Bitcoin: When does it make sense to trade real dollars for virtual money?
The virtual currency Bitcoin recently took another step closer to becoming a mainstream tool of finance, thanks to the debut of the Bitcoin Investment Trust (OTCQX: GBTC). The trust represents the first mechanism for trading Bitcoin on a public exchange, bringing it out of the shadows of alternate currencies.
What is Bitcoin?
For those unfamiliar with Bitcoin, it is a decentralized monetary system where all transactions are logged into the “Blockchain,” a giant third-party accounting ledger for worldwide transactions. The supply of Bitcoins is limited and based on increasingly difficult cryptographic puzzles that are solved by “miners” that bring Bitcoins into existence (“miners” being intentional to mimic the mining of precious metals, another limited resource).
Why was the Bitcoin Investment Trust created?
Prior to the Bitcoin Investment Trust, the only way to invest in Bitcoins was buying them either from an individual or from one of several online Bitcoin exchanges. This required tracking your Bitcoins in your digital “wallet,” an application that allows encrypted digital storage on your computer or smartphone with a private key. There is no central authority to send you a new key, so without a backup, your Bitcoins could be lost (“orphaned” in Bitcoin-speak) in case of a crash or a lost key. The Bitcoin Investment Trust makes investing easier and relatively hassle-free since you do not have to worry about storing and handling issues.
How does the investment trust work?
As a publicly traded vehicle, the Bitcoin Investment Trust also allows Bitcoins to be incorporated into some retirement accounts as a potential higher-return component, furthering mainstream acceptance.
The Bitcoin Investment Trust began as a private trust, with investors being allowed to sell their shares after a twelve-month lockup period. That period ended at the beginning of May, but original investors have been slow to sell any of their holdings. As a result, shares were scarce and the fund had been selling at a considerable premium over the Bitcoin price — although that gap has closed considerably as of mid-July.
The open-ended trust was set up to represent 1/10 of the current value of Bitcoin (as of this writing, one Bitcoin was worth slightly over $292). It is relatively small, with only $35.58 million in assets and just over 14 million shares outstanding. A fact sheet on the trust may be found here.
How has the trust done so far?
Results are mixed at best. After some volatility and sluggish trading during the early weeks of May, the Bitcoin Investment Trust has been steady at around 30 through June and July. Mainstream investors may still be slow to warm to Bitcoin due to a lack of understanding, or they may consider it too risky and unproven. The trust also charges 2 percent in fees, a relatively high rate for this type of fund.
The Bitcoin Investment Trust does have some enthusiastic backers, most notably the West Coast brokerage and investment bank Wedbush. Gil Luria of Wedbush says Bitcoin has “the potential to disrupt the existing financial infrastructure over the next few years,” especially with its potential use in cross-border online payments, micropayments (since Bitcoin can be divided into eight decimal places), and possibly in future machine-to-machine transactions (think the Internet of Things).
Competition may be coming soon in the form of the Winklevoss Bitcoin Trust, which is undergoing SEC review and would be the first official exchange-traded fund (ETF) for Bitcoins. The Bitcoin Investment Trust is not a true exchange-traded fund, although it operates like one.
If you are intrigued by Bitcoin but uninterested in the purchasing and maintenance of Bitcoins directly, the Bitcoin Investment Trust may be worth your consideration — or you may want to wait for the Winklevoss offering to compare fees. Most analysts consider Bitcoin to still be a high-risk, high-reward investment, so if you choose to invest in Bitcoins, be sure to give it the proper risk assessment in your portfolio.
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