What Financial Advisors Don’t Know About Bitcoin ETFs

Bitcoin exchange-traded funds made a long-awaited splash in the market in early 2024. Asset managers rushed out of the gate with 11 SEC-approved spot bitcoin ETFs, which have racked up billions in assets under management.

Has cryptocurrency finally hit the mainstream? How should financial advisors think about its fundamentals?

Matt Hougan, Bitwise chief investment officer, joined the Big Picture in Practice podcast the talk about the future of crypto. He explains how financial advisors should think about bitcoin ETFs and their place in a diversified portfolio.

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Since its January 11 launch, the spot bitcoin ETF has become the fastest-growing ETF class of all time. This year marked the first time that funds could invest directly in crypto, instead of tracking the price via futures. Investors showed enthusiasm, pouring over $12 billion dollars into the new category through the end of April 2024.

“The bitcoin ETF is like the IPO for crypto,” Matt says. “It's the first time professional investors have been able to access this market easily.”

But Matt believes we’re only in the early stages of crypto funds’ ascendance. Large wealth management platforms and institutional consultants have yet to join the bitcoin bonanza. And ETF flows often build over multiple years.

“We’ve moved beyond the existential now to a point where we need to figure out the fundamental,” Matt says. “Advisors need to begin to unpack the fundamentals of bitcoin crypto more generally. And most importantly, what that means in the context of a diversified portfolio that they would build for clients.”

Matt says that advisors should think about bitcoin ETFs in a portfolio context. As one part of the asset mix, they could be a potential avenue for higher absolute risk-adjusted returns.

• Liquidity. Like any ETF, bitcoin ETFs can be bought and sold throughout the trading day. And unlike bitcoin trusts, shares can be created and redeemed daily.
• Low market correlation. Crypto has continued to show a relatively low correlation with most major asset classes. However, its correlation with other asset classes has trended up over time and it tends to spike during market corrections.
• Low-cost access. The expense ratios for spot ETFs range from 0.19% to 0.25%. Bitwise’s spot bitcoin ETF filing came in at 0.20%.
• Potential returns. While past performance can’t guarantee the future, bitcoin has enjoyed some jaw-dropping returns, including 150% in 2023, 300% in 2020, and 1,300% in 2017.

Bitcoin still has major detractors. Warren Buffett called it rat poison squared. Others have dismissed it a bubble. Advisors should consider risks associated with bitcoin, such as:

• Volatility. Crypto’s extreme performance swings have been on full display in recent years. Bitcoin prices have had drawdowns of at least 45 percentage points four times in the past five years.
• Valuation. Some critics have argued that bitcoin is a speculative investment, making it difficult to predict future value.

Matt has a different perspective on bitcoin valuation.

He recommends that we think of bitcoin as a digital wealth storage service. Instead of paying a fee to access that service, investors buy bitcoin. To estimate its value, he says to divide the total addressable market by the total number of bitcoin available. (Morningstar analyst Madeline Hume compared this valuation tactic to three others).

And he sees room for growth in market share. Today, bitcoin has about one-tenth the market share of gold, and Matt discounts disruptors to blockchain’s place in the market.

“People worked on creating decentralized databases for 40 or 50 years,” he explains. “The only way they figured out how to do it securely is a blockchain.”

Matt acknowledges that the impact of bitcoin ETFs could go in two directions.

Matt has an optimistic perspective. He believes that as bitcoins becomes more accessible and broadly owned, volatility and liquidity will improve.

“My view is that bitcoin will continue to move up the utility curve and the valuation curve to the point where it’s really boring and valuable,” he says. “But if you’re an honest investor, you must also admit that it could spiral the other way.”

Rising share prices and easy access could create an incentive for advisors to recommend bitcoin ETFs. This inflow could create a feedback loop that drives bitcoin prices up to unsustainable levels, not backed by fundamentals.

Matt urges investors to think of bitcoin as one piece of a diversified portfolio instead of an isolated asset.

“If I lose 5% of my personal wealth, I'm going to be fine,” he explains. “But if I have 50% of my portfolio in bitcoin, and we get the left tail, that's bad.”

How much bitcoin is too much?

Analyst Stephen Margaria dug into the risk contributions of varying bitcoin weights. Morningstar’s Portfolio Risk Score is another useful data point to compare investment risks at the holdings level.

“The good news is the right tail is big enough that even at 5%, you can have a significant impact on your returns if you're right,” Matt says.

Now that bitcoin ETFs have launched in the United States, what’s next?

Matt has built his career on “informational alpha,” or technologies with real potential that initially attracted great skepticism. He started his career in biotech, became an early expert on ETFs, and now is pioneering crypto index funds.

Matt believes real-world applications will blossom in the mainstream as throughput and transaction costs decrease. He points to stablecoins, products whose value is tied to the US dollar and available in a digital wallet.

“We’re at a point where people are reflexively skeptical of crypto, often due to behavioral reasons or a lack of understanding,” he says. “In this unique market, there may be informational alpha that people can gain by studying it closely.”