1. What is Bitcoin?

Bitcoin, created in 2009 by an anonymous entity known as Satoshi Nakamoto, is a decentralised digital currency that, when traded as a spot product operates on a peer-to-peer network without the need for intermediaries like banks. 

Unlike traditional currencies, Bitcoin is not issued or regulated by any central authority. However, as we have seen, regulatory and political risk can have a significant impact on price fluctuations.

When held and traded directly, Bitcoin’s defining features include:

• Decentralisation: Operates on a decentralised network of nodes, reducing the risk of central point failures.
• Limited Supply: Only 21 million Bitcoins will ever be 'mined', giving it a scarcity which some have compared to precious metals like gold.
• Transparency: All transactions are recorded on a public ledger called the blockchain.
• Security: Uses cryptographic principles to ensure the security and integrity of transactions.
• Divisibility: Bitcoin can be divided into smaller units called satoshis, with one Bitcoin equal to 100 million satoshis.
• Global Accessibility: Accessible to anyone with an internet connection and sufficient data. 

2. What role can Bitcoin potentially play in a portfolio?

Bitcoin’s unique features have led some investors to consider it as a viable asset in a diversified portfolio. Its primary roles can include:

• Store of Value: Due to its limited supply and growing demand, some commentators  have compared Bitcoin to gold as a hedge against inflation and currency devaluation. However, significant price volatility might challenge this view. 
• Potential growth: With significant volatility, investors might be able to experience portfolio growth at certain intervals. However, this converse might also be correct (see Chat 1 below). 

Chart 1: Bitcoin’s Historical Returns

Source: CoinMarketCap.com, Bitcoin price history

3. What are the risks?

While Bitcoin offers potential benefits, it’s crucial to recognise the risks, especially for compliance and regulatory considerations:

• Volatility: Bitcoin is known for its extreme price fluctuations, which can potentially lead to significant losses.
• Regulatory Risks: Governments may impose regulations that could negatively impact Bitcoin’s value or usage.
• Security Risks: While the Bitcoin network itself is secure, individual holdings can be vulnerable to hacking, fraud, and theft if not properly managed.
• Market Liquidity: During periods of extreme market stress, liquidity could dry up, making it difficult to buy or sell Bitcoin at desired prices.
• Technological Risks: Bitcoin’s underlying technology is still evolving, and potential flaws or vulnerabilities could emerge.
• Environmental Concerns: Bitcoin mining consumes large amounts of energy, leading to criticism regarding its environmental impact.
• Market Manipulation: As an unregulated market, Bitcoin is susceptible to manipulation by large holders or coordinated activities.

Investors should approach Bitcoin with caution, understanding that it is a highly speculative asset.
 

4. Using an ETF for Bitcoin exposure

For many investors, directly purchasing and holding Bitcoin might be daunting due to the complexities of storage, security, and transaction management.

Exchange-traded funds (ETFs) provide an alternative means of gaining exposure to Bitcoin without these challenges.

Potential benefits of using a Bitcoin ETF:

• Accessibility: ETFs can be bought and sold through traditional brokerage accounts, making Bitcoin more accessible to mainstream investors.
• Liquidity: ETFs trade on major exchanges, providing liquidity and ease of transaction.
• Security: Custodial and security concerns are managed by the ETF provider, reducing the risks of hacking and theft.
• Regulatory Oversight: ETFs are subject to regulatory scrutiny, which may offer a layer of protection to investors.

Considerations when using a Bitcoin ETF:

• Management Fees: ETFs charge management fees, which can erode returns over time.
• Tracking Error: ETFs might not perfectly track the price of Bitcoin, leading to discrepancies in performance.
• Limited Upside: Some Bitcoin ETFs may invest in futures contracts rather than holding actual Bitcoin, which could limit upside potential.
• Regulatory Risks: While ETFs are regulated, changes in regulations could affect their availability or cost-effectiveness.
• Indirect Exposure: Gaining exposure to Bitcoin via an ETF means an investor does not receive some of the same features compared to holding Bitcoin directly, such as decentralisation, divisibility and global accessibility. 

5. Conclusion

Bitcoin represents a new frontier in the world of investing, offering both potential and risks. For investors considering adding Bitcoin to their portfolios, understanding its features, benefits, and risks is essential. 

Whether through direct ownership or an ETF, Bitcoin should be approached with caution and a clear understanding of its volatility and speculative nature.

Including Bitcoin should align with an investor’s overall strategy, risk tolerance, and long-term objectives, ensuring that it complements rather than disrupts the balance of the portfolio.

DISCLAIMER

The material in this article has been prepared by DigitalX Limited (ACN 009 575 035) (“Company”). It is intended for educational purposes only.  It is not a financial product or investment advice. 

This content is for educational purposes only and does not constitute financial advice or investment advice. Independent advice should be obtained from an Australian financial services licensee before making investment decisions. The information has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article.