Exchange-Traded Funds (ETF, for short) have rose to great popularity among the financial geek types during the last decade or so. They date back, however, to the 1990s and were partially modeled on the preceding Index Funds.
Index Funds were inspired by the thinking of John C. Bogle's insight that as a general rule fund managers could not usually beat the market: the prevailing assumption about the correct attitude to investing at the time. He noted that once fund managers' fees are factored in, the end-user, the fund consumer, has no pretty much no hope of beating the market. Believing otherwise, in Bogle's assessment, was folly.
There's some irony in that turn of phrase, as "Bolge's folly" was the term of derision used to dismiss his ideas by the Wall Street crowd. Bogle was, though, to have the last laugh: his philosophy, initially implemented through funds established to track the S&P 500, at minimal-to-no fees, proved to be a big time winner.
Today's ETF represent an attempt to learn these lessons of the Index Funds lessons, supplemented by the further bonus that they were - unlike the original Indexed Funds - very inexpensive to trade. In some cases, ETF can be traded commission-free. Additionally, not being indexed, these ETF can be considerably cheaper, since the lack of ongoing management reduces considerably potential transaction costs.
Recently, there have been efforts to apply this ETF financial technology to another leading edge technology in the economy: the digital currency Bitcoin. An especially prominent effort in this regard has been the initiative by the Winklevoss twins.
The brothers, renowned for their struggle over FaceBook, with Mark Zuckerberg, have been early adopters of Bitcoin. Estimates have their holdings in the crypto-currency at around $11 million.
Setting up a publicly traded ETF requires the nod of financial regulators. This effort has been undertaken by them. Yet, even before the regulators have had their say, the prospects of such ETF are already being belittled. No less a heavy roller than Knight Capital managing director Reggie Browne has dismissed such a prospect as unworkable in the ETF market.
Undoubtedly, the extreme volatility of Bitcoin recently does make it a little inconsistent with the Fund Index spirit that initially inspired the ETF tradition. Emphasizing this though perhaps really misses the more central point of importance.
Right off the bat, sweeping claims about the viability of Bitcoin on the ETF market has to be tempered with the realization that in fact such trading opportunities already exist. SecondMarket offers a private Bitcoin Investment Trust (BIT, for short, get it?). BIT is modeled on a well established gold ETF. And, with its $25k minimum investment, it is humming right along, according to its creator, the SecondMarket CEO: the close of 2013 finds it holding $65 million.
Obviously, then, to claim, as Browne does, that the volatility of potential Bitcoin ETF wouldn't be attractive to potential ETF investors does seem to be assuming a bit too much. There seems to me, though, to be an even more essential point that is too easily overlooked in all of this. That point is simply this: as a currency Bitcoin's raison d'etre is to be a medium of exchange. It may provide an investment opportunity, but the outcome of such investments is ultimately irrelevant to its fate.
The point here isn't that there's anything wrong with wagering on (or against) any new product, including a new currency. Speculation and short selling are perfectly legitimate and valuable exercises within any dynamic and free market. The hazard arises when the mistake is made of treating Bitcoin as an investment opportunity in disregard of its unique specifics: unlike, say gold, Bitcoin is designed specifically and precisely to operate as an alternate currency.
Like any other product designed to serve a specific purpose, its features and benefits will only be revealed as tested in time. The recent volatility has been a function of financial, rather than monetary, considerations. I can only see two long term prospects.
In the future, Bitcoin may manage (and there are many hurdles to overcome) to catch on with the monetary consuming public, bringing it expansive global usage - whether sanctioned by nation-states or not. On the other hand, the digital currency could be judged by those consumers (of currency) to offer insufficient benefits over so-called sovereign currencies. In that case, I expect it will pretty much collapse into disuse, despite the best efforts of the enthusiasts.
Should this former outcome come to pass, holdings of the currency will be so widespread (in light of its freedom from the inflationary manipulation characteristic of fiat currencies) that the kind of financial hiccups which have caused the recent fluctuation will simply cease having appreciable consequences. Should that be the outcome of this social experiment, Bitcoin ETF will wind up in fact providing exactly the secure, indexed funds which are the usual fare of ETF investors.
On the other hand, should we see the collapse of the currency, the truth is that it is those who bought into the currency, not for the virtues of its monetary features, but to gather its hoped for financial windfalls, that will be most hurt in the process. The big losers would be the speculators. And speculation offers the prospect of big rewards, because it presents the danger of high risk.
To be clear, I'm not suggesting that anyone feverishly convinced of Bitcoin's long term future should be discouraged from taking advantage of their knowledge of the product or their conviction in its viability to profit through investment in it. If however ones investment is merely an expression of excitement at rocketing exchange rates: what goes up, must come down. You know the risk you're taking.
These Bitcoin ETF initiatives are intriguing prospects. They're well worth watching. Do not ever lose sight though of the basic reality that the future prospects of Bitcoin will be determined in its utility as a currency. And that story will unfold, not on the financial markets, but the monetary, which is to say, the consumer currency markets. As always, the customer will decide. Confusion about this could be costly.
