Category Archives: Guides

Crypto Investment Cheatsheet

Published / by kgao

I’m compiling a cheatsheet as a forcing function to research and remind myself of each asset’s unique characteristics. Here it is, a Google doc with comments enabled.

The coins I’ve added so far include:

  • BTC
  • ETH
  • DASH
  • XMR
  • ZEC
  • DCR
  • NEM

I will add more with time.

My areas of focus when considering a new crypto investment – and so far they are limited largely to currency coins as opposed to app coins – are:

  • Issuance rate, method, and inflation
  • Transaction types and activity
  • Blockchain funding and governance models
  • Strength of team and community

Love to hear your feedback and what coins I should add. Cheers!

How to invest in cryptocurrency if you have $10K, $100K, and $1M USD

Published / by kgao

If you have $10K USD…

Use Coinbase to buy $8K of Bitcoin and $2K of Ethereum. Use the Coinbase Vault service to store your coins and turn on 2FA.

Resist the temptation to day trade. For simplicity sake, buy all at once, or you can setup a recurring weekly or monthly buy to dollar cost average.

If you have $100K USD…

Buy Bitcoin and Ethereum and one or two altcoins depending on how well you understand them. I’ve invested in the space since 2013 and right now I own 5: Bitcoin, Ether (and a negligible amount of ETC), Dash, Monero, and Decred.

If you go beyond BTC and ETH, I can only confidently recommend Monero at this moment. Crypto changes fast so that recommendation could change in a week. But since I first bought Dash around $17, the price has gone crazy and I don’t feel confident in it anymore. Decred is a flier for me.

Use a large trusted exchange like Poloniex and GDAX and Kraken to purchase your coins – ideally in a recurring buy over a number of weeks. If you want to buy all at once, consider an OTC service like itBit. I can introduce you to some OTC brokers as well, but I’d only recommend OTC if you’re an experienced financial investor.

You can invest in exchange listed products as well, like GBTC and COINXBT. The pros include convenience, tax benefits, and some additional regulatory oversight. Cons include extra fees and counterparty risk. For more, here’s my write-up on the crypto fund investing landscape.

Keep the majority of your coins in cold storage using a service like Coinbase Vault or Xapo, or a hardware wallet like Trezor and Ledger. Electrum is also a good local wallet.

If you have $1M USD…

Continue with the above, and diversify your portfolio into a few other altcoins. Perhaps Decred or Dash or Zcash. I’d stay away from ICOs and token sales unless you really know what you’re doing.

Crypto funds become an even more attractive option, especially private funds which have investor minimums. Examples include Pantera and Logos Fund.

Dollar cost average over a number of months, or find an OTC broker.

Diversify your cold storage solutions. Don’t put all your coins in one place. Check those places routinely. Always turn on 2FA and have unique site-specific passwords and if a seed is required, save it somewhere secure.

Tracking becomes important. CoinTracking is a good tool for portfolio monitoring and reporting and taxation. I’ve tried it, but am still wedded to my hacked together Google spreadsheet.

There’s a lot more you can do to optimize your crypto portfolio as you increase your time spent and financial investment. Some of the coins offer staking services to earn a return on your holdings, eg, Dash and Decred. Follow community happenings on reddit and Slack and read read read.

But don’t day trade and don’t short, unless you want to lose money. My view is that crypto will go from a $25B market cap today to $100B by 2020. Diversify your investments, watch them closely, adjust portfolio allocations to roughly match each coin’s respective market cap, and profit.

To champagne wishes and crypto dreams! 🙂

The Cryptocurrency Funds have arrived, and they’re bringing Wall Street money

Published / by kgao

If 2013-2016 was the era of venture investment in bitcoin and blockchain startups – VCs put north of a billion dollars to work, peaking at $290M in the first half of 2016 – then 2017-2020 will in hindsight be seen as the Wall Street era. The startup equity investors have come and – in the absence of unicorn valuations or breathtaking growth – they’re starting to move on. But now the bitcoin and cryptocurrency funds have arrived, and they’ve brought public markets investors with them.

Just about every week I’ll discover a new investment fund that gives investors liquid exposure to the cryptocurrency asset class. At latest count, there are at least 5 exchange-listed bitcoin investment products, 3 US-based ETFs under review by the SEC, and hedge funds that cover just about every cryptocurrency asset type and investment strategy. By my rough estimate, these funds represent $1-2B USD in AUM, or 5-10% of the $20B in total that’s been invested in cryptocurrencies.

For clarity, I define a cryptocurrency fund as a pool of professionally managed capital, available to outside investors, where the majority of AUM are invested in publicly tradable cryptocurrency assets. Examples of such assets include bitcoin, ethereum, and the 500+ altcoins and 50+ digital tokens listed on Coinmarketcap. Thus venture capital funds who invest in shareholder equity – eg, of blockchain startups – don’t qualify.

I’ve sorted the different funds into three broad categories and wanted to give a description of each category along with some prominent examples. They are:

  1. Publicly traded funds
  2. Private buy-and-hold funds
  3. Hedge funds

Disclaimer: Please consider this information as strictly educational and not meant to represent specific investment advice or recommendations.

Publicly traded funds

These funds follow a buy-and-hold strategy and usually focus on a single asset. For now, all of them are bitcoin-only, although I expect publicly traded ethereum funds to come online perhaps as early as this year.

A management fee is charged for the service, which ranges from 1.5-2.5% per year. As more funds enter the space, fees will likely decrease, perhaps to below 1% which is what most vanilla ETFs charge. You may wonder why anyone would invest in a public bitcoin fund when you can just buy bitcoin and hold it yourself, but you could ask the same of gold. The biggest gold ETF – the SPDR Gold Trust – manages $35 billion USD. That’s double the bitcoin market cap – all in one ETF. The attractions for investors are varied, from ease of access to peace of mind to lighter regulatory regimes. The consistent price premium of Grayscale’s Bitcoin Investment Trust (GBTC) shares over the NAV of its bitcoin holdings is more evidence that such vehicles are desired.

Within the cryptocurrency universe, there are roughly two types of such funds: ETFs and ETNs (what are also called asset backed notes). The main difference is that an ETF’s value is collateralized by an equivalent value of its underlying benchmark asset – eg, bitcoin – and allows an investor to redeem their ETF shares for the asset.

An ETN doesn’t allow redemption and doesn’t make the same guarantees about how much eg bitcoin it actually holds. An ETN is better thought of as unsecured debt that roughly tracks the price of its benchmark asset but has looser reporting and compliance requirements. Because of these differences, ETNs are a bigger credit risk, and we’ve already seen this risk manifest when KNC Miner filed for bankruptcy. KNC Miner was the guarantor of the COINXBT and COINXBE ETNs on the Nasdaq Nordic, and the bankruptcy filing forced trading to a halt. Two weeks later, the investment firm Global Advisors stepped in and became the new guarantor and trading was allowed to resume.

