Bitcoin: Coming to an ETF Near You

I first wrote about Bitcoin in 2017 and concluded that it probably wasn’t a good investment, but maybe my grandkids would be mad at me because I didn’t buy them a coin for $4,300.

A little more than six years later, I’m a little mad at myself as the price is about ten times today. But I’m not actually mad because I don’t see it as a good investment, even though it made a lot of money.

In my first article, I said that I didn’t think it made sense as a currency because it wasn’t likely a good store of value, even though it might be a good unit of account or medium of exchange.

I stand by those arguments, but I now think Bitcoin isn’t a useful medium of exchange because I can’t go to the grocery store and buy anything with it (except in Guatemala, where it’s an official currency, although I haven’t tried it).

When crypto-related exchange-traded funds (ETFs) started hitting the market, I argued that they weren’t a good investment because the funds couldn’t hold bitcoin itself and had to get exposure through futures markets, which was expensive.

That’s been true, but the caveat will be apparent in a moment. Since the launch of one of the first funds, bitcoin is up about 1,100 percent, and the fund is *only* up about 800 percent. So, yes, you missed out on about 300 percent of the rally, but I suspect most of us would have been happy with the first 800 percent (the S&P 500 has *only* doubled in that time).

Last week, the SEC approved a series of ETFs that can hold actual bitcoin, unlike the previous generation of funds that had to get their exposure through other mechanisms. Eleven funds were approved for trading, although the SEC clearly said they don’t “approve” of cryptocurrency as an investment.

Bitcoin ETFs are a welcome addition in the sense that they will be more efficient than the previous generation, have much lower fees than the previous generation, and have some level of regulatory scrutiny.

I didn’t trust the crypto brokerages and exchanges, which seemed like the Wild West, suffered from a lot of fraud and saw several senior leaders enter prison. I imagine that’s what stock brokerages were like 100 years ago before the creation of the SEC.

We can be mad at the SEC and other regulators for missing Bernie Madoff and creating some dumb and complicated rules that we have to follow, but in the end, we want a robust regulatory body to keep our money safe.

I trust Blackrock to hold Bitcoin safely and suspect they will be liable in case of a problem. Blackrock is a much stronger hand than FTX, even if they don’t have comedian Larry David shilling for them. There are probably other good firms out there, too; I just haven’t looked into them.

I’m still a crypto-skeptic for sure, but I felt like my arguments were running out, and I was just turning into a crusty old naysayer, so I downloaded the performance history of Bitcoin to see if it made any sense in a portfolio.

Despite my best efforts to poo-poo it, the data suggest it would have made a good investment despite the risk. Bloomberg let me pull data back to 2010, and I found that bitcoin’s annual return over that period was an annualized 63.2 percent. Over the last five years, it’s cooled off to *just* 24.2 percent.

The volatility is interesting because it’s so off the charts. For the entire period, the annualized volatility of Bitcoin is 74.1 percent. That’s about four times as much as the S&P 500 over this period, but even on a risk-adjusted basis, the return is so high that it made sense.

In an all-S&P 500 portfolio, I found that the optimal allocation to Bitcoin was 5-10 percent over this period. That’s because the average correlation over that time was 0.17, which means that stocks and bitcoin performance don’t have much relationship to each other.

So, will I buy a bitcoin in one of the new ETFs? Nope, even though I am not opposed to fliers, as I think I’ve communicated before.

So, why not? A few reasons. First and foremost, I just don’t believe in crypto as an alternative currency. The main argument for crypto (other than it keeps going up) is that no government body like the Federal Reserve is printing money and, therefore, debasing it.

If I lived in Russia, North Korea, or Zimbabwe, I might be more interested, although I would probably buy gold or those dollars backed by the Federal Reserve. And stocks and bonds that are denominated in dollars.

More seriously, I don’t know why another coin won’t just come along and replace Bitcoin (or Ethereum or whatever) if one coin gets “too” expensive. As far as I know, the underlying technology that does seem pretty cool can apply to something as silly as DaveCoins. (I want to sell you some DaveCoins, but I suspect those pesky regulators won’t let me; I’ll check with our compliance officer and get back to you).

Even more seriously, I think Bitcoins are too risky. If we look at the average monthly return back to 2010, it’s 15.6 percent. Amazing. The standard deviation of those returns is 54.0 percent.

In rough terms, that means I should expect to get wiped out in one or two months out of every ten years or so. Wiped out is pretty bad – you don’t recover when you don’t have any money left.

I suppose the good news is that volatility is coming down somewhat to 22.3 percent in the last five years. The correlation is higher but still low enough to justify adding it to a portfolio. I still won’t add it, maybe because I’m a fuddy-duddy, but also because I don’t understand why it should have any value, unlike stock in a business or a loan to a company or government.

If you want to add some to your portfolio, there are probably some good (or at least better) options now, but I’d give them time to see how they operate.

Still, I won’t be joining you with my money. If Bitcoin goes up another 10x in the next six years, I will be angry at myself, although the high volatility means that it will likely be a harrowing ride that I probably couldn’t sit through anyway. To own something like that, you really have to believe, and I just don’t.