Bitcoin surpassed $60,000 this week for the first time since November 2021. Demand for the digital currency has surged so much that cryptocurrency trading platform Coinbase crashed on Wednesday.
After a brutal crypto winter that began in 2022, Bitcoin could soon break previous records as investors pour money into newly created Bitcoin spot ETFs and exchange-traded funds.
The price of Ethereum, the native token of the Ethereum network, has also fallen to levels not seen since April 2022, as investors speculate that an Ethereum ETF will eventually receive approval from the U.S. Securities and Exchange Commission (SEC). The stock soared to over $3,300.
With billions of dollars pouring into Bitcoin ETFs every day, is it time to join the party? Proceed with caution.
What's so great about the new Bitcoin ETF?
In less than a year, 75% of Americans who had heard of cryptocurrencies said they had no confidence in their safety or reliability, according to a Pew Research Center survey.
But after a federal appeals court ruled that the SEC unfairly denied an application from Grayscale Investments to convert the Grayscale Bitcoin Trust into a Spot Bitcoin ETF, the world's largest cryptocurrency Prices began to rise again in late 2023. The SEC announced in October that it would not appeal the court's decision.
And in January, it gave the OK to nearly a dozen new exchange-traded funds called Spot Bitcoin ETFs. Spot ETFs own an underlying asset, such as gold, silver, or now Bitcoin, and closely track its price, net of transaction costs and fees.
“There has never been an ETF like this before,” said Rick Edelman, founder of the financial experts Digital Asset Council. “There are ETFs that invest in the stocks of companies that operate in the cryptocurrency industry, such as exchanges and miners, and ETFs that trade Bitcoin futures by purchasing stock options instead of stocks, but until now there have been no ETFs that invest in stocks of companies that operate in the cryptocurrency industry, such as exchanges and miners. I didn’t. Any ETF that invests directly in Bitcoin and owns Bitcoin will do.”
The SEC's decision will allow investors to gain direct access to Bitcoin without having to go through crypto exchanges or suffer from storage or security issues. Instead, investors can easily gain exposure to Bitcoin by holding stocks in a brokerage account such as an Individual Retirement Account (IRA).
“The new Spot Bitcoin ETF is widely considered to be the most secure from a custody standpoint because it is regulated by the SEC and takes care of protecting your Bitcoin for you,” Edelman said. Ta.
Is Bitcoin in your investment portfolio?
With all the hype surrounding Bitcoin, it's natural to want to buy it. But before you try to profit from soaring prices, there are a number of things you should know first.
it is still a speculative asset
Bitcoin and other cryptocurrencies are speculative investments, assets that people put money into in the hopes that the price will rise quickly. Speculative assets are sometimes referred to as unproductive assets because they do not generate income such as interest, dividends, or profits. Investors who purchase speculative assets typically seek to profit from short-term price fluctuations.
“Typically, the way we think about financial assets is that we're providing capital to a company,” says Wealth, the Frank M. Engle Distinguished Chair in Economic Security at the American College of Financial Services. says management professor Michael Finke. . “A company uses its capital to make something, and people buy it. That makes a profit. You can value a company based on its expected future profitability.”
“In the case of Bitcoin, the valuation is completely speculative because it doesn't produce anything,” he said.
That may not seem like a big deal to those watching the price of Bitcoin go up and up. Who needs dividends or interest when the price of Bitcoin is up 40% in two months?
You might think that the price of Bitcoin will continue to rise forever. After all, the stock market has a proven track record of rising over long periods of time. However, keep in mind that unlike companies in which you can buy stock, Bitcoin does not create products or services that people actually use. Its use as a payment method is extremely limited.
Also, much of the wealth historically created by the stock market has come from reinvestment, not from rising stock prices. When your dividends are reinvested (which usually happens automatically in most 401(k)s and many automated brokerage accounts), you end up buying more stocks, allowing your money to compound and grow over time. You can reap even more benefits over time.
