Do Bitcoin ETFs matter?

This article is first published on The Business Times.

The first Bitcoin-linked exchange-traded fund (ETF), BITO, launched in the US on 19 Oct 2021. Other Bitcoin-linked or physically-backed ETFs and ETNs have been around for some time in other markets, but this new ETF attracted a lot of attention because it is listed in the US.

By numbers it was a major success, with over 1 billion US dollars in volume on its first day of trading, over 1 billion US dollars in assets under management after two days of trading, marking it as one of the most successful ETFs debuts on record.

We keep hearing a narrative that Bitcoin is the next gold, the store of value of choice for the digital age. The expectation is that ETFs matter and will really launch it into the mainstream because it offers investors an opportunity to gain exposure to Bitcoin returns conveniently without the need for an account at a cryptocurrency exchange and for a crypto wallet.

If you asked me to wager on where BITO would be trading after two weeks, I would have definitely thought positively, but it is down around 9% as of writing this article, with the US S&P 500 up around 3% in the same period. Granted, two weeks in the context of the crypto or stock market is insignificant, but given the massive volume and media attention on BITO in the build up and aftermath, I am surprised.

The ETF effect on gold

The same narrative was used when gold ETFs first launched 17 years ago. The ETF GLD now manages over US$55 billion, and at one point there were over one hundred ETFs to track the price of gold, but has it changed the course of gold?

Since the first gold ETF launch, gold has had an annualised return of 8.65%, while stocks returned 10.40% in the same period. Over the last 50 years, gold has had an annualised return of 7.75%, versus 11.01% for stocks.

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My conclusion is that the gold ETF has provided more convenient access to gold as an asset class, but not made a huge difference to its price trajectory. ETF or not, if people really believe in owning an asset they will find a way to buy it.

Gold and Bitcoin are priced by the market, and as long as more money thinks that it is worth holding as a store of value, the more demand there will be than supply, and the more its price will go up. The inverse is of course true, too. The same goes for the price of art, stocks, currencies, watches, wine and more. Some have more utility in everyday life than others but they are the just result of market perception. They will not feed your family or keep you warm at night.

Does rising inflation mean we need to hold gold or Bitcoin?

In August 1971, direct convertibility of US dollars into gold was abolished. Without a doubt, this caused some stress on the markets and there was a flight to gold in the 1970s, marked by an impressive annualised return of over 26% for the ten years that followed. But the relationship between gold and inflation over the next forty years is not clear. The 1980s and 1990s had relatively high inflation and impressive stock market returns, versus gold’s negative return. The 2000s had relatively lower inflation and gold beat stocks by a mile.

Bitcoin was founded in July 2010 and has been alive during a great asset price bull run. We have no idea what a large and sustained market correction would do to the price of Bitcoin. We also don’t understand the leverage employed on Bitcoin holdings today. What we have seen in a few market corrections is Bitcoin behaves like a high growth stock and plunges faster and harder than the overall stock market.

In the third quarter of 2018, stocks were down over 15% and Bitcoin was down 45%. In February to March 2020, stocks were down 20% and Bitcoin was down 31%. Just last month in September 2021, stocks were down 5% and Bitcoin was down 8%. Bitcoin is around 8x more volatile than stocks, which makes it far too jumpy to be a store of value. Both are near all-time highs today and clearly somewhat correlated.

Speculate if you must, but cover your essential investing first

What remains very obvious through all this data is that an investor with enough time should ride out stock market volatility to capture higher expected returns. This does not mean go out there and pick your favourite stocks - it means to be diversified and low cost in order to be compensated for the risk you take. Stocks will be volatile and have had a history of dropping by over 40% in a short period of time, but this is not necessarily tied to inflation.

50 year total returns for stocks were over 180x, gold - the favourite store of value - had a return of 40x, and both did much better than inflation of 6x.

Fundamentally, I think this makes a lot of sense. Stocks are ownership in companies, which are the best gauge we have of collective human effort. Our technological advances, competitive spirit, desire to innovate and connect are embedded in productivity growth and long-term stock market returns.

Each of your investment goals should be the right combination of diversified stocks and bonds depending on the amount of time you have until you need to use the money in the real world. These goals make up your overall portfolio and should not be changed unless your essential life goals have changed.

Speculate on gold, Bitcoin, single stocks, and macro predictions if you are really itching to do so, but know that outcomes will be random and should not be depended upon for your essential wealth.

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