June 10, 2024News

We Finally Have Access to a Bitcoin ETF. Now What?

The cryptocurrency investing landscape continues to shift as stakeholders reevaluate the position it should hold in a portfolio

By Ivory Johnson, CFP®, ChFC – June 2024

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Ivory Johnson, CFP®, ChFC, is the founder of Delancey Wealth Management, LLC (www.delanceywealth.com). Mr. Johnson has a B.S. in finance from Penn State University, has been certified by the Digital Asset Council for Financial Professionals, and is a member of the CNBC Financial Advisor Council.

Statements are opinions and not guarantees. Investments mentioned have potential risks and uncertainties.

The day after Christmas can be quite a letdown for children who got all the gifts they’re going to get for the holiday season. Santa comes once a year, but for crypto enthusiasts, the bitcoin ETF was a once-in-a-lifetime confirmation, the culmination of crypto’s assimilation and an unprecedented regulatory triumph.

Other asset classes have come into the fold of legitimacy before bitcoin burst onto the scene, but they had already established themselves as securities, their DNA hatched from predecessors in long-established and regulated markets. Bitcoin, on the other hand, was an idea made whole in the body of a technology that didn’t exist 15 years ago.

Suffice it to say that informed detractors still exist on both sides of the argument and for good reason. After all, the traditional valuation methods do not exist with digital assets. There is no cash flow to discount, no balance sheet to dissect, no market shares, and no industry peers for comparison. The lack of any centralization can be frightening to investors who believe the markets are already efficient and that regulators are required to keep enough sharks out of the water to make markets safe.

Decentralization, however, is what popularized bitcoin—the initial hazards of obscure websites its biggest obstacle to adoption. It was later securitized in clumsy vehicles that included closed-end funds ripe with premiums and discounts as well as ETFs emboldened by futures contracts that eroded principal from the rolling over of contracts. A point-to-point ETF was to be the magic elixir that opened the door to mass adoption, and it remains to be seen what will happen now that Santa has packed up and gone home.

Institutional Interest in Bitcoin ETFs

Initial reports show promise. The SEC approved 11 spot bitcoin ETFs on January 10, and investors have poured $12.1 billion into them as of May 3.¹

Moreover, it seems the outfits known to have cast stones at digital assets must have been aiming these earthly projectiles at their competitors hoping they would ignore the obvious: Bitcoin had the potential to make blue-blood operations a boatload of money. After all, Larry Fink, the chief executive officer of BlackRock, called bitcoin “an index of money laundering” back in 2017 and later rebuffed cryptocurrencies as something his clients weren’t looking to buy.²

Lo and behold, 80 percent of the bitcoin spot ETF inflows have gone to either BlackRock’s iShares or Fidelity Investments.³ Investors are willing to roll the dice, but only if they’re familiar with the casino. The idea that crypto would occupy Wall Street through blockchain shenanigans was a mirage, this fledgling and sometimes trendy store of value gentrified in broad daylight. Larry Fink told the world that bitcoin was a scam seven years ago, did the math, and now has the fastest-growing ETF in the history of ETFs.⁴ So here we are, watching the blackjack dealer make a fee from every conceivable angle.

It’s important to consider the infrastructure and foresight required to pull off such a feat. On the surface, a spot bitcoin ETF requires five key partners: issuer, trustee, administrator, authorized participants, and a custodian. That sounds simple enough, but aside from the lack of a traditional issuer, Wall Street didn’t have the human capital or expertise to execute a bitcoin ETF with in-house talent. Instead, BlackRock secured a minority interest in the stable coin company Circle Internet Financial.⁵ They subsequently teamed up with Coinbase Global “to provide users of the asset manager’s Aladdin software platform with direct access to crypto through an integration with Coinbase’s institutional arm.”

More broadly, they had to hire experts who understood the crypto futures market, the intricacies of blockchain technology, liquidity concerns, risk management protocols with little to no back testing relative to other markets, and cybersecurity efforts, not to mention the assembly of a 24-hour trading desk. Imagine the risk to their reputation if bitcoin was indeed the tulip bubble of our day? This did not happen without a long runway or heavy financial commitments.

