Many investors are asking: Should I buy bitcoins or other cryptocurrencies? And if not, why?
Bitcoin, the leading digital money, has risen 700percent this year to as high as $7,146, and is up 3,500percent since a low in January 2015. Nearly every day bitcoin and other cryptos are making headlines. Some experts call them the new gold.
But are bitcoin, Ethereum and other digital currencies real investments or a speculator's game? And what about initial coin offerings, a hybrid of initial public offering and crowdfunding that has spawned Etherum and other projects? Even Wall Street is divided, so many experts warn Main Street investors to stay away or proceed with great caution.
No less than Goldman Sachs (GS) is said to be considering a cryptocurrency trading operation, according to the Wall Street Journal. Yet JPMorgan Chase (JPM) CEO Jamie Dimon recently called bitcoin "a fraud" and said it would likely stay on the black market.
Far from being safe for widows and orphans, like utilities, the bitcoin market — which hit $150 billion in August — looks more like the 1840s gold rush. Many rushed in, but few got rich.
On Saturday, bitcoin fell to around $5,500, wiping out a rally on news that a plan to split the crypto currency was called off. It's bounced back since and was trading above $6,400 midday Monday.
One risk is that governments likely will limit the currencies' use, such as barring them for tax payments, which would keep them out of the mainstream, according to UBS. China recently banned initial coin offerings and trading in cryptocurrencies, and it may not be the last government to act on concerns about giving up control over the flow of funds, the ability to monitor taxable gains or appearing vigilant in protecting investors.
Cryptocurrency investment vehicles
Only a handful of ETFs and other exchange traded products have significant exposure to bitcoin or other cryptos. One is Grayscale's bitcoin Investment Trust (GBTC). It's attracted $1.2 billion in assets and is up more than 630percent this year.
More vehicles could emerge soon if plans to offer futures contracts proceed at CME and CBOE. ETF provider VanEck's recent SEC filing to create a bitcoin ETF was withdrawn because of a lack of futures.
The surge in bitcoin's value is a boon for Coinbase, an exchange where crytpocoins can be bought, sold and stored in wallets. Coinbase added more than 100,000 users Nov. 2 in a 24-hour period after CME Group announced its plans to introduce bitcoin futures by the year's end, Bloomberg reported.
In a picks-and-shovels move vs. actually holding bitcoins, ETF provider Reality Shares has filed to offer Reality Shares Nasdaq Blockchain Economy ETF, which would invest in companies that commit significant resources to blockchain technology, the Street.com reported. Blockchain is the technology behind bitcoin and other cryptos.
What is bitcoin?
bitcoin arrived on the scene in 2009. The digital currency is created and held electronically. Its value stems partly from the fact that it's decentralized; no single institution or government controls the network. It was developed based on a proposal from a software developer called Satoshi Nakamoto, according to CoinDesk, which tracks cryptocurrency prices and reports on events in the crypto space. Low transaction costs are another feature along with instantaneous transfers.
Perhaps its biggest attraction is that its supply can't be increased or decreased at the whim of a controlling entity. Similar to gold and other precious metals, bitcoins can be "mined," but it's done by using computing power in a distributed network. And like gold, bitcoin supply is limited. And it's headed toward terminal creation.
Bitcoin rules state that only 21 million bitcoins can ever be created, though the coins can be split into smaller parts. That could make bitcoin, like gold, an attractive inflation hedge, backers say. There are 16.67 million bitcoin in circulation now.
On the other hand, the potential creation of new digital currencies creates "the possibility of limitless supply of different cryptocurrencies," undermining the value of existing ones, UBS warned recently.
Bitcoin vs. gold
SPDR Gold Shares (GLD), an ETF that tracks the price of gold bullion, is up about 11percent this year. That might look meager next to bitcoin's surge. Hence, internet news searches for bitcoin now outnumber those for gold.
But cryptocurrencies have been volatile. On the way to its all-time high this year, bitcoin plunged 28percent from $2,682.59 on June 12 to $1,938.94. And it plummeted 35percent from $4,950.72 on Sept. 1 to $3,336.41 on Sept. 14.
Critics warn of a bubble. "The relatively high volume of cryptocurrency turnover, against limited real-world use, suggests that many buyers are seeking speculative gain, never intending to use cryptocurrencies to make a real-world transaction," UBS analysts said in report quoted by CNBC.
The blockchain software behind bitcoin makes the digital currency a method of transferring value, but unlike at, say, a bank or real estate company. With blockchain, those expensive middlemen are no longer needed to ensure a transaction takes place as intended, a protection supplied by the blockchain software itself. The result: faster and cheaper transactions.
And since blockchain and cryptocurrencies offer various layers of anonymity, they are seen as attractive to those living in countries where transfer of wealth is restricted. Detractors say cryptos also draw drug dealers, money launderers and tax dodgers along with legitimate investors.
Coinbase is involved in a lawsuit in which it's trying to fend off IRS attempts to scan customer accounts for unreported taxable gains, Bloomberg reported.
How people invest in digital currencies
Those who want to own cryptocurrencies directly can go to exchanges to buy and trade them. Some of the largest are U.S.-based Coinsetter, Coinbase, Cryptsy, London-based Bitsamp and Bulgaria-based BTC-e.
They'll need what the industry calls a wallet to store the private keys that give access to cryptos. Major exchanges offer soft, or hot, wallets for customers. Such wallets are available for desktop computers and mobile devices and include bitcoin wallet, Mycelium, Xapo and Blockchain, according to Coindesk.
Hard wallets in the form of flash-drive like devices bring an extra layer of security, by limiting exposure to the internet. They have to be plugged into a computer or phone before they can be spent. Three popular ones, according to Buybitcoinworldwide.com, are Ledger Nano S, KeepKey and Trezor. Just remember, don't lose it, forget your password or fail to back it up, or you might lose your cryptocurrency forever.