Examples of bitcoin ETNs include BTCETI (which is co-listed on the Gibraltar Stock Exchange and the Deutsche Borse) and the abovementioned Global Advisors’ COINXBT and COINXBE.

Thus far no bitcoin ETFs have been approved. There are three US-based funds under review by the SEC. They are, in order of their filing:

GBTC is a hybrid, in that it’s currently an ETN which is filing to become an ETF. While it has filed for a $500M IPO on NYSE Arca to become an ETF, it is currently traded on the US OTC exchanges and doesn’t allow redemption of shares into bitcoin.

The only ETFs with bitcoin exposure are Ark Investment Management’s ARKK and ARKW, but these hardly count as official cryptocurrency ETFs because both hold less than 0.3% of their portfolio in GBTC.

Bitcoin IRA is an interesting outlier in that it’s a public bitcoin investment fund, available to any investors who have or want to open an IRA, a type of US retirement savings account. They allow the redemption of bitcoin, but the company is not listed on any publicly traded exchange.  You must contact them directly to invest. Bitcoin IRA charge a 15% one-time upfront fee of any money invested.

Finally, while the publicly traded funds are all bitcoin, the ethereum funds are coming. One example is the EtherIndex Ether Trust which filed in July 2016 with the SEC to be listed on the NYSE Arca, but has seen little activity since. Here are my notes on its filing. I have seen some other ethereum-based efforts and I expect at least one will be approved for public trading this year.

Private buy-and-hold funds

These differ from public investment funds in that they usually have restrictions either on investment size (eg, $100K USD and above) or status (eg, accredited investors only). They’re not listed on publicly traded exchanges, without the attendant regulatory requirements and investment disclosures, and you can’t use investment software like Bloomberg to obtain quotes and place trades. But otherwise the strategy and product and fees are similar: they offer investors comparatively simple and safe exposure to cryptocurrency and charge an annual fee for the service.

The best known example is probably the Pantera Bitcoin Fund. Pantera Capital is a blockchain investment firm which has multiple funds. One of them specializes in equity investments of blockchain startups. The one relevant for our discussion is a private bitcoin buy-and-hold fund which has over $100M in AUM and charges 0.75% annual management fee and a 1% fee for redemption.

An ethereum example is Grayscale’s Ethereum Investment Trust, which has not formally launched but will be a private product that provides qualified investors access to Ethereum Classic.

DLT10 Index is an interesting example of a private buy-and-hold fund which offers a proprietary basket of 10 publicly traded cryptocurrency assets. The index is a mixture of leading cryptocurrencies and digital tokens, with a preference for enduring assets.

Hedge funds

Last we have cryptocurrency hedge funds. A hedge fund is a pool of lightly regulated capital that invests in whatever it likes within some broad strategic parameters. They have active trading strategies including eg leveraged trading, price arbitrage, and algorithmic trading. In addition to charging a management fee comparable to the above two types of funds, they also charge a performance fee that in this space can range from 15-45%. The performance fee is only paid out when the hedge fund beats an agreed-upon benchmark, such as the price of bitcoin. So if a hedge fund can generate better returns than simply owning bitcoin, they’re paid very well for doing so. This benchmark outperformance is called alpha.

Known cryptocurrency hedge funds include:

  • Global Advisors – a Jersey bitcoin fund that is the sponsor of COINXBT and COINXBE
  • Polychain – a US fund digital token and ICO fund started by Coinbase’s first employee, Olaf Carlson-Wee and seeded with a $10M investment from prominent VC firms
  • Metastable – a US bitcoin and altcoins fund which counts some prominent Silicon Valley names among its investors
  • Logos Fund – a German bitcoin and mining fund from the founders of Genesis Mining

I believe the above mentioned funds are all actively seeking outside investment. Coinfund.io is an example of a cryptocurrency hedge fund which is no longer taking outside investors. They focus on digital token investment, what are often called ICOs, and host a knowledgeable and active community chat on Slack.

A final interesting example is the TaaS fund (Token-as-a-Service), which will exist on the Ethereum blockchain and in March will sell up to $100M of their tokens via the ICO process. The fund will keep some proceeds to fund operations and invest the remainder in a proprietary mixture of bitcoin, altcoins, and other digital tokens. Token holders will receive an ongoing percentage of trading profits.

The hedge fund space – of the three categories – is likely to see the most growth and proliferation because of its light regulatory touch, the speed to market, and the chance for fund managers to make outsized profits in a still volatile and developing asset class.

The next 3 years are a window of opportunity for starting and investing in cryptocurrency funds

We’ve entered a golden era of professionally managed money moving into liquid cryptocurrency assets. The risks that prevented Wall Street investor types from entering the market earlier – lack of liquidity, regulatory uncertainty, China trading centralization, lack of sophisticated financial products – are now reduced enough that those hungry for returns have taken the lead and others are starting to follow.

There’s no better time to start a fund or raise one, and there’s no better time to take a cryptocurrency position if you manage money, especially when you consider the past price performance of cryptocurrency assets and research that proves bitcoin’s lack of correlation with existing asset classes. An approved US bitcoin ETF will only add fuel to the growing fire.

In the coming years, the abovementioned three funds types will expand and evolve: Hedge funds will grow larger and develop more exotic trading strategies, increasingly blending cryptocurrency with mainstream asset classes like equities and commodities. Private funds will diversify from one cryptocurrency asset to multiple assets and seek listing on exchanges. Finally, publicly traded funds will expand from bitcoin to ethereum and then cryptocurrency indexes, and fees will likely come down as competition grows.

Thanks for reading! A number of people read drafts of this essay and I’m grateful for their feedback. I look forward to your comments and questions. Send me an email or find me on Twitter @kgao.

PS. I originally published this piece to LinkedIn but it got very few views so I decided to cross-post here as well 🙂

A Tale of Two Bitcoin ETFs: COIN and SolidX

Published / by kgao

ETFs are investment products that allows a certain kind of investor – usually professionally managed money – to gain exposure to a type of asset that would otherwise be difficult if not impossible due to their industry’s regulations and investment norms. There are two US-based ETFs currently under review by the SEC: the COIN ETF from the Winklevoss brothers Tyler and Cameron, and the XBTC ETF from SolidX, a blockchain investment fund. The consensus among experts is that at least one of them will be approved in 2017.

If one or both ETFs are approved, that should give be a major boost to bitcoin’s price. Some traders believe the price run-up to end 2016 – where bitcoin zipped from below 800 to above 1100 within a month – is a sign of market confidence that an ETF will be approved as early as Q1 of 2017. That doesn’t look like it will happen now, as the SEC has again extended its deadline to make a necessary intermediate decision until March 11th.

Two data points indicate ETF approval will be very good for bitcoin’s price and the legitimacy of cryptocurrencies as an asset class:

Number one: The Grayscale Bitcoin Investment Trust (GBTC), still the only US-based exchange-listed product that tracks the underlying price of bitcoin, is trading at a 30% price premium over bitcoin today. This premium was as high as 60% in 2015. This means some investors in the world would rather pay 30-60% more to gain exposure to bitcoin through a regulated and institutionally managed investment vehicle.

