Bitcoin funds should be viewed with caution

New York

CRYPTOCURRENCIES such as bitcoin are on their way to being the next big thing or yesterday's news. Their novelty makes it hard to tell which.

For better or worse, funds are being introduced that let investors capture the rewards and risks available in cryptocurrencies. Most are listed on foreign markets or aimed at accredited investors, those with high incomes or substantial wealth, although the funds often have minimum investments of as little as US$10,000 to US$25,000.

Several firms have filed to sell speciality exchange-traded funds in the United States, but none have been approved yet. The Securities and Exchange Commission (SEC) has cited "significant investor protection issues that need to be examined before sponsors begin offering these funds to retail investors".

Fund manager Van Eck and software developer SolidX asked the SEC in early June for permission to offer an ETF that addresses the agency's concerns, partly by setting the share price so high, nearly US$200,000, that small investors could not afford it. That request is still pending.

If and when funds are listed, prospective shareholders should treat them with caution and scepticism, investment advisers and authorities on cryptocurrencies warn. Since its invention in 2009, bitcoin has risen from pennies to about US$6,400, and other cryptocurrencies have experienced astounding runs of their own.

There are fascinating aspects to bitcoin and its peers, especially the underlying blockchain technology, but prices have been driven to a large extent by hype and hope, and the gains could be reversed.

"There is no intrinsic value to a bitcoin," said Lee McKnight, an associate professor in the School of Information Studies at Syracuse University. "The market is caught up in a frenzy for new technology."

One sign of the frenzy is in the trading price of Bitcoin Investment Trust, one of the funds for well-off investors. It has been 56 per cent above the value of the portfolio's assets this year on average, according to Morningstar, bid up by shareholders eager for access to the market when few other avenues exist. The premium, which was 45 per cent on June 30, could fall sharply if other investment vehicles come along.

"The challenge with cryptocurrency-oriented investing is it's hard to gain exposure, as there are no US-listed ETFs," said Todd Rosenbluth, director of ETF and mutual fund research at CFRA.

"When the supply to gain exposure to bitcoin grows via ETF choices and better meets demand, the premium will narrow." Just what the right prices are for bitcoin and other cryptocurrencies, fund premiums aside, is hard to judge, Matthew Hougan, global head of research at Bitwise Asset Management, said.

"The crypto ecosystem hasn't evolved an agreed-upon framework to value crypto," he said. Referring to extreme long-range valuation estimates floated for bitcoin, he added, "Anyone who says they know it's worth US$10,000 or US$20,000 or US$1 million or US$0 is wrong."

Mr Hougan thinks there's a reasonable chance that cryptocurrencies will become widespread alternative forms of money, much as gold may be considered today, putting a floor under prices. He cited the decentralised nature of cryptocurrencies - the blockchain ledgers recording transactions exist in no one spot and under no one's control - and their built-in digital scarcity.

"It's entirely feasible that a new store of value could emerge in the world," he said. "I don't think that concept began and ended with gold."

Bitcoin is the best-known cryptocurrency but not the only one. There are roughly 1,600 of them, Prof McKnight said, and, "80 per cent are scams, or assets with no value in the long run".

The technologies embodied in these ventures will undoubtedly serve other purposes, he said. Blockchains - secure, time-stamped sets of digital records - are expected to be valuable tools in areas such as supply chain management and banking that feature large amounts of information shared among multiple parties using varied data management systems.

"There's a mass of confusion between blockchain technology, which will have a big impact, and cryptocurrencies," Prof McKnight said. The blockchain technology "is what investors should be looking at."

A mature business devoting large resources to blockchain projects is IBM. It has about 15 commercial ventures focused on supply-chain management, he said, and it has "purposely stayed away from cryptocurrencies".

Many professional investors find promise in the core blockchain technology, even as they scoff at the notion it can be used to reinvent money. In a note to investors this year, Joe Davis, the head of Vanguard's Investment Strategy Group, said he was "enthusiastic about the blockchain technology that makes bitcoin possible".

But "as for bitcoin the currency? I see a decent probability that its price goes to zero". Even a believer in cryptocurrencies such as Mr Hougan said bitcoin is inefficient, with "a slow, simple network" and limited programming capabilities.

But he wouldn't rule it out as a portfolio holding. Because its price movements are minimally correlated with those of conventional assets, adding a modest allocation to bitcoin to a 60 per cent stock-40 per cent bond portfolio could improve performance, he said. A study by Bitwise found that a 5 per cent allocation would have doubled the Sharpe ratio, a measure of risk-adjusted returns, of such a portfolio between the end of 2013 and the end of March 2018.

Because bitcoin is so volatile, however, rebalancing the allocation is essential, Mr Hougan added. If the desired weighting is 1 per cent, he would sell back to that level whenever it reached 1.5 per cent and buy more when it reached 0.5 per cent.

The value of a bitcoin rose to just under US$7,000 from about US$600 during the time of the study. Whether owning it or other cryptocurrencies will be as helpful if the price persistently falls remains to be seen. Prof McKnight is sceptical: "It's buyer beware," he said. "Don't go into this space saying you're going to pick this or that cryptocurrency without knowing anything. And you should not be using your living money." NYTIMES