There’s been plenty of noise lately about the meteoric rise in value of the digital currency Bitcoin. But how should SMSFs think about them from an asset allocation perspective?
There’s been plenty of noise lately about the meteoric rise in value of the digital currency Bitcoin. But are Bitcoin and other cryptocurrencies investible assets and if so, how should self-managed super funds think about them from an asset-allocation perspective?
Bitcoin was created in 2009 as an electronic payment system. Its underlying technology is called blockchain. It is independent of any central authority and no single institution or country controls the Bitcoin network.
As the name suggests, every transaction that has ever involved a Bitcoin can be publically seen on the underlying blockchain ledger.
This offers a number of benefits. As all users can see transactions on the ledger, it reduces the risk of counterfeiting and increases trust. It also makes Bitcoin extremely portable – as there is no underlying physical currency there’s no need to carry around notes.
But Bitcoin also has a number of limitations, largely due to its immaturity. A key factor is its price volatility. In December 2016 one Bitcoin was worth about US$800. Now it’s worth US$8000 – after recovering following a price crash down to US$6000 in November this year, due to a number of factors.
The first being the split in the currency. This year Bitcoin has split twice, due to capacity constraints on the network. It became very slow to create new Bitcoins, so it split into core Bitcoin and cash Bitcoin.
China also announced it was cracking down on its citizens using Bitcoin as an alternative to foreign currency, which also drove its price down.
AMP financial planner Andrew Heaven explains Bitcoin is part of a group of digital currencies.
“Cryptocurrencies are a US$112 billion market turning over up to US$5 billion a day. There are thought to be more than 900 different cryptocurrencies, which is more than physical sovereign currencies. Bitcoin and Ethereum are the two most commonly traded of these,” says Heaven.
“There are only 21 million Bitcoins in existence. These coins can be divided into smaller parts, the smallest unit is one hundred millionth of a Bitcoin and this is referred to as a Satoshi, after Bitcoin’s creator,” he explains.
Bitcoins are bought and sold through cryptocurrency exchanges, or purchased directly from others on Bitcoin marketplaces. You can exchange Bitcoins for other currencies, as well as for services and goods.
“The Bitcoin system is peer-to-peer. Users directly transact without an intermediary,” says Heaven.
“To buy Bitcoins, you must first establish a Bitcoin wallet to store your Bitcoins. As there is no physical currency, the value is stored electronically,” he adds.
There is a range of wallet options. These include a software wallet stored on a computer, a web-based wallet or a vault.
“Each option has varied ease of access and different levels of security. The equivalents for regular currency would be keeping cash at home, having money invested in a bank account or having cash stored in a vault at a bank,” says Heaven.
Establishing a wallet in Australia is like opening a bank account and users are subject to conventional banking requirements to verify identity and the source of funds. Although there is a range of exchanges on which to trade Bitcoins, he warns they don’t provide the same level capital protection as a bank might.
But aside from the practicalities of holding Bitcoin, there are many other considerations SMSF investors should make when thinking about Bitcoin as an investment. Most notably the wild fluctuations in its price are a key factor.
Says Heaven: “The recent volatility in the value of cryptocurrencies is a warning. The primary function of any currency, crypto or otherwise, is to be a reliable store of value. With rampant speculation and competition from alternative cryptocurrencies having a large bearing on the setting of value, cryptocurrencies are far from being a reliable store of value.”
The fund’s trust deed would also have to allow cryptocurrency, or at least alternative investment. This asset class tends to form only a small part of most fund’s asset allocation and it’s likely prudent investors would only have a very small exposure to digital currencies, or hold these investments outside the super environment.
It’s important to recognise funds in the super environment must meet the sole purpose test, which is that they must be invested so as to support the member’s retirement. Any Bitcoin investment must meet this test.
In the event an SMSF trustee does allocate funds to Bitcoin, it’s important to recognise the ATO’s position, which is that income and profits derived from Bitcoin transactions are taxable.
As Heaven notes, cryptocurrencies should be considered a “frontier” market with inherent risks and extreme volatility.
“Over time the market will mature as legitimate uses by mainstream companies increase, supported by appropriate government regulation. For now, though it is a case of buyer beware,” he says.
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