Number two: When gold ETFs were first introduced in the mid-2000s, led by sponsors Benchmark Asset Management and Gold Bullion Securities, the gold spot price tripled within 5 years. Many more soon followed around the world.

Having read through both the COIN and XBTC S-1 filings with the SEC, I thought a good way to help us understand them would be a comparison chart of important features.

For the time-starved, here are the main differences:

  • The Winklevoss’ Brothers COIN ETF is all in the family: they use their own Gemini family of services to buy and secure bitcoin underlying the ETF shares. They use their own Gemini Exchange Auction Price as the price index to calculate portfolio value. They offer no insurance, although they have a sophisticated and well-explained cold storage process (again, a Gemini custodial service)
  • The SolidX ETF is more diversified: it uses a portfolio of respected independent services for buying and storing bitcoin and tracking its price. Their bitcoin holdings are insured up to $125M compared to an initial offering size of $1M. But they’re fairly vague about the process for securing their bitcoin

Until I know what fees either one is charging and what the final offering size will be, I recommend the Winklevoss Brothers COIN ETF because:

  • They are a more established and invested name in the bitcoin space, having launched a bitcoin exchange, bitcoin custodial services, and made many blockchain startup investments
  • They are already one of the largest holders of bitcoins, holdings that can provide liquidity in a pinch and a deeper familiarity with the market
  • They have staked their professional reputations on bitcoin and blockchain and have every incentive to see their product and the asset class succeed, and they’ve been working harder and for longer than the SolidX team
  • Finally, though they don’t have portfolio insurance (which I assume will mean they charge lower fees), they do have what seems to be a more sophisticated and thoughtful bitcoin storage system, and their ETF baskets represent a specified amount of bitcoin to start, unlike SolidX

That is not to say the Winklevoss Brothers ETF is perfect. As commenters have rightly pointed out, there are multiple conflicts of interest. They are not registered as an investment advisor with its attendant fiduciary and governance requirements (although I don’t think SolidX is, either).

Name COIN ETF [Form S-1] XBTC ETF [Form S-1]
Listed Exchange BATS NYSE Arca
Bitcoin Exchange Gemini Exchange a mix of major exchanges (eg, Coinbase, Kraken, and OKCoin) and the OTC market for large trades (eg, $500K or greater)
Offering Baskets of 10000 shares which represent, on the first day of trading, 1000 bitcoin each Baskets of 10000 shares with no specified quantity of bitcoin represented
Initial Offering Size $65 million (1000 baskets of 10000 shares at $65 per share, a price which will change depending on bitcoin’s price at launch) $1M
Fees Don’t know Don’t know; only clue is this NYSE Arca filing, regarding transaction fees: “Such expenses may vary, but the Trust currently expects such expenses to constitute 1% or less of the value of a Basket.”
Price Index Gemini Auction’s daily bitcoin auction price XBX, a composite reference rate for the price of bitcoin
Storage Gemini custodial services – cold storage using multi-sig and chain of custody with regular audits “a sophisticated technology system specifically designed to secure its bitcoin” ( we can assume it’s cold storage, but I don’t know if it’s multi-sig and what audit and verification procedures look like)
Insurance None provided Yes, up to $125M for 3 types of insurance: crime, excess crime and excess vault

Bitcoin price drivers: what moves the long-term price of bitcoin?

Published / by kgao

*Such is the nature of cryptocurrency investment. When I began to write this post bitcoin was trading at $900. It’s now past $1100 and may well break its ath soon. If you’re deciding whether to invest now, I’d say go for it – but only in small amounts, and only with a weekly or monthly schedule of dollar-cost averaging. The bitcoin price goes through boom and bust cycles, tied as it is to human psychology and irrationality, but I’m more of a believer than ever. Imho, anything above $2K is a bubble which will inevitably burst, as it has many times through its entertaining and volatile history. Buyer beware!

Bought my first bitcoin in 2013. Down the rabbit hole I went: obsessively checking the price tens or hundreds of times a day, scanning every new item posted to the crypto subreddits, reading more whitepapers than I ever had in school, devouring every analysis and essay I could google. And like every investor who has put far too much of their net worth into cryptocurrency, I’ve developed some strong – and always changing – views on what moves the long-term price. It’s impossible to consistently and accurately forecast short term price fluctuations, subject as they are to peoples’ whims, but I have a strong conviction that cryptocurrency will be one of the greatest wealth creation opportunities that we’ve witnessed in the Internet age.

Software is eating the world, and it is finally eating money.

So the below explanations aren’t factors that move the price every day. The daily price is more influenced by factors like technical analysis and slippage and popular press. Rather, the below arguments are the fundamentals, the pillars, that drove bitcoin from a fledgling technology to a $15B market cap today, and will still be relevant when cryptocurrencies as an asset class are worth $100, something I believe will happen within ten years.

Here they are:

  • Bitcoin’s intrinsic value as a payment technology without a central authority
  • Bitcoin as an increasingly attractive asset for institutional investors and professionally managed money
  • Bitcoin as the new and better Gold
  • Bitcoin as a relatively safe and accessible currency
  • Bitcoin as an increasingly legitimate asset with government recognition and regulation
  • Bitcoin as perhaps the best speculation vehicle the world has yet seen

If you have evidence that flat out contradicts any of the below, I’d love to hear from you. As an investor it pays to be right. It doesn’t matter, really, how you arrive at the answer.

While I sometimes mention cryptocurrencies as an asset class, I try not to discuss specific coins besides bitcoin. The market of altcoins and appcoins is somewhat correlated – and the precise correlation between them is a fascinating piece of potential research that I’ve yet see. So ethereum’s success will bode well, to a degree, for bitcoin. And vice-versa. But my commentary below will try to focus on bitcoin alone, because that is the biggest market and the most stable asset. The success or failure of cryptocurrencies will depend, to an important degree, on bitcoin.

At a very high level…

The growth of adoption of Bitcoin and therefore bitcoin price is following an S-Curve of Technological Adoption, which is itself characterized by fractally repeating, exponentially increasing Gartner Hype Cycles. This theory represents an overarching long-term fundamental factor that dwarfs the effects of other fundamentals such as: exchange hackings, government regulatory announcements, changes in economic policy and further technological advancement of the protocol.

That’s a fancy way of saying we’ll see a lot of price swings in the years to come, even as the price and market cap grow.

Now onto the arguments. They’re arranged roughly in order from most to least important.

bitcoin’s intrinsic value is Bitcoin

A diminishing number of critics like to argue that bitcoin has no intrinsic value. And for the longest time I sorta agreed with them. What is the intrinsic value of something that you can’t see or hold, that has no government backing, and is simply the result of some fancy math problems?

