Ask Forstrong: Do the new Bitcoin ETFs change your view on cryptocurrencies?

Who remembers the ad? Hollywood star Matt Damon, clad in all black, strolls confidently through a virtual display of humanity’s greatest achievements and then leads us to a dreamy vista to deliver the power line: “fortune favours the brave”. 

It could have been a movie trailer for the Jason Bourne franchise or even a promotional clip for CrossFit classes. It was neither of those. The last frame of the commercial finally revealed what Matt was flogging: a cryptocurrency exchange. 

We first published our firm’s negative view on crypto in April 2021. It went over like a wet blanket. In fact, the report received the largest reaction from any in Forstrong’s history (“ok boomer”, “have fun being poor” — you get the idea). Readers will have a sense of the task here then. To say anything controversial about crypto invites such backlash that, even here in rural British Columbia, we nearly look over our shoulder as we write. 

But our valued clients have questions, and this publication has never been a popularity contest, so let’s have another run at it. Please swipe left if this isn’t your thing.

Crypto Moving Closer To Wall Street  

What has changed over the last three years since we first wrote on the topic? Quite a bit. Even while Bitcoin has more than doubled over the past twelve months, the crypto carnage in 2022 — along with everything else in tech that year — still leaves prices more than a quarter lower. Many coins have collapsed. The lavish conferences are over. A few unsurprising scandals have unfolded. Sam Bankman-Fried is in jail — turns out he was not the new Thomas Edison after all. All the celebrities previously promoting crypto have gone silent. The SEC charged several of them, including Lindsay Lohan, Jake Paul and adult film star Kendra Lust. Even the Kardashians have stopped talking (quite an accomplishment).  

To be fair, we get the appeal of the crypto community’s message. They invite us to imagine a world where our currencies are decentralized — free from the heavy hand of government intervention and untouched by their modern tools of negative interest rates, quantitative easing and, lately, runaway fiscal deficits. Underpinning it all is blockchain technology which promises to offer anonymity, eliminate middlemen, transcend national borders and carry almost frictionless costs. 

We, too, like our fees low, federal budgets balanced and privacy heavily guarded. And, lately, the world does feel like a dark place in need of deep change. Trust in experts and institutions is at an all-time low. Many younger people view traditional finance as a rigged system. Crypto offers an alternative. And not just any alternative, but a radical vision for humanity to take on the Fed and the banks and everyone else involved in the establishment, enabling a revolution that will bring freedom to people all over the world.  Reading through crypto commentary can be excitingly subversive, making people feel like they have taken the red pill and seen the truth.

But has crypto made any progress toward this monetary nirvana? Hardly. First, crypto has not moved any closer to widespread adoption as a payments mechanism. Consider the qualifications to be accepted as money: stable, portable and widely used. Crypto has been anything but stable over the last few years (or “anti-fragile” in the nomenclature of our business). Despite the worst inflation in over four decades, Bitcoin — often touted as an inflation hedge — performed terribly and still has a high correlation to other risks assets like the tech-heavy NASDAQ. 

What about “widely used”? Perhaps some transact in it, but crypto has not exactly taken over the world of transactions. El Salvador made Bitcoin legal tender and required all businesses to accept it, and even there it is still not widely used. Of course, the primary purpose of currencies throughout economic history is to facilitate transactions and support the real economy through consumption, business interactions and capital investment. There’s no material sign that crypto is serving any purpose that regular, boring money already does. No one seems to discuss this anymore. Instead, conversations are always entirely focused on the price that crypto trades at.   

Crypto has also moved steadily closer to the established financial system. Digital currencies came to the market touting a promise to end the public’s dependency on traditional financial middlemen. Yet look at what has happened. We now have regulated crypto exchanges. The arrival of these exchanges may validate the importance of cryptocurrencies as a speculative asset (even if they blow up — looking at you FTX), but they also remove the original benefits the cryptocurrencies claim to bring. 

Less anonymity, more intermediaries and greater surveillance was not part of the plan. Embracing regulation and Wall Street means abandoning the role of challenging the traditional fiat currency system. This is completely antithetical to the original premise of crypto, ultimately leaving crypto exchanges as just another middleman operator. Even so-called Bitcoin maximalists consider these platforms a brazen sellout. Crypto has gone from being an exciting and rebellious alternative to traditional finance to simply another way for investors to speculate — and for Wall Street to generate extra revenue.  