Advisers, Clients Driving New Demand

The institutions are beginning to weigh in, but the next evolution of demand will likely be driven by investment advisers who control over $128 trillion of investable assets for clients who are dreadfully afraid of missing out on the next big thing.⁶ It’s one thing to be the pigeon at the table and quite another to watch prosperity fly the coop without you.

Bitcoin has been the best performer of all major asset classes in four of the last five years with a total return of over 1,000 percent.⁷ If investors are concerned about the 65 percent decline in 2022, wait until they hear about 19 percent and 33 percent drawdowns in the S&P 500 and Nasdaq, respectively, during the same year. When Grayscale conducted its 2021 study, 30 percent of investors wanted financial institutions to offer bitcoin. Additionally, advisers who are uneducated and woefully obtuse about digital assets run the risk of alienating younger investors who stand to inherit $90 trillion from their parents and grandparents.⁸

Our roles are fluid. Financial advisers are often mischaracterized as the street merchants of stock market appreciation when, truth be told, our greatest value is reducing our clients’ exposures to risk. The people we serve may get disabled, suffer long-term care expenses, pass away prematurely, or be exposed to high taxes, lawsuits, and market volatility. The strategies we employ to combat these unforeseen risks will determine the quality of life our clients ultimately enjoy.

Hedging Risk with Bitcoin

To suggest that our fiscal and monetary policies are unsustainable is no longer considered to be reckless scaremongering. Instead, the chronically dovish Federal Reserve and profligate government spending resemble a processed food diet of financial engineering that values short-term pleasure over long-term pain. Why waste time in the kitchen when you can snap your fingers like Jerome Powell and have a dish of great tasting diabetes delivered to your doorstep?

The Social Security trustees recently acknowledged that it won’t have enough money to pay benefits in 2035.⁹ This leads to speculation that future retirees will receive less than what was promised to them 15.3 percent of their paycheck at a time. It’s worth noting that inflation has already given our elders a haircut because their money doesn’t go as far as it used to. The official numbers don’t paint the full picture of price increases since the BLS embedded an imaginary 34 percent decline in healthcare premiums in the CPI calculations¹⁰ and ignored the real-life 20 percent increase in homeowners’ insurance.¹¹ How do advisers defend clients against this ever-present risk?

The CBO announced that the Treasury will spend more on the interest on our debt than it does on the military,¹² our debt-to-GDP ratio is north of 120 percent,¹³ and we must refinance 30 percent of the debt held by the public in this calendar year. Refinance risk is another concern as $929 billion in commercial real estate loans are set to come due by the end of 2024.¹⁴ Goldman Sachs estimates that $790 billion of corporate bonds will mature in 2024 and another $1 trillion in 2025.¹⁵ These borrowers will migrate from near-zero interest rates to something north of 5 percent.

A market crisis has two prevailing qualities: tight coupling and interactive complexity. Tight coupling suggests that components of a process are critically interdependent; they are linked together with little room for error or time for recalibration or adjustment. Tight coupling in the financial markets exists because information begets trading, and the trades are entered and executed without pause. Once a letter is mailed, the sender can do little to stop its delivery. Bubbles do not burst because of bad economic data; it happens due to an event.

To add context, Richard Bookstaber points out in A Demon of Our Own Design that from 2007 to 2010, $1.5 trillion in adjustable-rate mortgages began to reset at higher interest rates, a third of which took place in 2007. Furthermore, the dot-com collapse didn’t materialize because investors suddenly realized Pets.com didn’t make any money. Rather, only 10 percent of new technology companies’ shares were eligible to trade, while the other 90 percent had to wait four or five years from the time the internet companies went public before they could be sold. With few shares available, a small demand resulted in large gains. Unfortunately, $50 billion worth of shares became eligible in December of 1999, $65 billion came due in January 2000, and $100 billion was unlocked over the next three months. Game over.