The problem is that we are confusing Bitcoin’s forest for its trees. Bitcoin is many things, and one of the most important, and the source of its intrinsic value, is its use as a payment network. In Naval Ravikant’s wise words, “the Internet allows any two individuals to transfer data without permission from any central authority. Bitcoin does the same for value.”

In other words, what Bitcoin the payment network allows me to do is send you money no matter where you are in the world, as long as you have an internet connection. And we can do this without the help or approval for any intermediary.

Now what generates the confusion is that Bitcoin is also a currency. We call that currency bitcoin with a lower-case b. So you could think of the system as Bitcoin+bitcoin. The payment network + the currency. Or in the words of a Chicago Federal Reserve economist, “Bitcoin is a system for securely and verifiably transferring bitcoins”.

Now what’s generating all the excitement and hyperbole is bitcoin the currency, a finite accounting unit currently trading around $1000 USD.

Bitcoin is both a payment system and a money. The payment system is the source of value, while the accounting unit merely expresses that value in terms of price.

The intrinsic value is the payment network. But you can’t separate it from the currency, because bitcoin the money is the oil that makes this engine run. The currency pays the computers to solve tough math problems to secure the network. The currency allows us to transact and trade and spend. The currency is the network’s native unit of account and medium of exchange and for these reasons, it has become a store of value.

What’s important in Naval’s earlier quote is the keyword “value”. He specifically said value, not money, because the Bitcoin network can do much more than transfer money. It can send anything of value that can be encoded digitally, like a smart contract, or a property title.

This is how Bitcoin+bitcoin differs from gold: while gold has intrinsic value because you can wear a gold necklace around your neck and we can use gold in limited industrial applications, gold is just gold. The currency bitcoin’s value lies in its utility for Bitcoin the payment network, which itself is valuable for all the reasons stated earlier.

Bitcoin+bitcoin is the first time in history where the payment system and the currency are tied together in this way.

Think about government fiat: the US dollar is a currency, but the payment system relies on banks, on tellers, on the physical action of swapping money.

Gold and oil are currencies, in a way, but neither commodity can ship itself around the world, securely and in ten minutes, for a very low transaction fee.

So the biggest and perhaps most fundamental factor in bitcoin’s price – what gave a price at all, in fact, and what will continue to drive its growth and adoption – is its usefulness as a value-transfer network that can exist without the approval of any government or central authority.

As a result of this ability to transfer value without a central authority comes the ability to do things that governments dislike: activities like buying drugs and gambling online. Bitcoin+bitcoin gives users access to what people call the dark markets or shadow markets. Silk Road, a famous and now defunct dark market, at its peak accounted for as much as 10% of bitcoin’s price. This is known as regulatory arbitrage – the ability to take advantage of different regulations – or none at all – through the use of bitcoin and cryptocurrencies. And for a subset of users, this is their most important feature. A conservative bet is that at least 10% of the world economy is in this shadow economy, if not much more. Illegal drugs alone – both online and offline – is a $360B market. Given the worldwide government war on cash, cryptocurrencies could grow to 1/3 of this market. That alone would reach my $100B prediction. The proliferation of privacy-focused altcoins like Monero and Zcash only confirms this utility.

Money exhibits a strong network effect, and research shows a strong correlation between Bitcoin’s userbase, its transaction volume, and its price appreciation. So Bitcoin+bitcoin’s utility will grow exponentially as more people use it. Both scalability and privacy are problems today, but there are several solutions in the works, and many competing cryptocurrencies – from Ethereum to Monero – that solve address these concerns.

Outside of the dark markets, Bitcoin as a payment network is useful today but not yet indispensable. For much of 2014, merchant adoption was portrayed by the media as a major catalyst in bitcoin’s growth. But the data has proved otherwise. Merchant adoption rates are slowing, and there is little usage of bitcoin the currency for buying regular, everyday goods. For shopping on Amazon and at Target, cash and credit cards are good enough. And while there are many additional use cases for Bitcoin’s platform for value-transfer – from remittances to capital flight, from serving the underbanked to smart contracts – none of these have become, by themselves, large or fast growing pieces of the Bitcoin economy.

The argument that best captures the reason why bitcoin the currency rises appreciates in value as Bitcoin the network grows in utility is USV’s fat protocols thesis. In a nutshell: the protocols on which the Internet was built – like SMTP and HTTP and TCP/IP – were far less commercially valuable than the applications and websites which employed them – like Yahoo and Google. But Bitcoin and cryptocurrencies represent a class of protocols where a lion’s share of the value will go directly to investors in the protocol’s tokens, like bitcoin and Zcash.

Institutional investors at the gate

The second big driver of bitcoin’s value is an increasing interest among institutional investors and high net worth individuals. Granted, they’ve always been an essential part of bitcoin’s growth. Guys like Tim Draper and Chamath Palihapitiya and Wences Casares gave vocal and passionate support to its fledgling community. But there are a number of signs now that professionally managed money – from pension funds to hedge funds, from Wall Street to the Square Mile – is getting into bitcoin in a meaningful and sustained way.

Saying Wall Street money is coming into bitcoin is a little like saying global warming’s here: each year it gets a little warmer, but its almost impossible to convince a skeptic, since there’s rarely a smoking gun, a single notable domino.

One collection of signals is a growing number of cryptocurrency products marketed to institutional investors. Two US-based ETFs applying for SEC approval: the COIN ETF from the Winklevoss Brothers and the XBTC ETF from SolidX, to be listed on BATS and the NYSE Arca, respectively. I’ve read both S-1 registration statements and will have an analysis for you later. General consensus is that approval of these ETFs will be a major boost for bitcoin’s price, and that at least one ETF will be approved in 2017. But don’t hold your breath – the first equity ETF took the SEC more than 4 years to approve, and the Winklevoss twins filed for the COIN ETF in July 2013. The upside? When Gold ETFs were first introduced in the mid 2000s, the gold spot price tripled over the next 5 years.

These ETFs are just the latest and biggest entrants in a growing market of bitcoin products that facilitate professional money’s desire to gain bitcoin and cryptocurrency exposure. Products like Grayscale’s Bitcoin Investment Trust GBTC and Global Advisor’s European exchange listed funds COINXBT and COINXBE. There’s even a US bitcoin IRA now. At its peak GBTC traded at a 60% price premium over bitcoin, just one indicator that a class of investors seek bitcoin exposure but either can’t or don’t want to buy bitcoin directly.

There are many reasons for institutional interest. The simplest is bitcoin’s outstanding performance. Volatility – once one of the biggest concerns about bitcoin as an investment – has decreased to the level of a small cap US equity. And research indicates bitcoin’s price movement exhibits no correlation with major asset classes including equities, bonds, real estate, and commodities. This is huge for portfolios that seek asset diversification while also participating in bitcoin’s upside. In recent months Acatis became possibly the first European investment fund to publicly add bitcoin exposure to their portfolio, through a stake in COINXBT.

