Bitcoin, the most familiar name in the cryptocurrency world, has added a new dimension to the world of finance. Bitcoin pioneered a peer-to-peer electronic payment system that, unlike the U.S. dollar, does not have a central authority to manage and maintain the value of the currency. Bitcoin has grown in popularity since its inception but has gained notable media attention since 2020 as a result of its dramatic rise, subsequent collapse, and recent rebound. Now, with the introduction of several bitcoin exchange-traded funds (ETFs), investors are questioning how cryptocurrency, and specifically bitcoin, fits as part of their overall asset allocation.

First, a bit of history. Bitcoin emerged in 2009 as a response to the perceived shortcomings of traditional banking and centralized currencies. The initial concept of bitcoin was to:

• Provide the world with a digital currency that operates on a decentralized network
• Utilize blockchain technology, which is a digital ledger to record transactions to ensure transparency and security

Bitcoin, along with other cryptocurrencies, is created by using a “mining” process. Mining involves solving complex mathematical problems, through a computer, to validate transactions and secure the network. Miners are then rewarded for validating transactions and keeping the network secure with newly minted bitcoins.

Bitcoin has a fixed amount of supply (21 million bitcoins) and proponents argue that this fixed amount creates a store of value that is similar to physical gold but different from other currencies like the U.S. dollar. Proponents of bitcoin also point to the benefit of a decentralized currency that is free from fiscal pressures of government policy and is not bound by the economic trends of any particular region or authority.

Detractors of bitcoin provide counterarguments that include the extreme levels of volatility that make bitcoin challenging as a true store of value. Further, bitcoin transactions are anonymous, which detractors suggest lead to its significant usage for illicit activities.

The chart below shows the dramatic recent changes to bitcoin value relative to the U.S. dollar. As bitcoin gained in popularity, the price of one coin in terms of U.S. dollars began to increase quite rapidly. However, as fraudulent activity from cryptocurrency trading platforms came to light, investors pulled significant money away from digital currencies, including bitcoin, causing a rapid decline in prices.

In addition, the graph below shows the significant level of volatility present in bitcoin prices and returns. When investors think of volatility, often the stock market is considered among the highest sources of volatility in their portfolios. The graph reflects that the ups and downs of bitcoin over the last 10 years have been significantly higher than the S&P 500. This volatility is not only annually, but even day to day, as it is not uncommon for bitcoin prices to rise or fall by more than 5% on a daily basis.

In recent news, the Securities and Exchange Commission (SEC) recently approved several spot bitcoin ETFs after months of speculation. By approving these ETFs, it allows for more investors to have access to invest and/or speculate on the price of bitcoin. These ETFs can be bought and sold like stocks and do not need to be held at specialized exchanges and custodians with limited history of security. Despite a greater ability to trade via these new ETFs, they will not, in and of themselves, make bitcoin a more widely accepted currency for everyday payments and transactions. The picture below shows some of the ETFs and their expense ratios.

At Gradient Investments, the introduction of bitcoin ETFs provides a potential avenue for investment. As an example, it is possible for the Endowment Series to invest a portion of capital as part of the alternatives allocation. Another portfolio that could allocate to a bitcoin ETF is the Digital Discovery portfolio, which focuses on technological evolution and cryptocurrencies that fit within that focus. However, we continue to believe that bitcoin will remain an extremely volatile asset for the foreseeable future and investment in bitcoin requires significant due diligence. As innovations occur in the cryptocurrency space, especially as ETFs continue to proliferate the marketplace, Gradient Investments will monitor the bitcoin marketplace and communicate any changes to our philosophy.

1. https://www.bankrate.com/investing/bitcoin-price-history/