Wednesday, July 3, 2013

ETF Speculation Taken to Another Level: Bitcoins

ETF Speculation Taken to Another Level: Bitcoins

Yesterday I suggested that Exchange Traded Funds (ETFs) don’t belong in the lineup of 401(K) or state college savings plans.  Today I turn to the best example yet of a speculative ETF.  The Winklevoss twins have filed documents with the SEC to establish an ETF that would represent an investment in bitcoins. [1] 

First, some background:  the Winklevoss twins were played by Armie Hammer and Josh Pence in Social Network, the movie about the founding of Facebook.  Cameron and Tyler Winklevoss were the Harvard students who claimed that Mark Zuckerberg stole their idea in creating Facebook.  The twins have moved on to their latest venture: investing in bitcoins.
 
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Bitcoins are digital money created by a complex mathematical formula.  Governments or central banks issue currencies such as dollars, yen, or euros.  Proponents of bitcoins like to remind us that conventional currencies are prone to political manipulation and inflation.  The founders of bitcoins promise that their formula will only be able to produce a finite number of digital coins (21 million), which will prevent its debasement, and that the formula is so complex that counterfeiting is nearly impossible.  The value of money, of course, is ultimately a matter of faith.  Do you believe in the basic soundness of the United States or another country?  Or, do you place your trust in the integrity of semi-anonymous software engineers?

The value of bitcoins remains in doubt and prices have fluctuated wildly.  Fortunately, bitcoins are difficult to trade, and thus the average investor has been spared the temptation to stash some cash in bitcoins.  The Winklevoss Bitcoin Trust promises to put bitcoins within reach of the retail investor.  Instead of exchanging dollars for bitcoins, investors will be able to exchange dollars for shares in the Winklevoss fund, which in turn will buy and sell bitcoins.  Investors will pay Math-Based Asset Services LLC, a company controlled by the twins, an unspecified fee for trading and holding bitcoins. 

My issue is not with digital money.  I am positive that digital money will compete with government-backed currency in the years ahead.  Just like conventional currencies, some digital money will be sound, and other forms will be rife with scandal and fraud.  Bitcoins are merely an early attempt to create monetary value outside the conventional arena. 

It’s the ETF wrapper that is offensive to me.  By proposing a fund, the Winklevoss’s are implying that bitcoins are an investment.  As I’ve written (“What About Commodities” [February 2, 2013]), commodity investing is pure speculation.  Since a commodity produces no income, it is merely a wager on whether its price will rise or not.    However, an investment in a commodity ETF is at least an investment in something.   Currency ETFs are also speculations, but again, they at least invest in something.  For example, a Japanese Yen ETF converts the US dollars invested by shareholders into Yen and in turn holds the investment in short-term instruments that earn interest.  While the commodity and currency investment may be speculative, there is an asset somewhere in the picture.  A bitcoin ETF would be a speculation on something entirely intangible or the equivalent of nothing.

Investing in a currency ETF will always be a speculation, and shouldn’t be part of anyone’s retirement plan.  However, until a bitcoin or other digital currency has a money or bond market willing to lend in the digital currency, bitcoin ETFs shouldn’t exist.  We’ll see if the SEC agrees.

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