Our first buy was conducted on October 7, 2016. Since then the price has appreciated 35.49 percent. This alone gave our funds, as a whole, a return of 1.06 percent and we gained more than €1 million with bitcoin’s price rise. This is quite good and ranks in the top 20 percent of the quality of our assets.

Bitcoin as Gold 2.0

For many investors, bitcoin is the new gold. More divisible and transportable. Easier to spend and easier to store (if not necessarily safer). And Bitcoin’s perceived waste of electricity to power its mining is minuscule when compared to the cost and pollution of gold mining. In 2013 it was estimated that the total electricity cost of bitcoin mining in a 24-hour period was $1.5M, or about $500M a year. The average cost to mine an ounce of gold is $1000, and about 80M ounces are mined each year. That’s $80B dollars, or 160x more costly than bitcoin, without taking into account the added expenses of refining, storing, securing, and transporting gold.

Needham research estimates 75% of bitcoin purchases are as a store of value, which is also the primary reason people buy gold. This is confirmed by other experts in the space including Wences Casares, CEO of Xapo.

In a world of money supply inflation, people buy commodities like gold to preserve their wealth. Bitcoin is becoming another option because, among other reasons, its inflation rate is known and decreasing and its long term supply is fixed at 21M bitcoins – or 21 trillion bits. There will never be more bitcoin than that. This rule only applies to bitcoin, not other cryptocurrencies, and only in its present form. In each of the last two halvings which occurred on November 2012 and July 2016 – when inflation rate of bitcoin supply dropped by half – bitcoin’s price went on a run price some 4-6 months after. The next halving will occur in mid-2020. This may not be a real pattern, as research shows at best a weak relationship between bitcoin’s price and its supply.

Money as its traditionally known serves three functions – a store of value, a medium of exchange, and a unit of account. Right now the bulk of money coming into bitcoin, especially from the developed world and from big investors, seems to be for its attractiveness as a store of value. Gold 2.0. Bitcoin as a medium of exchange is developing, but slowly and largely in speculation markets. And it’s still too early – and bitcoin too volatile – to be considered a reliable useful unit of account, although my view is that as the world of altcoins and blockchain tokens grow, bitcoin will be seen more and more as the unit of account for this new world of digital assets.

Bitcoin drives out the bad currencies

On a related note, more a subset than a separate thought from the above, bitcoin is becoming an exit plan and safe haven for citizens living in countries suffering from high inflation (like Venezuela) and geopolitical risk (like Britain and Greece). Research showed a link between the 2012-2013 Greek-Cypriot crisis and increased demand for bitcoin. In the aftermath of UK’s Brexit referendum, bitcoin was – alongside gold, the US dollar, and the Japanese yen – one of the few assets to appreciate in price.

Gresham’s Law states that bad money drives out the good. The theory goes as follows: in a free market economy, if you hold two currencies – let’s say the stable US dollar and the crumbling Venezuelan bolivar – you are likely to hoard the dollar and spend your bolivar. If everyone does this, eventually only bolivars will circulate in the economy and their value depreciation will accelerate and concurrently the demand for dollars will rise as a safe and stable asset. Vinny Lingham has a great essay on how people around the world are starting to use bitcoin as a hedge against weaker currencies.

…the recent fed rate hike which puts pressure on emerging market currencies, strengthens the dollar and in turn creates a surge in the forex/BTC trading price. This in turn creates additional foreign buying and demand for Bitcoin as a forex hedge, particularly outside the US, because the price of Bitcoin in that country is rising quickly.

Are regulators friendly, are they not. Are regulators friendly, are they not

Government regulations are another important factor in bitcoin’s long-term price performance. The drivers I’ve mentioned earlier – Bitcoin’s intrinsic utility, rising institutional interest, and bitcoin as the new gold – generally increase bitcoin’s price. Regulations go both ways. Long-term, it’s arguably good for bitcoin to have a clear set of regulations no matter how restrictive they are (save, perhaps, for an outright ban on bitcoin trading and mining). But the more regulations that exist, the more friction there will be in bitcoin investment and cryptocurrency innovation. One need look no further than New York’s BitLicense.

The multi-billion dollar question here is how China and America will regulate bitcoin. China has been cautious with bitcoin, officially banning banks from dealing with bitcoin exchanges, lately they’ve issued some supportive statements and taken steps to explore blockchain technology. Because a majority of Bitcoin mining activity and exchange trading are located in China, a wholesale ban could mean a large drop in bitcoin’s price although this will not lead to its demise. But such a move grows less likely by the day, and in fact recent signs are that the Chinese government is warming to digital assets.

The US has a patchwork of federal and state regulations for bitcoin and its ilk. Today federal regulations by the CFTC treat bitcoin as a commodity, the IRS treats bitcoin as property, and the US Treasury calls it a “convertible decentralized virtual currency”. President-elect Donald Trump appointed Mick Mulvaney, nicknamed the Bitcoin Congressman, as his budget chief. So clarity is emerging, and signs are positive, that regulation will at the least not be a huge roadblock for growing bitcoin adoption and innovation in the States.

Another trend that should positive impact bitcoin’s price is the worldwide government war on cash. India recently banned all 500 and 1000 rupee bills. As the world continues to move – voluntarily and through coercion – to digital money, bitcoin will benefit. The network is nowhere near as anonymous as some people think, despite its usage for dark market transactions. Bitcoin is at best pseudonymous. Research has shown that perhaps as much as a majority of on-blockchain transactions can be identified to a reasonable level of certainty. Everything on Bitcoin’s public blockchain – I mean everything – is public and linkable and source-able to the beginning of that blockchain’s existence. Just have a look at the Big Bang visualization from Elliptic, a company that helps law enforcement identify illegal blockchain activity.

For this reason and others, I believe regulatory risk is low. A clear regulatory environment is better than no rules at all. In business, knowledge is better than hope. Smart governments are starting to realize that money moving to public blockchains is actually aligned with their goals of consumer protection and law enforcement. This is why everyone from the US Federal Reserve to the Swedish Financial Authority are actively studying cryptocurrencies and their underlying technology. A problem – indeed perhaps a cause – of the 2008 financial crisis was the difficulty in determining who owned what complex assets, when, and in what amounts. Blockchain technologies is no panacea, but it would help fight this growing financial complexity and uncertainty.

In fact I think more than governments, it is private companies that will fight bitcoin and its brethren. Some will see it as a competitor instead of what it really is: a foundational technology that anyone can employ to operate better, faster, and more cheaply.

Speculation in a bottle

Finally, we have speculation to thank for helping to make bitcoin what it is today. This factor will decrease in importance, perhaps, as the market matures and volatility decreases and regulation grows, but to date it’s been hard to think of a better speculative asset than bitcoin. A digital borderless asset that operates in a global 24/7 market where trades are executed quickly and settled just as quickly, performing like a small-cap stock with mid-cap liquidity. And easily the best performing world currency since its inception. Never a dull moment for traders. There’s even a link between the number of Wikipedia views of the bitcoin entry and its price!

