Bitcoin: An Uncorrelated Asset Class?

By Julie Neitzel

Investors looking for new growth opportunities might want to consider bitcoin, a peer-to-peer cashless system also known as cryptocurrency. Launched in 2009, bitcoin’s value was less than $1 a unit and reached a historical high of more than $1,360 at the end of April 2017.

Today, the bitcoin market capitalization is nearly $30 billion, with $600 million of daily trading of more than 200,000 transactions. It is estimated that there are more than 10 million bitcoin “wallets” globally.

How does bitcoin work? Bitcoin users establish digital accounts, known as wallets, with private key codes that enable access to balance information and the ability to transact. The price of bitcoin is determined by demand and supply, subject to price volatility similar to a commodity or a stock. All bitcoin transactions are handled through what is called the blockchain, which is a database containing a record of every bitcoin transaction from inception. The integrity and the chronological order of the blockchain are enforced with military-grade cryptography, and it is critical for bitcoin users to use trusted blockchain exchanges to process transactions.

While bitcoin has the potential to change the way payments are made globally, there are challenges. Given its technology foundation, bitcoin is susceptible to hackers. According to Reuters, nearly one-third of the trading platforms have been hacked, while nearly half of them have shut down because of inadequate funding. Well-publicized hacking events have occurred, including the theft of $70 million from the Bitfinex platform in 2016 and $350 million from Tokyo’s Mt. Gox exchange in 2014.

Currently, more than 100,000 merchants such as Microsoft, Expedia and Walmart accept bitcoin, although adoption remains low. In 2013, Lamborghini became the first car company to accept payment in bitcoin, and Vancouver, British Columbia, became the first city with a bitcoin ATM.

Beyond the tech world, however, three out of four Americans have never heard of bitcoin, based on research done by Gfk and The Street. Additionally, the regulatory environment is evolving internationally. Earlier this year, Chinese regulators banned bitcoin exchanges, and India’s government might consider legalizing bitcoin this summer. Other countries are drafting laws to regulate bitcoin transactions, and U.S. regulators recently rejected a proposal for a bitcoin-backed exchange-traded fund.

There are benefits with cryptocurrency. Family members living in different countries can access funds within minutes, with lower costs than bank transaction fees. Capital controls and excessive costs for cross-border transitions make bitcoin appealing. Also, because it exists in the public domain, where there is no point of authority that a government can enforce, individuals have full control of their financial activity. Bitcoin is creating a global network of developers whose goal is to pool resources and continue to build the blockchain framework; it is estimated that more than 200,000 advanced computers are involved in bitcoin mining to enable transactions.

Is there a wealth management role for bitcoin? Investors in markets where there are strict capital controls (such as China) may use bitcoin and bitcoin investment products as a means to circumvent the traditional financial system through a shadow banking system, thus enabling them to export capital. U.S. investors generally consider bitcoin a speculative investment given its risk profile, and private capital has been invested in the development of the underlying blockchain technology and infrastructure, which could create significant cost efficiencies, transparency and enhanced risk management tools for asset managers.

The future of bitcoin is uncertain, but it might be the next uncorrelated asset class and an addition to managed portfolios. As always, investors should confer with their wealth advisers about the risks and opportunities.

Julie Neitzel is a partner and adviser with WE Family Offices in Miami and a board member of the Miami Finance Forum. Contact her at Julie.Neitzel@wefamilyoffices.com or 305.825.2225.

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