All of the above signals that the state, not crypto, is winning in terms of control of the monetary system (sorry, we don’t make the rules: money is highly political). This matters because increased regulation adds risks as governments now have an easy way to render crypto a stranded asset by destroying the links that connect it to the real economy. You can be sure regulators are not thrilled with having to monitor what SEC Chair Gary Gensler considers a full-time casino attached to the established financial system, that serves no economic purpose and only creates more instabilities and systemic risks. As we wrote in our original crypto analysis:

The biggest threats come from the regulatory and competitive side. The reality is that anyone can issue money. The problem is getting people to accept it. Here, cryptocurrencies face a serious competitor. They are called the government. And, they are no longer standing still with crypto oversight. If this author has learned anything after two decades in finance, it is this: policymakers are control freaks. Eventually, they will demand their slice of the spoils (raising taxes) or regulate something (increasing costs for the private sector). To paraphrase former US president, Ronald Reagan, the government’s view of things can be summed up as “if it moves, tax it and if it keeps moving it, regulate it”.  

Enter ETFs

What about the recent approval of 11 US-listed ETFs tracking Bitcoin? This is simply an extension of the move closer to the traditional financial system. While it was declared a watershed moment, the irony nearly jumps off the page: Bitcoin ETFs are vastly less useful as a payment mechanism or a way to displace the traditional financial system as buying Bitcoin directly. Instead of an alternative peer-to-peer payments system in which people hold their Bitcoins directly and transfer them to each other without middlemen, Bitcoin is now held in a traditional brokerage account. How useful is that for payments? And do people buying Bitcoin ETFs look like participants in a financial revolution or speculators hoping someone will pay a higher price for it from them in the future?  

Of course, some people don’t care about revolution. Whether crypto comes in encased a nice, regulated wrapper or bought off the dark web, they simply want to make money. Many hold the view that these new ETFs will create further demand and put upward pressure on prices for the roughly $1.7 trillion crypto sector. This is a tale as old as time. ETFs do not define trends; they are designed to follow them. Most ETF trading occurs on secondary exchanges which does not impact the liquidity of the underlying securities. And while ETFs may bring liquidity and allow people to enter the crypto market, they also allow people to exit it too. In short, the arrival of ETFs still does not demonstrate anything beyond what it always has been: a breeding ground for speculation (leaving a huge carbon footprint in the process).   

Investment Implications

People regularly lose their minds. Single tulips once traded hands in Holland for more than the cost of entire homes. A Saudi prince once paid millions for a picture of a pixelated ape. And, most recently, cryptocurrencies have captured the public’s fertile imagination. 

With hindsight, the madness is obvious. But living through it in real time can be hazardous. Despite all the above analysis, many will still want to experiment with crypto, perhaps because others transacting in them say they will give you a rush or even alter your state of mind … or because Matt Damon urged you to do so. 

But investors should not confuse dopamine hits with investing. In crypto, speculation is a feature, not a bug. Despite the rally over the last year, we are still on the other side of the bubble that burst in 2022, exhibiting all the hallmarks of a speculative mania. Many of the industry’s biggest companies and coins have already collapsed. In the grand history of investing, cryptocurrencies will be a curious sideshow and another cautionary tale that serves to demonstrate that long-term prosperity rests on industries that actually benefit the real economy. 

Meanwhile, long-sighted investors that steadily accumulate wealth will recognize today’s largest opportunity: after more than a decade of underperformance, many investment classes that previously struggled with chronically weak demand and dismal pricing power in the era of slow growth are deeply on sale. Assets in the real, productive economy are primed for a long-running period of outperformance. Banks, industrials, international value stocks and commodity-oriented equities trade on low multiples with high dividend yields. These are the exposures we are emphasizing in our family of actively-managed and internationally focused ETFs. Combined with the normalization of interest rates and higher nominal growth in world economies, investors now have a generational opportunity to create a globally diversified portfolio with high return prospects. 

Fortune will indeed favour the brave — but only for those investors willing to stay focused on those assets that will stand the test of time.