Volatile cryptocurrency investments not for everyone
By Sayem Hossain

Cryptocurrencies have been much in the news recently. In fact, it’s been hard to avoid headlines recently about “Bitcoin” or “Ethereum.” And stories about how you’d now be a millionaire “if only you had purchased US$100 in Bitcoins six years ago” are fascinating to be sure, even if there’s more than just a whiff of 20/20 hindsight to them. But with cryptocurrencies still very much in the news, is there a way for the average investor to get into these things? An even more important question: Should you?

First, a bit of background on this mysterious new asset class. Bitcoin is a new form of money called “cryptocurrency.” It’s an entirely digital currency that has no sovereign backer as does “fiat” currency (i.e., money created and backed by national governments). Cryptocurrencies are seen by some observers as the ultimate medium of exchange and the currency of the future.

Cryptocurrency relies on something called “blockchain technology.” Imagine a spreadsheet that has no central location, but exists instead as thousands of copies everywhere that can be used to validate the information and pertinent changes on any individual ledger.

The technology was initially created to support the existence of a currency that is not susceptible to the regular security flaws of current forms of “money,” with an added layer of privacy. No central body is able to manipulate the currency’s value, and thus its value is based only on the demand and the current supply.

However, like fiat money, cryptocurrencies can serve all three primary functions of money as we know it: 1) a medium of exchange for payment of goods and services; 2) a unit of account in which the value of goods and services can be expressed; and 3) a store of value, which can be saved and used to pay for work or goods later.

To make matters even more complicated, several forms of other cryptocurrencies have emerged since the advent of Bitcoin, and these are often referred to as “altcoins.” Ethereum may be the most prominent form of altcoin available in the market, and it has also seen unprecedented growth of over 70,000% in two years. Other notables in the list are Litecoin, Zcash, and even one comically named PotCoin. The latter, as the name suggests, aims to become the standard form of payment for the legalized cannabis industry.

Investment instruments

Beyond the economics and public intrigue of cryptocurrencies, portfolio managers and analysts are also beginning to take notice. Majestic Asset Management recently launched Canada’s first cryptocurrency fund. Rivemont Crypto Fund, an unlisted private offering that was launched on Dec. 8, 2017, and is available for purchase directly from Majestic only to accredited investors in Canada.

Following in the footsteps of similarly styled funds in the U.S., Rivemont says the fund will seek to “take advantage of the development of blockchain technology by identifying the most promising cryptocurrencies.” The fund aims initially to invest heavily in Bitcoin and Ethereum futures, and will eventually invest directly in the cryptocurrencies and other altcoins as they become available and gain a credible track record.

The fund itself will hold futures contracts traded on the CBOE and CME markets. The digital currencies will trade on Gemini Trust, an exchange platform founded by Tyler and Cameron Winklevoss, twin brothers who have become billionaires from owning Bitcoin. You may also recognize them as the brothers who won a $65 million lawsuit against Facebook, alleging that founder Mark Zuckerberg stole their idea for social networking while they were all undergraduates at Harvard.

However, the regulatory kinks involved in cryptocurrency funds are still being ironed out on both sides of the border. While hedge funds have the flexibility of betting on digital currencies, recent efforts to bring a cryptocurrency ETF to Wall Street have been derailed by the U.S. Securities & Exchange Commission (SEC), which cited lack of regulatory systems for cryptocurrencies and the potential for undue volatility in capital markets. Just this past week, two U.S. financial services companies, ProShares and VanEck, withdrew requests to list cryptocurrency ETFs on the NYSE.

Regulators may have legitimate reasons for concern. Bitcoin and Ethereum have both had unprecedented growth in the last few years. Many skeptics are quick to suggest the existence of a bubble, which they say is bound to burst in the near future. The recent drop in Bitcoin prices by 22% over a four-day period in December 2017 may have been all the signs that risk-averse investors needed to avoid these currencies.

Stephen Poloz, the Governor of the Bank of Canada, recently voiced his concerns about cryptocurrencies in an address on Dec. 14 to the Canadian Club aptly titled, “Three Things Keeping Me Awake at Night.” Among other things, he pondered the larger implications of the arrival of cryptocurrencies, which he argued were misnamed as currencies, and their potential effects on the cash in our pockets. He also dismissed their value as a “currency” because of their volatility, noting that a currency must act as a reliable store of value. The tax authorities agree, as both the Canadian Revenue Agency and U.S. Internal Revenue Services view cryptocurrencies as securities on which any capital gains may be taxed.

The circumstances surrounding the situation are quite evidently fluid. Details are changing weekly, if not daily. The legal status of cryptocurrencies as either a security or a currency is under fiery debate, and the volatility of their values has made them prone to constant scrutiny. It seems likely that the debate will continue for some time.

Bottom line: For cryptocurrencies, their derivatives, and funds that invest in them, it’s truly a case of “buyer beware”!

© 2018 by Fund Library. Sayem Hossain is Analyst, Analytics & Data, at Fundata Canada Inc. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. No guarantee of performance is made or implied.

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