Investors face the impact of refinance risk on numerous fronts that would likely result in the Federal Reserve increasing the money supply to stop the bleeding. They may or may not use the term quantitative easing. Perhaps it will be a discount window or the Bank Term Funding Program that was instrumental in quelling the run on the regional banks that lacked the liquidity needed to stay afloat, the same ones that still own commercial real estate loans.

What cannot be disputed is the Fed’s pivot at the last meeting when it announced that starting on June 1 it will reduce to $25 billion (from $60 billion) the monthly cap on Treasury securities on the balance sheet that it allows to mature and not be replaced.¹⁶ This has the potential to put downward pressure on rates. When fewer bonds on the Fed’s balance sheet are refinanced with money created out of thin air, it reduces the quantitative tightening, or money being drained from the system, and on a relative rate of change basis is a synthetic form of quantitative easing. America is not alone—the Bank of England said restrictive monetary policy was taming inflation and suggested rates would be cut in the fall.¹⁷

If investors face the risk of inflation and several event risks that would invite a dovish Fed to the rescue, it can be argued that any asset that is correlated with the growth of the global money supply would serve as a hedge. The case can be made, therefore, that bitcoin is a defensive position against events that we know will come to fruition because a date has already been set, even if the subsequent effects are unclear. Odds are that one of three things would happen if high interest rates and refinance risks roil the markets: the Fed might panic and cut rates during an inflationary environment, the market might adjust on its own without the need for intervention, or something else. Anything can happen—and that’s the point.

We’re solving for the rising supply of fiat currency. Bitcoin, like any other hedge, will drag performance when the risk you’re trying to protect against fails to materialize. This is true for homeowner’s insurance, a 60/40 portfolio, dollar cost averaging, and an assortment of other strategies financial advisers employ to protect their clients’ assets. Forget the fear of missing out or the latest narratives for the time being and reconsider why bitcoin should or should not play a role in the portfolio now that we have a spot ETF. In the final analysis, we can all agree on one guiding principle: it’s not how much you make, it’s how much you keep in your pocket.

Delancey Wealth Management and Vanderbilt Financial Group are separate and unaffiliated entities. Vanderbilt Financial Group is the marketing name for Vanderbilt Securities, LLC and its affiliates. Securities offered through Vanderbilt Securities, LLC. Member FINRA, SIPC. Registered with MSRB. Clearing agent: Fidelity Clearing & Custody Solutions. Advisory Services offered through Consolidated Portfolio Review Clearing agents: Fidelity Clearing & Custody Solutions, Charles Schwab & TD Ameritrade Insurance Services offered through Vanderbilt Insurance and other agencies. Supervising Office: 125 Froehlich Farm Blvd, Woodbury, NY 11797 • 631-845-5100 For additional information on services, disclosures, fees, and conflicts of interest, please visit www.vanderbiltfg.com/discl.

Bitcoin and other cryptocurrencies are a very speculative investment and involves a high degree of risk. Investors must have the financial ability, sophistication/experience, and willingness to bear the risks of an investment, and a potential total loss of their investment. Information provided here is for informational purposes only and is not intended to be, nor should it be construed or used as investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest in cryptocurrency. An investment in cryptocurrency is not suitable for all investors. Past performance is no guarantee of future results. All investments involve risk and may lose value. There is no assurance that the objectives of any strategy will be achieved. No strategy can guarantee a profit or fully eliminate the risk of loss.

We Finally Have Access to a Bitcoin

We Finally Have Access to a Bitcoin ETF. Now What?

The cryptocurrency investing landscape continues to shift as stakeholders reevaluate the position it should hold in a portfolio

Institutional Interest in Bitcoin ETFs

Advisers, Clients Driving New Demand

Hedging Risk with Bitcoin

Endnotes

Financial Resources & Information:

Delancey Wealth Management

CNBC News with Ivory Johnson, CFP®, ChFC