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Investing and Retirement
Digital assets should be a part of a total portfolio. They are ideal assets for a portion of a retirement portfolio for the reasons we've already discussed in previous chapters. They provide diversification. Because they are volatile assets with price, holding digital assets for a longer duration decreases risk. Investing in both bitcoin and other digital assets can provide high risk/high returns in the portfolio as well as monetary inflation protection from the Fed's money‐printing schemes. Finally, a savvy investor can use stablecoins to generate income similar to bonds in a traditional portfolio, oftentimes with much less risk. It's counterintuitive, but holding a U.S. dollar–backed stablecoin, like $USDC, is less risky than having a U.S. dollar in a savings account because the stablecoin is overcollateralized (i.e., more assets are held as collateral than the stablecoin's value in circulation) and backed by U.S. Treasuries. And, if the investor uses DeFi, they can remove any counterparty risk from the equation. Holding three different digital assets can produce a portfolio similar to a traditional portfolio that has stocks, bonds, and gold.
Right now, people are contemplating how to gain exposure to crypto inside their retirement accounts through vehicles such as crypto funds and direct token investment. A more practical solution is to have self‐directed IRAs that hold digital assets directly. Crypto assets are bearer instruments without counterparty risk if investors can keep the digital assets directly inside a secure wallet. The smart investor of the future wants to avoid counterparty risk, and that's the beauty of digital assets executed on public blockchains. There are no intermediaries to add uncertainty or corrupt motives to your retirement planning. Think about the CeFi/DeFi historical example we talked about earlier. Those investors using DeFi instead of CeFi were not wiped out like the investors who used a CeFi firm like Celsius. Those Celsius investors are still waiting for the bankruptcy process to work out to see if they will get any of their principal back, and the answer is most likely that no, they won't. Crypto is like owning bearer bonds or physical gold. You hold it, and we have all heard the anecdote Possession is nine‐tenths of the law.
Ways to Invest in Digital Assets in Retirement Accounts
There are several ways an innovative investor can get exposure to digital assets. The most common approach, investing in an indexed stock exchange–traded fund (ETF), is not currently possible. As of the time of writing this book, the SEC has approved a futures‐based Bitcoin ETF but not a spot Bitcoin ETF. However, many other ways do exist. This section will outline ways an investor can invest using a retirement account.
Investing with IRAs
There are several ways to invest in digital assets using a retirement account. Several companies provide the option for an investor to use a self‐directed IRA. Companies like uDirect and Equity Trust Company are among many that will help an investor set up a self‐directed IRA and then from there, an investor can look to invest in digital assets directly. A self‐directed IRA is required if an investor wants to invest directly. This is one reason why so many people would like a 40‐Act‐compatible (discussed later) fund for bitcoin, ether, and other digital assets.
Using Options and Futures Accounts
There are options for options investing in crypto (pardon the pun). Options are structured derivative products, available via the Chicago Board of Options Exchange (CBOE), the only regulated provider in the United States. There are also other options contracts available by firms like FTX.US (formerly LedgerX), which provides a complete set of options on bitcoin and ether. All options trading employs leverage in the investment product since an investor is buying or selling a right to purchase or sell a fixed amount of tokens at a specific price (the strike price) by a certain date (the expiry date).
Bitcoin and ether futures are available on the Chicago Mercantile Exchange (CME). Futures contracts allow an investor to buy one contract equivalent to 5 bitcoins or 10 ether. This product will enable an investor to employ leverage as well as use a margin account. A margin account holds U.S. dollars as collateral against the purchased futures, and the margin account can have fewer dollars than the number of futures contracts held. Therein lies the leverage. Investing in futures contracts requires an investor to be accredited and able to get a commodity account.
Investing with Single‐Asset Trusts
Single‐asset trusts are a compelling way to get some exposure to the crypto markets. There are a couple of companies that provide these products. The benefit is that this might be a solution for you if you don't want to manage and store the digital asset. With these trusts, you'll need to be an accredited investor to purchase directly, although any investor can purchase units in the trust on the secondary market through a brokerage. Investors can buy units in these trusts and hold them now in a standard retirement fund, like an IRA, with an account at a brokerage firm like TDAmeritrade or Fidelity. This is much simpler than setting up a self‐directed IRA, then investing directly with coins and tokens, although there are drawbacks to trusts because they don't expand or shrink the number of units that are circulating. Instead, all the outstanding units add up to a value that may be at a premium or discount to the net asset value (NAV) they represent, which is the value of all the coins held in the trust multiplied by the price per coin.
For example, if a trust like $GBTC or $ETHE were available to a nonaccredited investor through their brokerage account, those products might trade at a significant premium to NAV. As an investor, you'd be taking a risk both on the underlying asset's price move and the premium. If the premium fell dramatically, even if the underlying asset did not move, an investor could experience significant loss. I remember a time in 2020 when the Ether single‐asset trust offered by Grayscale was trading at a 400% premium to NAV. At one point, if all the premium had been pulled out of the vehicle, investors could have experienced an 80% loss even if the underlying asset price went up or did not change!
