Bitcoin ETFs bring new questions, worries to advisors

Brett Bernstein has a simple question for clients who come to him with curiosity about bitcoin and other digital assets.

"If you were to go with me to Las Vegas for the weekend, how much would you be willing to put on one number and one color at the roulette wheel?" said the CEO and co-founder of XML Financial Group in Bethesda, Maryland.

With the Securities and Exchange Commission's historic approval on Jan. 10 of 11 exchange-traded funds tracking the value of the cryptocurrency bitcoin, Bernstein and other advisors are likely to hear only more questions about the possible benefits and downsides of digital assets.

Let's have some fund

For many advisors, exchanged-traded funds are one of their clients' best friends. ETFs tracking broad market indexes like the S&P 500 offer investors exposure to a vast array of stocks. And because the funds are bought and sold on public exchanges just like equities and bonds, they also make it easy for clients to pull money out as needed.

But the new bitcoin ETFs are a different animal. Rather than tracking all the stocks in a particular index, they offer ownership in only one particular asset: bitcoin. And bitcoin has proved to be fairly volatile.

The most widely known cryptocurrency now trades at around $40,000 and, in the past three or so years, has seen its price rise as high as $65,000 and fall below $12,000. Its value increased by 160% in 2023 amid widespread expectation that the SEC would approve bitcoin ETFs only to fall slowly in recent weeks.

Such fluctuation is reason enough for many advisors to be skeptical. Bernstein said he does not rule out cryptocurrencies, especially for clients who have enough money to shoulder losses and enough appetite for risk to try something outside the norm. 

But he does caution them to not put down anything they can't afford to lose. The new ETFs may have made it easier to invest in bitcoin, Bernstein said, "but we as a firm have not changed." 

"It's still a very speculative investment," he added. "And I think it's inappropriate for a lot of clients."

Flowing in

The 11 new bitcoin ETFs have proved popular to investors, drawing in about $4 billion within a week of their approval. Lori Van Dusen, the CEO and founder of LVW Advisors in Rochester, New York, said her clients have taken note of the new opportunity.

She said even some of the large and mid-sized institutional investors her firm works with have begun to ask about digital assets, whereas in the past they had "zero interest in even talking about this." Van Dusen said some of her clients — who tend to be high net worth and ultrahigh net worth — like to buy gold as a hedge against the possibility that the U.S. dollar will plummet in value amid ballooning federal deficits.

Some now think bitcoin and similar assets can serve a similar purpose. Others, Van Dusen said, look at cryptocurrencies as offering them an opportunity to be a venture investor supporting one of the next great leaps in technological innovation.

An advisors' chief responsibility in all of this, she said, is to help clients gauge how much they can afford to put into crypto with the understanding that "you could lose everything."

As a rule of thumb, Van Dusen said she thinks no investor should have more than 5% of a portfolio in digital assets, a figure that of course should be adjusted down depending on individual circumstances. Van Dusen said she herself has invested in bitcoin — partly as a hedge against the U.S. dollar — and has "done pretty well."

Regulatory mixed blessing

Although the funds have received the government's official sanction, many regulators still view them with skepticism. SEC Commissioner Gary Gensler backed approval for the ETFs only after his initial attempt at blocking them was swatted down by a lawsuit. In giving them funds the greenlight, he cautioned that bitcoin is a "speculative, volatile asset that's also used for illicit activity including ransomware, money laundering, sanction evasion and terrorist financing."

Regulators have also been urging financial advisors to take care in their discussions of bitcoin and other digital assets with clients. The Financial Industry Regulatory Authority, the brokerage industry's self-regulator, released a report on Tuesday suggesting that firms are violating its communications rules in a good deal of what they tell investors about crypto. 

Looking at 500 communications that firms had with their clients on digital assets and similar topics, FINRA discovered possible violations in 70% of them. Among other red flags, some brokerages were found to be implying the crypto assets can act like cash or cash equivalents.

Almost all advisors agree that caution is due with digital assets. But some take a slightly more favorable view than others.

Many investors already have it

Ric Edelman, the founder of the Digital Assets Council of Financial Professionals, or DACFP, said 40% U.S. adults already own bitcoin and thus are likely to have taken some notice of the SEC's approval of bitcoin ETFs. Financial planners, he said, should jump on the opportunity to explain to investors what these new funds mean.

He said DACFP, which offers financial planners an online certificate in blockchain and digital assets, has seen a sharp increase in the number of advisors who are reaching out for help understanding bitcoin ETFs. In response, it released an Advisor Toolkit offering answers to some of the more commonly asked questions.

In keeping with his belief that more investors could benefit from putting money in digital assets, Edelman cheered the arrival of bitcoin ETFs. Giving the usual caveat about every investor's circumstances being different, Edelman said, "Bitcoin is still a very risky investment, so a 1% to 5% allocation would not interfere with a client's ability to retire in financial comfort if it were to become worthless. Meanwhile, a 1% to 5% allocation can materially improve the overall return of the portfolio if bitcoin performs as well as many predict."

You can always walk away

Others remain skeptical. Ryan Kenny, a director and portfolio manager at Crestwood Advisors in Boston, said it's incumbent upon him to listen to his clients' investing ideas and try to accommodate them within reason. That's true even if they're considering a risky asset like bitcoin.

Kenny agreed that anyone committing part of a portfolio to digital assets should take care to keep the allocation small. Even then, his preference is to guide clients to long-term investments in well-understood assets like quality stocks and bonds.

The trouble with cryptocurrencies, he said, is not only in their volatility. 

"It doesn't produce earnings or dividends, making it difficult to assign any intrinsic value to it," he said. "Those things combined don't line up with our investment philosophy."

Bernstein of XML Financial Group said advisors of course can't be forced into doing something that they firmly believe would go against their clients' best interest. If an investor insists on putting an unreasonably large sum of money into cryptocurrencies or other unusually risky assets, sometimes the best response is to walk away. 

"If someone comes to me and says, 'I want you to put 65% of my portfolio into bitcoin,' I'm going to say, 'I think you are committing financial malpractice and potentially financial suicidal,'" Bernstein said. "And if they insist, I'm going to say they need to take their business elsewhere, because I have a responsibility not to allow clients to do something that would potentially cause them serious harm."