Post by stcks on Apr 6, 2017 23:25:34 GMT
SEC Rejects Bitcoin ETFs: Should You Reject Bitcoin Investments?
Apr 6, 2017 @ 03:44 PM
Advocates of exchange traded funds (ETFs) based on bitcoins are now 0 for 2 as the Securities and Exchange Commission (SEC) recently rejected two bitcoin-based ETF proposals. Nevertheless, you can still invest directly in bitcoins through various exchanges, for example. You may also invest indirectly through a bitcoin investment trust, an ETF-like investment product that is publicly quoted using alternative reporting standards and doesn’t require the same level of SEC approval as ETFs.
Before you invest, you may wonder, what are bitcoins or ETFs for that matter? An ETF is a well-established investment product that works like a mutual fund (i.e., an ETF represents indirect ownership of the assets owned by the fund), but it trades like a stock. Bitcoins are a virtual currency created by Satoshi Nakamoto, a pseudonym that sounds almost as cool as Keyser Söze (a character in the film The Usual Suspects). Other than the bitcoin creator, and perhaps some close associates sworn to secrecy, the creator’s—or creators’—true identity remains a mystery.
Great Investment? (Photo credit PHILIPPE LOPEZ/AFP/Getty Images)
How bitcoins work, however, isn’t a mystery. They’re based on a fascinating technology that has many potential applications beyond bitcoins. It allows bitcoin transactions to be conducted directly (i.e., peer-to-peer) instead of through an intermediary such as a bank.
The CFO's Critical Role In Driving Corporate Culture
Bitcoins can be used to buy things just like a traditional currency, though many people view bitcoins as investment opportunities as evidenced by the recent ETF proposals. The SEC is concerned about the potential for fraud and price manipulation in the bitcoin markets because of the markets’ lack of regulation and transparency.
Does the attractiveness of investing in bitcoins—directly or indirectly—offset the SEC’s concerns about bitcoin markets? Here are the three most compelling reasons to consider investing in bitcoins, and why they fail to make a case for taking the bitcoin investment plunge.
Reason #1: Expectation of a bitcoin price increase
The price of bitcoins has skyrocketed over the past several years from 7 cents on July 19, 2010, to $1,175 on April 6 (midday ET) of this year. That works out to a suh-weet compounded annual return of 325%.
Does this past performance imply anything about future performance? Yes, it does according to technical analysis (i.e., the extrapolation of future returns based on past returns and possibly other historical data such as trading volume). This technique has long been derided by many academics, and yet many investors use it. Indeed, there is evidence that technical analysis can produce market-beating returns in the U.S. stock markets, for example.
There are countless technical trading rules, however. Some rules may suggest you should buy based on the historical returns in the bitcoin market while others may suggest you should sell. The fact that some rules have been historically profitable in some markets may tell you nothing about the future profitability of these rules in the same markets, much less a notably different market like the bitcoin market (even if there wasn’t a concern about the potential for fraud and price manipulation).
More generally, what makes a bitcoin worth $1,175 on April 6, 2017? An economist would say “supply and demand,” but that’s about as helpful as a medieval physician attributing an illness to an imbalance in the patient’s humors, unless the economist knows the supply and demand functions for bitcoins. Notwithstanding some interesting research showing the relation between the bitcoin price and various supply and demand factors, there’s no consensus on which factors determine the price, much less the rationality of the factors.
Given the uncertainty surrounding the rationality of the current bitcoin price, what chance do you have of accurately forecasting future prices? You might think the future fixed supply of bitcoins (i.e., no more than 21 million are scheduled to be “mined” in the parlance of bitcoins) would ensure bitcoin price rises. But this supply ceiling is well known and, therefore, knowledge of this fact should not offer any special advantage in forecasting future bitcoin prices. And, who knows what the future demand will be for bitcoins.
Reason #2: Invest in an interest-bearing bitcoin account
Instead of storing your bitcoins under the proverbial mattress and hoping for a price increase, you can invest in various interest-bearing investments based on bitcoins. Just don’t confuse these investments with U.S. Treasury Bonds because, unlike U.S. Treasury Bonds, there’s no guarantee you’ll get your money back with interest in bitcoin-based investments.