While it can be a hassle to buy your first bitcoin, once you have a purchase process established, it’s remarkably easy to fund cryptocurrency exchanges with bitcoin to invest in the growing world of altcoins and blockchain tokens.

For example, when I first setup an account with the Poloniex exchange, I funded my account with bitcoin and was able to buy the Monero altcoin (XMR) within an hour. Try doing that with stocks, bonds, or gold. Establishing an account with an online broker like Fidelity takes days, primarily because funding the account requires a standard US bank transfer.

If you get bored of bitcoin itself, there is a Cambrian explosion of other math-based currencies and digital tokens that can be traded on the same exchanges. At latest count there were 642 such cryptocurrencies with sufficient liquidity, from privacy centered coins like Zcash to permissioned networks like Ripple. Beyond altcoins, there are now tens and eventually hundreds of what are interchangeably called blockchain tokens and ICOs and appcoins that will see similar investor interest.

I would go so far as to venture that while bitcoin is not yet a true medium of exchange and unit of account in the same way the US dollar functions in our traditional economy, bitcoin increasingly serves those two functions for cryptocurrencies as an asset class. It is far easier to fund my Poloniex account and buy altcoins using bitcoin as my medium of exchange than trying to do the same through the US dollar and the standard banking system. Increasingly I see altcoin and appcoin prices denominated and reported in terms of bitcoin and ethereum, another leading cryptocurrency.

Derivatives and futures and other financial instruments have entered this space. This will only accelerate. CME Group runs one of the world’s largest options and futures exchanges. They recently added a bitcoin reference rate which many see as a precursor to launching derivative products for bitcoin. We’re just at the beginning, and all of these innovations and layers will only add money and fuel to the cryptocurrency economy.

Known unknowns

Finally, I’d like to briefly address two important questions about Bitcoin’s long-term future.

One is the likelihood of more hacks and malicious attacks against the Bitcoin ecosystem. While the protocol has never been successfully attacked (although this is not impossible), the apps and services that interact with the Bitcoin blockchain have been attacked successfully. Investors have lost money – more than $500M with Mt. Gox and $72 million with Bitfinex and lots of others besides – and will continue to do so if they aren’t careful and lucky to a degree about how they secure their bitcoin.

Because bitcoin is a purely digital asset that lives only in code and computers, and because the ecosystem has and always will be complex, with billions of dollars at stake, you can bet there will be more security incidents that cause some investors to lose confidence and temporary dips in price. That is pretty much table stakes, even though the trend is toward fewer and less damaging such incidents as the ecosystem matures.

And the final question (and my greatest gratitude for your patience, I hope it was worthwhile!) is how long Bitcoin can maintain its #1 position? It was the first cryptocurrency that has since launched a thousand digital currency ships. But Facebook wasn’t the first social network, Linux wasn’t the first open source operating system, and the US dollar was definitely not the first currency.

Bitcoin has to date held onto its top ranking, but there is more and more good and smart innovation. Despite strong network effects and first mover advantage, I believe bitcoin will incrementally lose market share. Its price will still rise, and rise a lot, if for no other reason than a surging tide lifts all boats. Within its use cases as a payment network and a store of value, I can’t see a challenger supplanting bitcoin in the next five years. But many other currencies will flourish alongside and the ecosystem will thrive.

It’s been a fun journey and the rollercoaster’s only getting faster. Strap in and buckle up! (or is it “buckle up and strap in”?)

Sources

There were many sources that I used to compose this essay. Not all of them receive attribution. The ones that are referenced – that I can remember – are listed below. I prefer to minimize in-line links because they seem to detract from a focused and clean reading experience.

Coinmarketcap – a great place to check coin prices and statistics on the cryptocurrency asset class

Why Bitcoin as both a young technology and its price are subject to repeated cycles and swings [Medium]

Vinny’s essay on bitcoin’s late 2016 price rise and his predictions for 2017 [Vinny Lingham]

Equity research shop Needham’s thorough and well-written report on bitcoin. I shared notes in an earlier post [Needham & Co]

A great description of how Bitcoin is both a payment network AND a currency (what I refer to as Bitcoin+bitcoin). This was the essay that finally put to rest my doubts about Bitcoin’s intrinsic value [FEE]

A GREAT if somewhat dated research paper on the factors that move bitcoin’s price, which I reference throughout this essay [Arxiv], and this paper which confirms the Wikipedia-price correlation

USV does it again – a simple must read essay for any serious investors in the cryptocurrency and blockchain tokens space [USV blog]

Bitcoin Buying Guide: How to buy bitcoin as a new investor

Published / by kgao / 3 Comments on Bitcoin Buying Guide: How to buy bitcoin as a new investor

I wrote this essay because there aren’t many thorough and reliable guides on how to buy bitcoin. A bitcoin investor since 2013, I’ve rode the price up and down…and up and down…and now mostly up. I’ve bought bitcoin through exchanges and buying services. I’ve earned bitcoin by lending it out. I’ve spent it and given it as a wedding gift. And in those four years I’ve consumed everything I could get my hands on – whitepapers, essays, panel discussions, podcasts. Now I’ll try to share the useful bits with you.

In this essay we’ll go over why an individual investor should buy bitcoin and how to do it responsibly and securely:

  • Who is the intended audience?
  • What are my credentials?
  • Why should you invest in bitcoin?
  • What are bitcoin’s risks?
  • How do you actually buy it?
  • What are some advanced ways to gain investment exposure?
  • Additional related reading

Who is this buying guide intended for?

The target reader is an individual investor who wants to put a few thousand dollars into bitcoin as a long-term, buy-and-hold investment opportunity. Long-term means at least 2-3 years. Buy and hold means NOT trying to time the markets but instead either buying all of them at one time or dollar cost averaging over an extended period.

For an individual investor, your bitcoin investment should only be a small percentage of your cash and cash-like assets, perhaps 2-3%, and not more than 5-10%. Yes, I’ve invested more than that, but this is one of those scenarios where I’ll recommend that you do what I say, not what I do. Why? Because Bitcoin is young, it is a comparably volatile asset, and there are a lot of unknowns. Your investment could fall 50% in a few months and take years to recover as it has done several times already. Daily 5-10% price swings are not uncommon.

My reader will have some knowledge of money management and financial investing. They should already own an investment portfolio. They’ve purchased stocks and bonds and mutual funds. They may own complex products like real estate and know how to trade derivatives. I assume this because there is an ocean of good investing information out there and my goal is to add some value. So I won’t, for example, explain concepts like dollar-cost averaging and opportunity costs and financial leverage.

If you’re looking to buy $10K or more of bitcoin, this guide won’t be as useful for you. At a certain dollar amount, somewhere in the range of $10,000 to $100,000 USD, your safest and smartest option is to buy bitcoin directly through specialized services that go by many names, among them bitcoin brokers, dark pools, and over-the-counter (OTC). Not only will they get you a better price than standard bitcoin buying services, but they often offer storage services as well.