While proponents extol the fraud-proof safety of blockchain technology, wallets have proved vulnerable. In the latest mishap, an estimated $280 million of Ethereum ether coins were locked up after a user accidentally deleted the code needed to access digital wallets hosted by Parity Technologies. The freeze affects all multisignature wallets created on Parity after July 20.
Ethereum has jumped 3,810percent this year from $8.03 on Dec. 31 to $313.98 on Nov. 13. It's 20percent off its Sept. 1 high of $390.34.
Meanwhile, the financial industry is moving ahead.
In other moves by financial companies to bring bitcoin to investors, on Sept. 6, CoinIRA, Goldco's digital currency unit, launched its new Digital IRA Bundles. The bundles, available in amounts of $25,000, $50,000 and $100,000, come prepackaged with digital currencies. Investors can choose from three portfolios based on their risk appetite: conservative, moderate or aggressive. The conservative bundle is made up of 50percent bitcoin, 41percent Ethereum and 3percent each in Ether classic, Litecoin and Ripple.
Could exchange traded funds make digital cash more widely accessible?
"A diversified ETF that has some exposure to cryptocurrencies will likely be somewhat less risky than direct investment," Ben Johnson, director of global ETF research at Morningstar, told IBD. "But that's a bit like comparing the risks associated with juggling knives to those you'd face juggling chain saws."
Thus far no exchange traded funds trade on a major exchange like SPDR Gold Shares or iShares Gold Trust (IAU). Grayscale Investments' bitcoin Investment Trust, which launched May 4, 2015, trades over the counter. Grayscale had filed for SEC approval to trade GBTC on NYSE Arca, but on Sept. 27 withdrew the application, remaining as a less-regulated investment trust.
Morningstar Direct lists GBTC with its ETFs, but there doesn't appear to be an efficient arbitrage mechanism that keeps the price and NAV in balance. GBTC recently traded at a 44percent premium to its holdings.
GBTC shares fell as much as 54percent from an Aug. 31 high but are still up more than 600percent this year. They started tumbling 20percent Sept. 1 after short-seller Citron Research called GBTC the "most dangerous way to own bitcoin" and said it should trade no higher than $550 a share.
"Right now, many investors are using the bitcoin Investment Trust, which is arguably even riskier than bitcoin because it trades at high premiums, which means you could lose money even if bitcoin doesn't go down," Eric Balchunas, ETF Analyst with Bloomberg Intelligence, told IBD. "In contrast, the ETF structure and its creation/redemption process would give investors the best possible chance to get A fair deal on investing in bitcoin. ETFs have proved themselves in terms of being able to handle all kinds of non-equity holdings, such as bonds, physical gold and derivatives."
Proposed ETFs in the SEC review process
Potential ETFs under review by the Securities and Exchange Commission include Winklevoss bitcoin Trust, which the SEC rejected in March amid concerns including lack of liquidity and regulation. Officials are again reviewing the ETF candidate, a seemingly recurring process over the past three years.
ETF provider ProShares on Sept. 27 filed with the Securities and Exchange Commission for a ProShares bitcoin ETF and ProShares Short bitcoin ETF. Instead of owning the currency, both ETFs plan to track bitcoin futures contracts, which are not yet available.
CME Group and Cboe Global Markets have said they plan to offer bitcoin futures as early as this year, pending regulatory review.
But the same day, VanEck withdrew its Aug. 11 application for VanEck Vectors bitcoin Strategy ETF, which would have also invested in bitcoin futures. According to VanEck's application withdrawal letter, the SEC's policy is to not review a registration statement until the underlying instruments (bitcoin futures contracts) become available.
Even Fidelity Investments is dipping its toes in the cryptocurrency field by teaming up with Coinbase. Fidelity's innovation unit on Aug. 9 said it will allow Fidelity customers to view their bitcoin, Ethereum and Litecoin balances in their Coinbase wallet accounts.
Balchunas puts the odds at about 50/50 of a new ETF option in the next two years.
"There have been two key developments since the SEC rejected it in March," he told IBD. "One is the likelihood of a regulated bitcoin futures and options markets, and the second is that the SEC's changing with the new administration, and its brand-new head of the division of investment management was a lawyer at the same firm that represented the Winklevoss twins' bitcoin filing."
Still, caution is warranted.
Other ETF choices
"In an ETF wrapper, volatility of bitcoin could prove higher than alternative currency-based products and investors will need to be prepared," Todd Rosenbluth, CFRA's Director of ETF & Mutual Fund Research, told IBD. "Interestingly, ARK Innovation (ARKK) and ARK Web X.0 (ARKW) provide exposure to bitcoin, but have diversification to more traditional equity investments such as Amazon.com, Tesla and Twitter, dampening the risk."
ARK Investment Management, which runs six ETFs, offers exposure to bitcoin and was the first ETF to own GTBC shares, which has helped boost the funds' performance.
ARKK and ARKW were the top two sector ETFs based on their year-to-date returns through Nov. 10, according to Morningstar Direct, with respective gains of 73percent and 71percent.
ARKK has attracted $209 million in assets since its October 2014 launch; ARKW has gathered $136 million since September 2014. Both funds bear a 0.75percent expense ratio.
Even as more options unfold for investors seeking exposure to bitcoin and other virtual currencies, investors should keep in mind potential risks.
"If market prices retain any useful informational content, which theory suggests they do, then the 10x run-up in the crypto market capitalization over the last year signals there is something important taking place," ZenCash co-founder Rob Viglione said. "Whether that something ends up being radically transformational, or simply a speculative delusion is yet to be seen."