To be fair, you’re also at risk of not getting your money back with interest in corporate bonds and other traditional interest-bearing investments that aren’t backed by the U.S. government. These investments, however, are typically traded in markets that operate efficiently (e.g., there is minimal risk of fraud or price manipulation). When markets are efficient, investors willing to accept more risk are rewarded with a plausible increase in their expected return. You cannot make such an assumption with a bitcoin-based investment given the concerns about the potential for fraud and price manipulation in bitcoin markets.
Reason #3: Bitcoins as a hedge against global uncertainty
There is preliminary evidence that bitcoins can serve as a hedge against global uncertainty (i.e., bitcoin prices tend to rise when global uncertainty rises). You can think of this evidence as justifying an investment in bitcoins for insurance purposes. However, this evidence is based on historical patterns over a short time period, and there is no guarantee these patterns will continue even if bitcoin markets are free of potential fraud and price manipulation concerns.
As I have mentioned in a previous article, if you really want to hedge against uncertainty, you should invest in U.S. Treasury Inflation Protected Securities (TIPS). These are the only investments that guarantee a future amount of purchasing power (i.e., the amount of goods and services you can buy with your dollars).
What about the possibility the U.S. government defaults on its obligations and TIPS investors lose some or all of their investment? The market clearly views this possibility as extraordinarily small as evidenced by its insatiable demand for U.S. government securities despite their historically low yields.
Of course, I can’t completely rule out the possibility of a collapse of the U.S. government, but what’s a pile of bitcoins going to do for you if things truly go south and we descend into chaos? If you’re really worried about a catastrophic scenario, you might consider binge-watching the TV series The Walking Dead for some preparation tips.
In summary, even without the SEC’s concerns, I think the reasons for investing in bitcoins with the hope of a price increase or as a hedge against global uncertainty are unconvincing. On the other hand, I would be interested in ETFs based on interest-bearing bitcoin investments if they received SEC approval. For now, however, I’m steering clear of all bitcoin investments.
Allan Eberhart is a Professor of Finance and Founding Director of the Master of Science in Finance Program at Georgetown University's McDonough School of Business. Follow him on twitter @profaeberhart
Apr 6, 2017 @ 03:44 PM
Advocates of exchange traded funds (ETFs) based on bitcoins are now 0 for 2 as the Securities and Exchange Commission (SEC) recently rejected two bitcoin-based ETF proposals. Nevertheless, you can still invest directly in bitcoins through various exchanges, for example. You may also invest indirectly through a bitcoin investment trust, an ETF-like investment product that is publicly quoted using alternative reporting standards and doesn’t require the same level of SEC approval as ETFs.
Before you invest, you may wonder, what are bitcoins or ETFs for that matter? An ETF is a well-established investment product that works like a mutual fund (i.e., an ETF represents indirect ownership of the assets owned by the fund), but it trades like a stock. Bitcoins are a virtual currency created by Satoshi Nakamoto, a pseudonym that sounds almost as cool as Keyser Söze (a character in the film The Usual Suspects). Other than the bitcoin creator, and perhaps some close associates sworn to secrecy, the creator’s—or creators’—true identity remains a mystery.
Great Investment? (Photo credit PHILIPPE LOPEZ/AFP/Getty Images)
How bitcoins work, however, isn’t a mystery. They’re based on a fascinating technology that has many potential applications beyond bitcoins. It allows bitcoin transactions to be conducted directly (i.e., peer-to-peer) instead of through an intermediary such as a bank.
The CFO's Critical Role In Driving Corporate Culture
Bitcoins can be used to buy things just like a traditional currency, though many people view bitcoins as investment opportunities as evidenced by the recent ETF proposals. The SEC is concerned about the potential for fraud and price manipulation in the bitcoin markets because of the markets’ lack of regulation and transparency.
Does the attractiveness of investing in bitcoins—directly or indirectly—offset the SEC’s concerns about bitcoin markets? Here are the three most compelling reasons to consider investing in bitcoins, and why they fail to make a case for taking the bitcoin investment plunge.