About 69% of the S&P 500's total return from 1960 to 2022 came from dividends, not price appreciation, according to research by The Hartford Fund. Put another way, if in 1960 he invested $10,000 in the S&P 500, by the end of 2022 he would have been worth more than $4 million. But without dividend reinvestment and compounding, that same investment would only have been worth about $641,000.
Bitcoin and other cryptocurrencies cannot earn dividends, so returns must come solely from price increases.
“People tend to be attracted to things that have recently gone up in price,” Finke said. “And that's attractive to people who are investing, but especially to investors who tend to be driven by sentiment. They see prices going up and they see themselves as one of them. You want to be in the division. There’s always that fear of missing out.”
Bitcoin price remains volatile
Bitcoin is much more volatile than the overall stock market. When prices are collapsing, as we've seen in recent months, it can be an exciting situation.
However, when the economy worsens, the price of Bitcoin often falls significantly compared to stocks. Take 2022, for example, the S&P 500 index was down about 19%, and it was a terrible year for the stock market in general. In the same year, Bitcoin lost more than 60% of its value.
Edelman said that while Bitcoin is highly speculative and has a history of volatility, he believes that if investors limit Bitcoin to between 1% and 5%, its potential is suitable for long-term portfolios. Emphasize that there is.
“The risks are high, and if it fails, there will be no significant damage if the allocation is low, in the single digits,” he said. “And with the potential for huge returns, even a small allocation can have a big impact on your overall investment return.”
Not the diversifying factor it once was
Still, one common reason to invest in Bitcoin and other cryptocurrencies is to diversify your portfolio. Spreading your risk across multiple asset classes can reduce your overall risk of incurring large losses.
The relationship between stock prices and virtual currency prices has been debated for a long time. However, recent research suggests that the correlation between stock prices and Bitcoin prices is increasing, meaning that they are increasingly moving in the same direction.
A 2023 research report by the International Monetary Fund states that Bitcoin and stock prices “had little correlation until 2020, but the correlation has increased since the second half of 2020.” One possible explanation is that institutional investors are more likely to have exposure to both Bitcoin and stocks.
Researchers at Georgetown University noted that the correlation between Bitcoin and the S&P 500 increases, especially during times of crisis. The paper notes that this correlation “increased significantly during the coronavirus pandemic, Russia's invasion of Ukraine, and the crypto winter, suggesting that Bitcoin did not act as a hedging asset during these events.” It shows,” he said.
Bitcoin probably won't come to your 401(k)
Don't expect your 401(k) administrator to start offering Bitcoin right away. Both Fidelity and FORUSALL, a small management company, offer employers the option to allow plan participants to invest small amounts of their retirement funds in cryptocurrencies.
However, Finke does not foresee any plans to make crypto widely available to employees, even with the new Bitcoin ETF. Plan sponsors have a fiduciary responsibility and are obligated to act in the best interests of their participants. One of those responsibilities is to minimize the risk of large losses.
“Plan sponsors are very cautious and their consultants are very cautious about adding investment options to the plan's core menu,” Finke said.
In fact, the U.S. Department of Labor has warned 401(k) plan administrators to be careful before contributing crypto assets to retirement plans, stating in a March 2022 memo that “Professional Investments Even at home, valuing crypto assets can be very difficult.” Organize your assets and separate fact from hype. ”
So, should you invest in Bitcoin?
Ultimately, investing in Bitcoin is a personal decision, whether you buy an ETF or an actual digital coin. If you decide to invest, you should already have a diversified portfolio of assets, such as an index fund. Typically, you don't want to invest your money in speculative assets that you can't afford to lose.
Before buying Bitcoin, think about what motivates you. Do you believe Bitcoin has long-term investment value, or is it a case of FOMO, or fear of missing out?
“Investors who are attracted to shiny things because they have recently increased significantly in value tend to be consistently punished,” Finke said. “This recent rally in Bitcoin seems like a great example of a shiny thing that is getting a lot of attention from investors, but may not perform as well in the future.”
