Should Spot Bitcoin ETFs Be Part of Mainstream Investment Portfolios?

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The Securities & Exchange Commission (SEC) recently voted to allow spot Bitcoin Exchange Traded Funds (ETFs) to trade on U.S. stock exchanges for the first time. Eleven firms1 – including heavyweights such as BlackRock, Invesco, Fidelity, and others – received approval for spot Bitcoin offerings.

An ETF is an investment fund that tracks the performance of an underlying asset. Typically, ETFs are associated with stocks but can be tied to currencies, precious metals, real estate, or art. In this case, ETF shares represent ownership of actual Bitcoins (the term “spot” refers to today’s price rather than a price for a transaction to be settled in the future).

If you need a quick review of Bitcoin or other cryptocurrencies, please read our blog post “Investing in Cryptocurrencies: the Unbiased Basics.” That post touched on arguments for and against the asset class in general.

Now that Bitcoin can be purchased and traded through ETFs, it offers the opportunity to earn potential returns with the added benefit of diversification. For investors, one of Bitcoin’s features is that its returns are largely uncorrelated with returns from stocks and bonds, which comprise the majority of most investors’ portfolios. However, it’s important to note that, like any investment, Bitcoin carries certain risks, and its price can be highly volatile.

An analysis from Fidelity published in 2023 shows that from January 2015 to June 2021, by shifting just 1% to 2% to Bitcoin, a traditional portfolio of 60% stocks / 40% bonds would have earned higher returns without significantly increasing portfolio volatility2. As shown in the Fidelity analysis, reducing bond holdings to allocate to Bitcoin indicated an increase in the portfolio’s return and volatility more than if stock positions were reduced to buy Bitcoin. Important caveat: the correlations between Bitcoin and other asset classes can change without warning, potentially affecting the diversification benefits discussed in this post. As always, past performance is not indicative of future results.

A Prudent Path to Adding Bitcoin to Your Portfolio

As we navigate the introduction of Bitcoin ETFs, Gold Medal Waters prioritizes maintaining a prudent approach, focusing on the long-term investment horizon rather than reacting to short-term market movements. We acknowledge the potential of these new investment vehicles to influence market dynamics, including liquidity and volatility. However, our philosophy is to consider these factors within the broader context of personalized investment strategies rather than making decisions based on immediate market trends.

For investors who want this exposure, we advise caution and suggest only a small allocation of 1%-2% of a portfolio to Bitcoin, ensuring it aligns with our clients’ risk tolerance, time horizon, and overall financial goals. Understanding that Bitcoin carries a higher risk level than traditional asset classes is crucial. Furthermore, while Bitcoin exposure can provide portfolio diversification benefits, it’s essential to recognize that it may also introduce additional volatility, particularly in the 1-2% of the portfolio allocated to this investment.

Weighing the Pros and Cons of Owning Bitcoin ETFs

As discussed in our blog on cryptocurrencies, Bitcoin evangelists and naysayers make spirited arguments for and against the asset class. Here are a few of our responses to questions we hear most frequently:

Bitcoin is often called “digital gold3”—does that analogy hold up? The process of creating new Bitcoins is called “mining.” Like gold, the Bitcoin supply is limited; when it has all been mined, there will be 21 million coins4 available, and there will be no more. Physical gold is often viewed as a store of value (meaning its price is expected to hold up over time). Investors have been able to invest in gold via spot ETFs for a long time and can now do so with Bitcoin.

Is Bitcoin a good hedge against inflation? This topic is an evolving one, and the answer may vary. To some extent, the answer depends on how we measure inflation. Based on the traditional measure, the Consumer Price Index, we think it’s premature to say whether or not Bitcoin will be a good inflation hedge going forward. However, if we view inflation more broadly, as an increase in asset prices overall, we believe Bitcoin has the potential to keep up.

Doesn’t mining Bitcoin use a lot of electricity, which increases CO2 emissions? This idea could be true unless the Bitcoin mining operation uses renewable power. According to Jamie Coutt of Bloomberg 5, more than 50% of all energy used in Bitcoin mining comes from renewable sources. Somewhat counterintuitively, Bitcoin’s growing popularity could be a force for increasing the use of renewables and expanding the power grid (which needs to happen for many reasons). Bitcoin protocol periodically reduces the reward for Bitcoin mining to control supply by maintaining scarcity6 . This process is known as “halving”. Since the reward Bitcoin miners earn for mining new coins will soon be cut in half, they are looking for ways to cut electricity costs, turning to renewables for help.

What about all of the big crypto-blowups, like FTX – is this just a scam? That is a fair question, but the recent failures littering the cryptocurrency landscape have nothing to do with Bitcoin, and trusting a crypto exchange or crypto custodian to hold your assets is not the same as using a brokerage account held with a broker dealer who is a qualified custodian. With most cryptocurrencies, there is a real risk that the SEC will classify them as securities7, which would mean that trading them in their current form violates securities laws. However, the SEC has clearly said that Bitcoin is not a security8.

Our Path Forward with Bitcoin ETFs

In conjunction with their goals, risk tolerance, and financial time horizon, Gold Medal Waters works with our clients to identify what Bitcoin ETFs, if any, are appropriate for them and their portfolio. In evaluating any investment we will look at the management, fees, and risk factors associated with the Bitcoin ETF recommended.

Individual investors should do the same, considering both the risks and rewards of Bitcoin exposure. While we are optimistic about the diversification potential offered by Bitcoin ETFs, we are advocating a slow dip into the water rather than plunging in headfirst.

1. Approved Spot Bitcoin ETFs: ARK 21Shares Bitcoin ETF (NYSE:ARKB)