Crypto Hedge and Venture Funds
Many crypto hedge funds focus on investing in liquid crypto assets. Our firm, Tradecraft Capital, manages such a fund. These investment vehicles are private and often exempt from certain regulatory requirements provided certain conditions are met. They are comprised of limited partners who invest in the fund and a manager who is responsible for the actual investments. A crypto hedge fund might employ many different investment strategies just like in the traditional hedge fund world. Some strategies include volatility, arbitrage, long‐only, long‐biased, long/short, quant, smart beta, discretionary, and opportunistic. Crypto hedge funds require investors to be qualified investors, which means they have a net worth of more than $2.2 million in assets, excluding their primary residence. Crypto hedge funds typically have a lockup of 12–18 months and are more liquid than their venture fund counterparts, although they often have longer‐term investment horizons.
Crypto venture funds specialize primarily in early‐stage venture investing within the crypto space. These funds invest in companies to get both equity and tokens in crypto enterprises. Venture funds typically have a 7‐ to 10‐year time horizon with a 5‐ to 7‐year lockup. Investors must also be qualified investors, just like with crypto hedge funds. This higher qualification for investors generally is required for investment vehicles like funds that charge higher fees while, generally, an investor could invest directly in a crypto startup and only need to be accredited, which means income of more than $200,000 per year for at least two years and/or a net worth of more than $1 million.
No “40‐Act” Spot ETFs (Yet)
Currently, there are no spot ETFs that give exposure to spot bitcoin or any other crypto asset, although there is a futures‐based Bitcoin ETF. Spot bitcoin refers to the actual coin asset versus some derivative investment products like futures or options, which are contracts and not the actual underlying asset. The term “40‐Act” refers to legislation, the Investment Act of 1940, which Congress enacted after the 1929 stock market crash and subsequent bear market that lasted almost a decade.
Some trusts act somewhat like an ETF, but they do have drawbacks, as discussed previously in this chapter. There have been many attempts – from the Winklevoss twins to Van Eck to Bitwise Asset Management – to launch a spot Bitcoin ETF. From interpreting communication from the SEC, we're not going to see a spot ETF anytime soon. However, spot Bitcoin ETFs do exist in other countries like Canada though an investor would need a Canadian‐dollar account with a brokerage dealing in Canadian stocks and funds.
While no spot ETF exists at the time of publication of this book, Grayscale Investments filed a lawsuit on June 29, 2022, against the Securities and Exchange Commission (SEC) for denying the conversion of its Grayscale Bitcoin Trust (GBTC) to a spot Bitcoin ETF. Since the SEC used the argument of a lack of investor protection, Grayscale Investments also lay out a reasonable argument, stating that the futures‐based ETF that was approved is riskier to potential investors than a spot ETF.
Investing in Digital Assets
Whether you're investing in a retirement account or directly, the key is to invest in the digital assets themselves. Buy the tokens and coins directly and hold them. By doing this, you'll avoid massive risk, and you'll enjoy the benefits of digital asset investing.
Toward the end of 2022's crypto winter, there was the downfall of FTX. FTX was one of two of the big‐daddy global, unregulated centralized exchanges where customers were able to buy and sell digital assets. FTX came crumbling down due to fraud and a whole bunch of reasons that we will all find out. But the main problem was easily avoidable if you weren't trying to participate in the new school of thinking bringing the old‐school way of doing things. The whole point of digital asset investing is to not have counterparty risk, which those who trusted FTX with their funds and their digital assets learned the hard way. Lessons are expensive. Investors and customers alike lost billions in the collapse of FTX. But don't mistake that for digital asset investing. The people who invested in the coins and tokens and used decentralized finance (DeFi) to lend and borrow their digital assets did just fine. They got their interest payments that the smart contracts execute and maintain, and they kept on running 24/7/365.25.
FTX was a centralized exchange that allowed its customers to buy spot digital assets – that is, the actual coins and tokens – or to buy futures contracts called perps (for perpetual contracts). Perps are a new form of futures investment contracts in that they don't have an expiration date like all other futures contracts. Many sophisticated crypto investors were using these perp futures contracts to express a long position in a particular digital asset. For example, instead of going out to a centralized exchange and buying, say, ether (the digital asset of the Ethereum blockchain), customers would buy ether perps (futures contracts) and they would get to participate in investing in Ethereum. If $ETH went up $100, then the Ethereum perp futures contract would go up (roughly) $100. The perpetual futures markets mimic the spot market, but it is not the same.
Futures contracts, like perps of digital assets, are “paper” assets. They require a counterparty, and you don't own the actual digital asset. Digital assets are bearer instruments, and although they are digital, you can own/control them; they're yours. Relate to them more like gold or stock certificates or bearer bonds. You own them, you hold them, and you control them. You can take them and hold them on your computer in a digital wallet. You can lend them out if you want and generate interest income. You can stake them in a node/pool and generate income by being a holder of a particular digital asset.
For example, with ether, you can hold your ether in a wallet. You can pay for things in $ETH. You can stake your $ETH and generate staking yield whereby you'll get paid for securing the Ethereum blockchain network.
The future potential is unlimited – and you'll want to participate in that future. Investing in digital assets and holding them directly is the key to success. They belong in a total portfolio with other active investments.