What are my credentials?

I graduated Stanford in 2006 and have since worked at McKinsey and Google and started several tech companies. Most of them failed. I graduated Y Combinator with a publishing startup and raised $1M from great investors. Ultimately we couldn’t scale the business. I was on the founding team of another startup, shopkick, that was acquired by SK Telecom for $200M.

As for bitcoin, I have invested personally since 2013 and have also bought altcoins such as ethereum and dogecoin. I am now learning about blockchain tokens and ICOs (initial coin offerings) and expect to participate in those as well. I am still skeptical about the latter, but it’s in my interests to understand it thoroughly. It’s a world of fascinating innovation. I read and watch just about everything tangentially related to cryptocurrencies and blockchain, from white papers to podcasts to YouTube lectures, take notes on all of it, and want to share that knowledge with you.

Why should you buy bitcoin?

Since May 2010 when Laszlo Hanyecz persuaded someone to order him two large pizzas in return for 10,000 bitcoins, setting the price of a bitcoin at one quarter of a penny, bitcoin has appreciated by 360,000x (that is not a typo) to nearly $1000 at the end of 2016. If we consider bitcoin a currency – a function it performs among many others – it would have been the best performing currency in 2010, 2011, 2012, and 2013, the worst performing one in 2014, and the best one again in 2015 and 2016. Buckle up.

To give you a concrete and small sense of its performance, if you put $1 in at the beginning of each year and sold it on December 31st of that year:

$1 bitcoin in 2011 would become $14 at the end of the year.

$1 in 2012 would become $2.58.

$1 in 2013 would become $57.51 (again, not a typo!).

$1 in 2014 would become $0.38 (its one losing year).

$1 in 2015 would become $1.35.

$1 in 2016 would become $2.20.

You’d have made money every year – and usually a lot of it – except for 2014.

And today, I’m more confident than ever that what bitcoin represents – a class of math and cryptography-backed currencies, an innovation called the blockchain, and a community of hackers and entrepreneurs hoping to reshape money – is one of the best investment opportunities you can make in the next 10 years. If you can simply buy the right coins, and store them safely, and wait patiently, I’m almost certain your investment will pay off. Just don’t mortgage your house to do it!

Bitcoin investing carries many risks. We’ll talk about all of them in somewhat excruciating detail in later essays. But even with these risks, your average investor would be remiss – indeed even irresponsible – to not invest at least SOME of their money in this asset class.

Your investment could be $100. It could be $2 million. If you’re going to invest, plan to hold your bitcoin for AT LEAST 2-3 years. The speculative nature of cryptocurrency and its comparatively small trading volume means it is subject to wild price swings day and night. It’s a true 24/7 global market and it moves at the speed of math and data.

While its fundamentals consistently improve, the price may not reflect this reality for a long time. Investors are not always rational and we shouldn’t expect them to be. In my view, 2-3 years is a long enough period to smooth out the uncertainty and prevent you from making poor decisions based on emotion and a desire to time the market.

I expect to hold onto my bitcoin well into the 2020s. Now, that doesn’t mean I’m not re-evaluating my position every day. And it doesn’t mean I won’t sell some of my position or invest more money along the way, into bitcoin or altcoins or other related digital assets. It just means I have a very long-term view of my core holdings and will do whatever I can to help this future come to fruition.

What are bitcoin’s biggest risks?

Every great investment carries great risk. Like CV White says, success is the accomplishment of that which most people think can’t be done.

There is a nonzero chance you could lose your investment. This should be stated over and over until you’ve internalized the reality. But we will do our best to minimize every controllable risk, from buying to storing to selling to diversifying into altcoins to investing in ICOs to gaining yield through services like bitcoin lending. And much more.

For now, I will name just a few of the major concerns about bitcoin as an investment opportunity:

  • Bitcoin could be banned by major governments such as the US and China which would severely reduce its rate of adoption, its level of network security, and its perceived potential
  • Bitcoin’s protocols could be hacked or its encryption algorithms (SHA-256 and RIPEMD-160) broken for long enough to undermine trust in the network, leading to a cascade of events such as media scrutiny and panic selling before developers and the community have time to make the necessary fixes
  • Bitcoin could be subject to miner collusion via a 51% attack or something less well-known, resulting in damaging behavior such as double spending and unconfirmed transactions, undermining trust in the network and slowing growth
  • Bitcoin could stop growing as it reaches the transaction limit of its current 1MB blocksize which reduces user and transaction growth and / or increases interest in competing cryptocurrencies

These are just some of the risks that which we’ll discuss in future essays. Buyer beware. Really.

How do you buy bitcoin?

What I optimize for here is safety and convenience over price and flexibility. I want you to invest in bitcoin because it will go up many-fold in the years to come, so I’m not trying to optimize for saving a few percent in transaction fees. I want you to invest today, not “some time in the future”, and the simpler I make it for you, the greater this likelihood.

I live in the US, and thus my two primary purchasing services have been Coinbase and Circle. I preferred Circle for the longest time because they had lower fees and also carried insurance against your deposits, but Circle recently got out of the bitcoin buying game. So now I buy all of my bitcoins from Coinbase.

Why Coinbase? It’s well-funded. I’m familiar with their culture and some of their team. It’s as trustworthy and competent a service as you will find in the bitcoin world. And while they have some policies that may frustrate a small segment of users – from purchase fees to identification requirements – this is also part and parcel of why they’re a safer service than, say, buying directly from an individual you meet on LocalBitcoins.

By default, Coinbase also provides a wallet, so you don’t need to worry about creating your own. They even provide a vault service which is a safer, offline way to secure your bitcoins. However, at some point you’ll want to create your own wallets to diversify your holdings and to familiarize yourself with the cryptocurrency world. The Open Bitcoin Privacy Project publishes an annual ranking of bitcoin wallets that is a solid list of reliable services.

So if you want to buy bitcoin in the US, start with Coinbase. You’re charged a 1-2% fee, but you can buy through PayPal, credit card, and a bank account. You can even schedule recurring buys for dollar-cost averaging.

If that doesn’t work for you, try Xapo. Unlike Coinbase, Xapo requires a bank wire transfer to purchase bitcoin. But like Coinbase, both are secure and trustworthy. I’ve found Xapo tends to quote a higher price than Coinbase.

If you’d like to buy bitcoin without going through the process of sharing your personal information, you can try LocalBitcoins. This is a Craigslist-like service which helps you meet bitcoin buyers and sellers throughout the world, and arrange in-person meet ups. The risks here are like the risks of buying stuff from Craigslist, but heightened because unlike buying a used TV, bitcoin is harder to understand and it’s been a well-known honeypot for hackers. Having said that, here’s a solid guide on how to use LocalBitcoins.

