The recent approval of the first U.S. exchange-traded funds (ETFs) that can directly invest in Bitcoin (BTC) marks a pivotal moment for cryptocurrency investment. These new “spot” Bitcoin ETFs offer financial advisors a way to provide clients with direct exposure to Bitcoin, eliminating the complexities of crypto exchanges and the security risks associated with digital wallets.
Though these Bitcoin ETFs are stirring a lot of interest, I’m cautioning my clients against making any rash purchases.
Key Takeaways
- Spot Bitcoin ETF approval in the U.S. offers direct exposure to Bitcoin without crypto exchange complexities.
- There remains a high degree of uncertainty about the role of Bitcoin in portfolios as either a return enhancement or a diversification tool.
- Two approaches for Bitcoin ETF investment include treating it like an individual stock investment or incorporating it into long-term asset strategies.
Until now, investors seeking direct Bitcoin exposure faced high transaction fees and security challenges. Previous ETFs relying on futures contracts didn’t track Bitcoin’s price directly, leading to return discrepancies. However, the new spot ETFs aim to accurately mirror Bitcoin’s price movements, providing a simpler and potentially safer investment option akin to traditional stocks.
This shift resembles the introduction of gold ETFs, which simplified gold investing while providing secure storage solutions. Bitcoin ETFs similarly use advanced digital custody in “cold storage” to enhance security.
The idea that Bitcoin is capable of replacing government-issued currency is something many of its proponents agree is extremely unlikely, if not impossible. Nowadays, Bitcoin enthusiasts are more likely to make a case to own it as a diversification tool rather than a stable currency.
Diversification involves integrating a variety of investment types, each with unique risk and return profiles, which react differently under various market conditions. This strategy helps mitigate overall portfolio volatility, enhancing the potential for compounded returns over time.
Tip
Diversification is a strategy that helps mitigate overall portfolio volatility.
What I’m Telling My Clients
Investing in Bitcoin ETFs just because the price is going up is not encouraged. You really should only do it if you see the value in doing so. Generally speaking, the reason to add a new exposure to your portfolio is for return enhancement or diversification. There remains a great deal of uncertainty about Bitcoin’s ability to meet either objective, but I see two rational approaches for investors keen on using Bitcoin ETFs:
Warning
Investing in Bitcoin ETFs just because the price is going up is not encouraged.
The first is treating it like an investment in an individual stock. While the risks of owning individual stocks are a bit different, there are some decent parallels between the betting nature of owning an individual coin like Bitcoin.
Carving out some part of your portfolio to actively trade can actually be positive if it helps you stay the course with your long-term allocation. If you hit it big with your active portfolio, great. If you don’t, at least you’ve limited your exposure to speculative assets.
A second way to incorporate Bitcoin ETFs is making it part of your strategic, long-term asset allocation. The way I think about allocating to a new exposure in a portfolio is by considering its relative market weight compared to the relative weights of your other portfolio assets.
For example, given Bitcoin’s market cap of just over $1 trillion, a starting allocation of 0.5% of a portfolio would roughly represent its market proportion compared to global stocks and bonds, which have a market cap of roughly $200 trillion.
The Bottom Line
When considering Bitcoin for diversification purposes, it should be noted that its unique behavior, distinct from traditional asset classes such as stocks and bonds, poses challenges. It doesn’t offer any expected premium for bearing the risk of its price movements, in turn increasing the already high uncertainty.
Thus, I’m more concerned about implementing a bad idea rather than missing out on a good one. However, those who choose to invest in Bitcoin ETFs should consider treating it like an investment in an individual stock or to incorporate it as a long-term asset allocation.