Moves by the Japanese government to recognise the bitcoin as an investment-grade asset, and high turnover in bitcoin trading in China, have turned investors’ attentions towards the crypto- currency as an investable asset within their longer term portfolios. The rapid appreciation in the price of Bitcoin is also prompting some investors to consider whether an exposure to bitcoin could help drive portfolio returns. But is it an investable asset? Or a gamble?
At the end of 2014 the exchange rate for one bitcoin was US$817.12. At time of writing one bitcoin was worth US$4585.09.
Bitcoin is an electronic currency that is not tied to any one nation, as other currencies are, nor is it governed by a central bank. Rather, it relies on an underlying technology called blockchain that gives asset owners a transparent view of its trading history.
Dr Adrian Lee, researcher and senior lecturer in finance at the University of Technology, Sydney, says stringent Chinese capital controls are a reason why bitcoin is popular in China.
“One way to bypass the rules is to invest in bitcoin,” he explains, qualifying his statement by adding that this view is based on anecdotal rather than academic evidence. Nevertheless he says China now dominates bitcoin trading.
Although there’s a perception bitcoin is the currency of choice for the black market, Adrian says that’s a myth.
“It’s very easy to track bitcoins. Once you have bought on a bitcoin exchange, you have a footprint. So it’s not so suitable for illegal operations,” Lee adds.
It’s still extremely rare for bitcoins to be used in normal transactions, for instance to buy a meal or a coffee.
“The main reason people hold bitcoin is for investment or speculation purposes. A lot of people who buy bitcoin hold it in their account and don’t use it. They are speculating or investing for the future,” he adds.
However, it’s important to understand Bitcoin has been implicated in a number of cybercrimes. For instance in 2014 US$450 million in bitcoin was stolen from an exchange called Mt.Gox. This should be an important consideration for anyone buying and selling bitcoin, even on exchanges that appear robust.
“After the heist bitcoin’s value did drop, but it has subsequently recovered,” Lee notes.
Nevertheless, heists do expose crypto currency investors to technology risk that other currencies don’t carry.
Another element to factor in is internal politics in the crypto currency world.
“Bitcoin has split into two. Some people didn’t like bitcoin’s rules and wanted to make a different bitcoin. So they created bitcoin cash. But the value of bitcoin cash has plummeted compared to mainstream bitcoin,” says Lee.
He attributes the price differential to the lack of acceptance of bitcoin cash on some exchanges – lower demand equals lower value. “If it’s more difficult to trade then people don’t want to buy so much of it,” he says.
Investor considerations
Bitcoin carries different and substantial risks compared to other assets that are important for self-managed super fund trustees to understand.
Its highly speculative nature means for most people, it would only form a very small portion of their overall investment portfolio.
In general, SMSF trustees would also only be able to invest in bitcoin if the trust deed allowed it and if it helped fund members meet their retirement goals. The investment must also meet the sole purpose test.
“If you’re a regular mum and dad investor, you probably wouldn’t want to hold too much bitcoin because it’s a very volatile asset. It’s at least ten times as volatile as a stock market index,” says Lee.
“Its value is very unpredictable and there’s no cash flow from it. There’s no safety in it; it could be that one day, people don’t use bitcoin and it becomes worthless. At the end of the day, it is just data,” he adds.
Bitcoin’s value comes from its acceptance by people as a form of investment or currency. SMSF trustees need to keep that in mind if they want to invest in bitcoin.
It’s also not a very big market. There’s only US$76 billion of bitcoin in circulation with a free float of about US$16 billion.
“It’s not an institutional-grade investment; it’s really restricted to retail investors,” Lee adds.
A small sub-group of investors, for instance those with knowledge of crypto currencies, may find an exposure to bitcoin suits them. But anyone investing in this market must face the very real prospect of losing their money.
Like any investment, the idea is to do thorough due diligence before making a decision to invest.