Index Funds were inspired by the thinking of John C. Bogle's insight that as a general rule fund managers could not usually beat the market: the prevailing assumption about the correct attitude to investing at the time. He noted that once fund managers' fees are factored in, the end-user, the fund consumer, has no pretty much no hope of beating the market. Believing otherwise, in Bogle's assessment, was folly.
There's some irony in that turn of phrase, as "Bolge's folly" was the term of derision used to dismiss his ideas by the Wall Street crowd. Bogle was, though, to have the last laugh: his philosophy, initially implemented through funds established to track the S&P 500, at minimal-to-no fees, proved to be a big time winner.
Today's ETF represent an attempt to learn these lessons of the Index Funds lessons, supplemented by the further bonus that they were - unlike the original Indexed Funds - very inexpensive to trade. In some cases, ETF can be traded commission-free. Additionally, not being indexed, these ETF can be considerably cheaper, since the lack of ongoing management reduces considerably potential transaction costs.
Recently, there have been efforts to apply this ETF financial technology to another leading edge technology in the economy: the digital currency Bitcoin. An especially prominent effort in this regard has been the initiative by the Winklevoss twins.
The brothers, renowned for their struggle over FaceBook, with Mark Zuckerberg, have been early adopters of Bitcoin. Estimates have their holdings in the crypto-currency at around $11 million.
Setting up a publicly traded ETF requires the nod of financial regulators. This effort has been undertaken by them. Yet, even before the regulators have had their say, the prospects of such ETF are already being belittled. No less a heavy roller than Knight Capital managing director Reggie Browne has dismissed such a prospect as unworkable in the ETF market.
Undoubtedly, the extreme volatility of Bitcoin recently does make it a little inconsistent with the Fund Index spirit that initially inspired the ETF tradition. Emphasizing this though perhaps really misses the more central point of importance.
Right off the bat, sweeping claims about the viability of Bitcoin on the ETF market has to be tempered with the realization that in fact such trading opportunities already exist. SecondMarket offers a private Bitcoin Investment Trust (BIT, for short, get it?). BIT is modeled on a well established gold ETF. And, with its $25k minimum investment, it is humming right along, according to its creator, the SecondMarket CEO: the close of 2013 finds it holding $65 million.
Obviously, then, to claim, as Browne does, that the volatility of potential Bitcoin ETF wouldn't be attractive to potential ETF investors does seem to be assuming a bit too much. There seems to me, though, to be an even more essential point that is too easily overlooked in all of this. That point is simply this: as a currency Bitcoin's raison d'etre is to be a medium of exchange. It may provide an investment opportunity, but the outcome of such investments is ultimately irrelevant to its fate.
The point here isn't that there's anything wrong with wagering on (or against) any new product, including a new currency. Speculation and short selling are perfectly legitimate and valuable exercises within any dynamic and free market. The hazard arises when the mistake is made of treating Bitcoin as an investment opportunity in disregard of its unique specifics: unlike, say gold, Bitcoin is designed specifically and precisely to operate as an alternate currency.
Like any other product designed to serve a specific purpose, its features and benefits will only be revealed as tested in time. The recent volatility has been a function of financial, rather than monetary, considerations. I can only see two long term prospects.
In the future, Bitcoin may manage (and there are many hurdles to overcome) to catch on with the monetary consuming public, bringing it expansive global usage - whether sanctioned by nation-states or not. On the other hand, the digital currency could be judged by those consumers (of currency) to offer insufficient benefits over so-called sovereign currencies. In that case, I expect it will pretty much collapse into disuse, despite the best efforts of the enthusiasts.
Should this former outcome come to pass, holdings of the currency will be so widespread (in light of its freedom from the inflationary manipulation characteristic of fiat currencies) that the kind of financial hiccups which have caused the recent fluctuation will simply cease having appreciable consequences. Should that be the outcome of this social experiment, Bitcoin ETF will wind up in fact providing exactly the secure, indexed funds which are the usual fare of ETF investors.
On the other hand, should we see the collapse of the currency, the truth is that it is those who bought into the currency, not for the virtues of its monetary features, but to gather its hoped for financial windfalls, that will be most hurt in the process. The big losers would be the speculators. And speculation offers the prospect of big rewards, because it presents the danger of high risk.
To be clear, I'm not suggesting that anyone feverishly convinced of Bitcoin's long term future should be discouraged from taking advantage of their knowledge of the product or their conviction in its viability to profit through investment in it. If however ones investment is merely an expression of excitement at rocketing exchange rates: what goes up, must come down. You know the risk you're taking.
These Bitcoin ETF initiatives are intriguing prospects. They're well worth watching. Do not ever lose sight though of the basic reality that the future prospects of Bitcoin will be determined in its utility as a currency. And that story will unfold, not on the financial markets, but the monetary, which is to say, the consumer currency markets. As always, the customer will decide. Confusion about this could be costly.
About the Author:
To keep up on the rollercoaster ride of Bitcoin, check in regularly on our Bitcoin Profit Calculator . Wallace Eddington is staff writer at our website, providing a practical and unique approach to monetary and financial issues concerning Bitcoin. His recent post explaining the role of Bitcoin address and private key is a must read for those who want to take advantage of the exciting new crypto-currency.
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