Bitcoin bound for ‘guns and gold crowd’

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Bitcoin is making its way from shadowy digital exchanges to the mainstream US retail fund market and even retirement accounts – much to the dismay of financial advisers.

SecondMarket, a New York-based trading platform that launched a Bitcoin fund for institutional and wealthy investors last year, intends to roll it out to less sophisticated investors in the fourth quarter.

Its Bitcoin Investment trust, or BIT, will become tradable on OTC Markets’ OTCQX, an electronic exchange, pending approval from OTC Markets and the Financial Industry Regulatory Authority, the securities industry’s self-regulatory agency, says Barry Silbert, chief executive of SecondMarket.

“Any investor in the US with a retail brokerage account will be able to buy shares,” he says.

Structured similarly to the SPDR Gold Shares exchange traded fund, BIT tracks Bitcoin price movements, providing dollar-denominated exposure to the volatile digital currency without the need to buy it directly or store it.

It is audited by Ernst & Young, and the Bitcoins in the portfolio are protected by a “state of the art” security system, Mr Silbert says. Assets were $45.9m as of April 1.

The prospect of a widely available Bitcoin fund leaves some industry gatekeepers concerned.

“I don’t even know what to say,” says Kim Forrest, vice-president and senior equity analyst at Fort Pitt Capital Group, a Pittsburgh-based registered investment adviser.

“I get that people want to have some non-government affiliated store of value, but this really is not it,” Ms Forrest says. “This is something that is totally fabricated.”

Though OTCQX-traded entities are subject to less rigorous listing requirements than those on the major exchanges, they must be sponsored by a third-party investment bank or attorney adviser. OTCQX-listed companies include Allianz, BNP Paribas and Volkswagen.

SecondMarket developed BIT in large part to create a Bitcoin investment option for institutional investors whose charters barred investment in the other available Bitcoin venues. It is broadening access to the retail market, Mr Silbert says, because Bitcoin is now already widely available through venues such as the Coinbase exchange.

“Anybody, regardless of financial net worth or sophistication, can go to a company like Coinbase and connect their bank account and buy Bitcoin, so this does not in any way open up this asset class to a broader group of investors who did not already have access to it just by buying Bitcoin directly,” he says. “Also the regulatory landscape has really been clarified and crystallised over the past 12 months.”

A retail Bitcoin fund is simply inevitable, whether or not it belongs in mainstream investors’ portfolios, says John Rekenthaler, vice-president of research at Morningstar, the fund research firm.

“There is an ETF [exchange traded fund] for everything under the sun,” Mr Rekenthaler says. “I don’t think there is a legitimate [investment] case, but I don’t think there is a legitimate case for many exotic ETFs.”

Indeed, others are racing to bring Bitcoin funds to public markets.

Cameron and Tyler Winklevoss, the brothers whose claims to founding Facebook were dramatised in the 2010 movie The Social Network, filed plans in July with the Securities and Exchange Commission, the US regulator, to launch an ETF tracking Bitcoin.

Given the SEC’s record in reviewing ETF proposals, which can languish for years before being approved, BIT seems better positioned to launch publicly first, Mr Silbert says.

The earliest launch would be late September, as that is when a 12-month lock-up period for existing BIT investors expires.

Surprisingly, retirement savers have emerged as a large constituent in BIT, accounting for 16 per cent of its investors. Several custodians handling “self-directed” individual retirement accounts, including Pensco Trust, Entrust Group and Millennium Trust, allow accredited investors to allocate retirement savings to the fund.

A far better means for shielding portfolios from central bank interventions would be commodities, Ms Forrest says.

“If you are really serious about wanting to divorce yourself from fiat currency, then real goods is what you should be buying as a store of value,” she says.

Morningstar’s Mr Rekenthaler agrees that he could imagine Bitcoin appealing to what he calls “the guns and gold crowd”.

“This is a doomsday asset,” he says. “There is clearly a segment out there in the market that listens to talk radio and thinks the dollar is going down the toilet and the US is going down and so forth, and they would argue that Bitcoin is like owning guns and gold: it is prudent because you should not have all your assets in mainstream dollar-denominated investments or standard currencies, which may fall apart.”

The argument for holding gold in retirement portfolios is no less dubious to Mr Rekenthaler.

“Your standard investment economics would say it is not necessary, it does not belong in a long-term portfolio like a retirement portfolio,” he says.

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Bitcoin: a brief history

Bitcoin traces its origins to a 2008 paper by the mysterious Satoshi Nakamoto. It proposed a form of electronic cash relying on peer-to-peer networks and cryptography, in place of central banks, to overcome the threat of “double spending” and fraudulence.

The following year, the first open-source “Bitcoin client” processing software was released, along with the first batch of 50 Bitcoins. Payments escalated from awkward novelty transactions – a pizza delivery order executed with the help of a transatlantic credit card remittance – to contraband dealings and then more legitimate purchases, including WikiLeaks contributions and WordPress blogging services. Online exchanges trading Bitcoin for conventional currencies, including Mt Gox and Coinbase, accelerated acceptance.

A year ago, market capitalisation surpassed $1bn, just as the US began grappling with the regulatory puzzle Bitcoin presented. The Treasury ruled that entities engaged in the exchange and issuance of virtual currencies constitute regulated money service businesses. In December, China’s central bank effectively banned Bitcoin by barring banks from using it in transactions, and the European Banking Authority began warning consumers of the currency’s risks.

This year, Mt Gox filed for bankruptcy after revealing more than $450m in Bitcoins had disappeared from the exchange. But demand remains high. Market capitalisation is nearly $6bn, according to Blockchain.info, a Bitcoin specialist.

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