketing price.
It’s still a speculative asset
Bitcoin and other cryptocurrencies are considered speculative investments, meaning they are assets that people invest in, hoping for a rapid increase in price. They are often referred to as nonproductive assets because they do not generate any income, such as interest, dividends, or earnings. Investors who purchase speculative assets are typically seeking to profit off short-term price fluctuations.
Michael Finke, a professor of wealth management at The American College of Financial Services, explains that “Normally, the way you think about a financial asset is you’re providing capital to the company. The company uses that capital to make something, and the people buy it. That creates profit. You can value the company based on the profitability you expect in the future. With bitcoin, it’s not producing anything, so the valuation is entirely speculative.”
While it may not seem like a big deal when the price of bitcoin is continuously rising, it’s important to keep in mind that bitcoin is not creating a product or service that people actually use. Additionally, its usage as a payment method is limited. The majority of wealth generated by the stock market comes from reinvestment, meaning that dividends are reinvested to buy more shares, allowing for compounding and potentially higher returns over time. However, since bitcoin and other cryptocurrencies do not earn dividends, any returns are solely based on price appreciation.
Bitcoin’s price remains highly volatile
Bitcoin is significantly more volatile than the overall stock market. This can be exciting when the price is increasing, but it also means that when times are bad, bitcoin’s price may take a much harder fall compared to stocks. For example, in 2022, the S&P 500 index dropped by around 19%, while bitcoin lost over 60% of its value.
Edelman believes that bitcoin is highly speculative, with a history of volatility. However, he also believes that its potential makes it suitable for a long-term investment portfolio, as long as investors limit their exposure to 1% to 5%.
Diversification may not work as well as it used to
One common reason for investing in bitcoin and other cryptocurrencies is portfolio diversification. However, recent research suggests that the correlation between stock and bitcoin prices is increasing, meaning they are becoming more closely linked and moving in the same direction.
A working paper by the International Monetary Fund in 2023 stated that bitcoin and stock prices were “fairly uncorrelated before 2020, then increasingly correlated from the second half of 2020.” The researchers suggest that this may be due to institutional investors having exposure to both stocks and bitcoin.
Another study by Georgetown University found a growing correlation between bitcoin and the S&P 500, particularly during times of crisis. The paper states that the correlation “significantly increased during COVID, the Russian invasion of Ukraine, and the crypto winter,” indicating that bitcoin did not serve as a hedging asset during these events.
Don’t expect bitcoin in your 401(k)
Despite the availability of new bitcoin ETFs, it’s unlikely that your 401(k) administrator will offer bitcoin anytime soon. While companies like Fidelity and FORUSALL are offering employers the option to let plan participants invest a small portion of their retirement money in cryptocurrency, it’s unlikely that it will become widely available in 401(k) plans. Plan sponsors have a fiduciary duty, meaning they are obligated to act in the best interests of participants. This includes minimizing the risk of significant losses.
The U.S. Department of Labor has also cautioned 401(k) plan administrators against offering crypto assets in retirement plans, stating that it can be “extraordinarily difficult, even for expert investors, to evaluate these assets and separate the facts from the hype.”
So, should you invest in bitcoin?
Ultimately, the decision to invest in bitcoin is a personal one, whether it’s through ETFs or buying actual digital coins. If you choose to invest, it’s essential to have a well-diversified portfolio that includes assets like index funds. Additionally, you should only invest money that you can afford to lose in speculative assets.
Before investing in bitcoin, consider your motivations. Do you believe in its long-term investment potential, or are you experiencing FOMO (fear of missing out)? As Finke warns, “Investors who get attracted to shiny things because they’ve gone up in value a lot recently tend to get consistently punished.” The recent surge in bitcoin’s price may be a case of a shiny object attracting attention from investors, but its performance in the future is uncertain.