An added benefit of buying from a service like Coinbase and Xapo is that they automatically come with an online wallet. A wallet is simply a way for you to store your bitcoin, like a leather wallet for your cash and credit cards. There are many types of wallets, with various levels of security and authentication and ease of use, and we’ll talk about the different ways to safely store your bitcoin in a follow-up essay. The short answer right now, if you’re a new bitcoin investor, is to trust Coinbase and Xapo if you use them. But make sure to turn on two-factor authentication: this is when you use a phone number or – even better – an app like Authy to generate a security code that provides an additional level of security over your password. Apps like Authy and Google Authenticator are safer than supplying your phone number, if a little more work. You find that more work typically means more security.

Again, I recommend these services for buying small amounts, up to $10K or so dollars. For larger amounts you can buy from the exchanges or use direct brokers. I’ll write about these in a future guide.

A quick note about tax treatment: currently the IRS regulates bitcoin and what they call “convertible virtual currencies” as property. What this means for the individual investor, as best as I can understand, is that the buying and selling of bitcoin is subject to capital gains and should be approached the same way you handle gains and losses on stocks and bonds.

Some more advanced ways to gain investment exposure to bitcoin

There are some other ways to invest in bitcoin and these will only proliferate in the years to come. I won’t spend a lot of time talking about them here, since this is a basic bitcoin buying guide, but I wanted to offer you a sense of the different flavors and options for learning.

Bitcoin exchanges

More advanced investors can use exchanges to purchase bitcoin. The advantages include faster purchasing time, lower costs, and reduced fees. But it’s a more complicated tool to understand and you must use it properly to save money. Finally, the biggest risk is that you’ll simply lose your coins, because exchanges themselves are subject to constant attack. The biggest hacks in Bitcoin’s history have happened to exchanges (think Mt. Gox) because, in part, of their complexity. Coinbase has an exchange called GDAX. Other well-known exchanges (excluding China) include Kraken and Poloniex.

Bitcoin ATMs

Bitcoin ATMS – of which there are 927 at latest count – are a convenient if expensive way to acquire bitcoins. Here is a useful map to find them. They often charge very high fees, but they’re considered safe and reliable. I’m not sure whether Bitcoin ATMs are really making money, but they exist for now, so take advantage of them if you like. I haven’t used one. The Swiss Railway operator SBB has even enabled bitcoin buying at their ticket kiosks, of which there are 10K scattered through the country.

Bitcoin derivatives

You can now buy bitcoin derivatives. They work just like equity derivatives, but with an added layer of risk because, well, it’s bitcoin. I won’t explain derivatives here, but I just want to make you aware of the option. TeraExchange is one that I’m familiar with, although I haven’t used it, and I believe LedgerX is coming online soon when it receives its CFTC approval (one US regulatory body that is taking a lead on bitcoin regulations).

Investment products like trusts and ETFs

These are institutional products that provide you exposure to bitcoin without directly owning bitcoins themselves. If you’ve invested in index funds and ETFs then you’re familiar with this product type.

The best known US investment fund is the Grayscale Bitcoin Investment Trust which trades as the ticker GBTC on the US OTC Markets. There are others, including two Bitcoin exchange traded certificates listed on Nasdaq’s OMX in Stockholm that trade by the ticker COINXBT and COINXBE (for all practical purposes identical to XBT, but denominated in Euros).

A product generating lots of excitement – which has yet to be approved – is the first Bitcoin ETF called COIN which was created by the Winklevoss Brothers. Most people expect the SEC to approve it in 2017.

These products are popular with institutional investors who are sometimes limited in how they can invest, and because an additional layer of perceived experts reduces perceived risk. Compared to buying bitcoin directly, you’re safer from regulations and hackers. They make buying bitcoin as easy as buying a publicly traded stock and come with some tax advantages. For example, you can purchase the GBTC through your IRAs but you can’t directly buy bitcoin.

There are downsides, of course. You don’t personally own bitcoin, merely exposure to the asset. You don’t even have guarantees of how much bitcoin the product represents, because the ratio is rarely constant. So a $500 investment today might result in .75 bitcoin but as the investment product increases its assets, it might not increase its bitcoin holdings in proportion.

There are added rules and restrictions to how you can sell your position. And they usually charge fees. For example GBTC charges a 2% fee and COINXBT charges 2.5%.

It is the same as investing in a Gold ETF – you don’t own gold and can’t carry it with you during an apocalypse, but if gold increases in price, you will – more often than note – see an increase in the price of your investment.

Altcoins

There are many cryptocurrencies besides bitcoin. Ethereum and litecoin are two of the better known examples. Altcoins are to bitcoin what a small-cap stock like Twitter is to a large-cap stock like GE: even less volume, even more volatility.

I diversify a small portion of my cryptocurrency dollars into altcoins, mostly into ethereum, for reasons I’ll explain later. And over time, I’d recommend that you do the same. There are currently 643 cryptocurrencies listed on CoinMarketCap. Most of these are not worth your time or money. Some are scams. A few have genuine promise. All of them are volatile.

For the most part, I don’t believe altcoins are good investments. I put some money into altcoins because a) there is a small probability that bitcoin fails but cryptocurrencies succeed and b) some coins represent an interesting technological innovation that could lead to their success, which may or may not be correlated with bitcoin’s price.

Data shows that investing in an index fund of cryptocurrencies including bitcoins has not outperformed bitcoin itself. The network effects of money and the past performance of the industry seem to indicate that the safest, and smartest, investment is to buy bitcoin itself.

But the world of math-based currencies is a rising tide, and it will lift all boats. Bitcoin is the biggest and will remain so for some time.

Until you know what you’re doing, stick with bitcoin.

Bitcoin startups

A final way to gain bitcoin exposure – perhaps the riskiest of all – is to invest in bitcoin and blockchain startups. Saying you’re a blockchain startup is kinda like saying you were a social startup when Facebook was exploding, or an Uber for X today. It pays to be skeptical.

But a quick look at AngelList shows 1062 cryptocurrency startups (!). As with any startup investment, the upside is a stake in the next Google and the downside is losing all your money. Like Marc Andreessen says, VC investing is not about batting average but slugging percentage. This means if you’re going to invest in bitcoin startups, prepare to make a lot of investments if you want the best chance of success. Then pray that one of them becomes a homerun. If you’re an angel investor, this means you should make at least 25-50 investments. Let diversification and the portfolio effect work its magic. Which means if you’re putting $10K (a small amount for an angel investor) into each startup, you’re looking at half a million dollars. With $500K, I’d rather invest straight in bitcoin. But that’s just me. There have as yet been no unicorn startups in bitcoin land (Coinbase might be the closest that I’m aware of), but that doesn’t mean we won’t see several examples in the coming years.

Additional recommended reading

  • This Coindesk essay includes a good list of buying sources and some storage options [link]
  • This 99bitcoins guide includes 9 ways you can buy bitcoin with a credit card and some nice screenshots and breakdowns [link]