Reason #1: Expectation of a bitcoin price increase
The price of bitcoins has skyrocketed over the past several years from 7 cents on July 19, 2010, to $1,175 on April 6 (midday ET) of this year. That works out to a suh-weet compounded annual return of 325%.
Does this past performance imply anything about future performance? Yes, it does according to technical analysis (i.e., the extrapolation of future returns based on past returns and possibly other historical data such as trading volume). This technique has long been derided by many academics, and yet many investors use it. Indeed, there is evidence that technical analysis can produce market-beating returns in the U.S. stock markets, for example.
There are countless technical trading rules, however. Some rules may suggest you should buy based on the historical returns in the bitcoin market while others may suggest you should sell. The fact that some rules have been historically profitable in some markets may tell you nothing about the future profitability of these rules in the same markets, much less a notably different market like the bitcoin market (even if there wasn’t a concern about the potential for fraud and price manipulation).
More generally, what makes a bitcoin worth $1,175 on April 6, 2017? An economist would say “supply and demand,” but that’s about as helpful as a medieval physician attributing an illness to an imbalance in the patient’s humors, unless the economist knows the supply and demand functions for bitcoins. Notwithstanding some interesting research showing the relation between the bitcoin price and various supply and demand factors, there’s no consensus on which factors determine the price, much less the rationality of the factors.
Given the uncertainty surrounding the rationality of the current bitcoin price, what chance do you have of accurately forecasting future prices? You might think the future fixed supply of bitcoins (i.e., no more than 21 million are scheduled to be “mined” in the parlance of bitcoins) would ensure bitcoin price rises. But this supply ceiling is well known and, therefore, knowledge of this fact should not offer any special advantage in forecasting future bitcoin prices. And, who knows what the future demand will be for bitcoins.
Reason #2: Invest in an interest-bearing bitcoin account
Instead of storing your bitcoins under the proverbial mattress and hoping for a price increase, you can invest in various interest-bearing investments based on bitcoins. Just don’t confuse these investments with U.S. Treasury Bonds because, unlike U.S. Treasury Bonds, there’s no guarantee you’ll get your money back with interest in bitcoin-based investments.
To be fair, you’re also at risk of not getting your money back with interest in corporate bonds and other traditional interest-bearing investments that aren’t backed by the U.S. government. These investments, however, are typically traded in markets that operate efficiently (e.g., there is minimal risk of fraud or price manipulation). When markets are efficient, investors willing to accept more risk are rewarded with a plausible increase in their expected return. You cannot make such an assumption with a bitcoin-based investment given the concerns about the potential for fraud and price manipulation in bitcoin markets.
Reason #3: Bitcoins as a hedge against global uncertainty
There is preliminary evidence that bitcoins can serve as a hedge against global uncertainty (i.e., bitcoin prices tend to rise when global uncertainty rises). You can think of this evidence as justifying an investment in bitcoins for insurance purposes. However, this evidence is based on historical patterns over a short time period, and there is no guarantee these patterns will continue even if bitcoin markets are free of potential fraud and price manipulation concerns.
As I have mentioned in a previous article, if you really want to hedge against uncertainty, you should invest in U.S. Treasury Inflation Protected Securities (TIPS). These are the only investments that guarantee a future amount of purchasing power (i.e., the amount of goods and services you can buy with your dollars).
What about the possibility the U.S. government defaults on its obligations and TIPS investors lose some or all of their investment? The market clearly views this possibility as extraordinarily small as evidenced by its insatiable demand for U.S. government securities despite their historically low yields.
Of course, I can’t completely rule out the possibility of a collapse of the U.S. government, but what’s a pile of bitcoins going to do for you if things truly go south and we descend into chaos? If you’re really worried about a catastrophic scenario, you might consider binge-watching the TV series The Walking Dead for some preparation tips.
In summary, even without the SEC’s concerns, I think the reasons for investing in bitcoins with the hope of a price increase or as a hedge against global uncertainty are unconvincing. On the other hand, I would be interested in ETFs based on interest-bearing bitcoin investments if they received SEC approval. For now, however, I’m steering clear of all bitcoin investments.
Allan Eberhart is a Professor of Finance and Founding Director of the Master of Science in Finance Program at Georgetown University's McDonough School of Business. Follow him on twitter @profaeberhart