Back to the drawing board for bitcoin ETF backers

Would you invest into an asset that, quote: “may be illegal now, or in the future”?

It’s an interesting question, especially because the warning clause above is taken directly from the prospectus of the Winklevoss Bitcoin Trust — the entity vying to become the world’s first exchange-traded fund linked to the decentralised digital currency, bitcoin.

The clause forms part of an extensive “risk factors” section in the prospectus that runs to some 25 pages, covering potential investment hazards including market manipulation, sovereign intervention, changes to trading regulations, sabotage, fraud, hacking, conflicts of interest, not to mention possible taxation costs.

For would-be investors, there is also the significant risk that, if listed, the ETF securities will trade at a substantial discount or premium to the actual price of bitcoin. That’s because of the different operating hours between the niche Kansas-based Bats Global Markets exchange where they would trade and the unregulated global Bitcoin Exchange Market, which operates 24 hours a day.

And bitcoin is well known for its daily volatility, with the price of the cryptocurrency dropping by more than $US100 in a matter of minutes last Wednesday on nervousness around the ETF ­approval and a crackdown on bitcoin trading in China.

For now, the bitcoin ETF plans are in stasis.

The only thing that stood in the way of the 35-year-old Winklevoss twin brothers, Tyler and Cameron, who are backing the ETF — better known for suing Facebook founder Mark Zuckerberg for allegedly stealing their idea to create the social network — was the US corporate regulator, the Securities and Exchange Commission.

The SEC’s deadline was last weekend (Saturday) and, right on cue, the regulator issued its verdict: it decided to block the ETF listing, for now at least.

At the heart of the SEC’s ruling was one simple fact: bitcoin is a totally unregulated trading and investment commodity, and the SEC wasn’t prepared to stick its neck on the line by opening up the bitcoin floodgates to small investors, to an asset that is effectively lawless.

Bitcoin buyers and sellers currently use so-called “digital wallets” to trade over computers using blockchain technology — which is used to record a permanent record of transactions across an online network. An exchange-traded fund would effectively eliminate the need for investors to trade that way as they would be able to buy units on-market.

The immediate lead-up to the SEC ruling saw bitcoin traders bid up the price to a record high of $US1300 on Friday. Earlier in the week, as the cost of buying one bitcoin became even more expensive than an ounce of gold, and kept on soaring, most bitcoin marketers and traders believed a positive SEC ruling was virtually in the bag.

So what’s next for bitcoin? Over the weekend Tyler Winklevoss, chief financial officer of Digital Asset Services, stated: “We remain optimistic and committed to bringing COIN to market, and look forward to continuing to work with the SEC staff.”

Two other bitcoin ETF applications were also hanging on the SEC verdict. The Bitcoin Investment Trust, backed by Digital Currency Group, filed an application last year along with SolidX Partners, a US technology company that provides blockchain services.

The digital currency world is buzzing, and investors can expect more events to unfold over the near to medium term as product providers try to cash in. Bitcoin is just one of more than 700 digital currencies that have sprung up in recent years, none of which are formally regulated or supervised by a central banking authority because, in effect, they are not connected to any country.

It’s tantalising to think that bitcoin could be worth more than gold. After all, it is a lot less cumbersome and awkward than holding gold bars in a vault. But the reality is a little more complex.

Consider that the returns from owning bitcoin have been nothing short of phenomenal over time. The price of bitcoin has rallied almost 30 per cent since the start of 2017, and in 2016 it gained around 120 per cent — more than any other currency.

It seems many investors are prepared to take on the high risks in return for potential high returns. In the case of the Winklevoss Bitcoin Trust, there was an estimated $US300 million ($396m) of investment capital already lined up to buy into its ETF.

Some market analysts are tipping that bitcoin could hit $US3000 by the end of the year, representing an annual gain of more than 130 per cent.

In an interview on television network CNBC last week, Adam Davies of global IT and engineering services firm Altus Consulting said he believes bitcoin could go much higher.

“In terms of price this year, I think it will go up to $US3000. As it becomes more pervasive and more generally accepted, I think you’ll see rapid growth in adoption,” Davies said.

Few, if any, will dispute that the investment demand for bitcoin is intense, especially those involved in selling the online currency in Australia and elsewhere.

Australian-based bitcoin distributors point to take-up by retail investors here, including self-managed super funds.

But, with all the inherent and potential risks involved in owning and trading bitcoin, one should tread very carefully. As mentioned earlier, bitcoin remains illegal. T o quote more fully from prospectus for the Winklevoss ETF, bitcoin “may be illegal now, or in the future, to acquire, own, hold, sell or use”.

For those with a very high-risk investing profile, holding bitcoin directly or through an ETF in the future may be worth considering — but be prepared to lose your cash.