Until recently, much of the bitcoin discussion revolved around its merits as a potential investment. With the closure of the large bitcoin exchange Mt. Gox earlier this year amid allegations of the theft of 6 percent of the world’s bitcoins, two important question arise — are unregulated areas like bitcoins worthy investments, and how safe are more traditional investments such as mutual funds?
To contextualize the alleged bitcoin theft, if 6 percent of U.S. bank and money market accounts disappeared, that would equal about $655 billion. That is equivalent to the vanishing of all deposits held at PNC, BNY Mellon and Capital One combined.
My opinion is that mutual funds are a much sounder investment than bitcoin, simply because the roughly $7 billion bitcoin market is unregulated and lacks the safety controls of the $13 trillion mutual fund industry.
A public log exists of all bitcoin transactions, which seems to have given some investors peace of mind that bitcoin was completely transparent and impervious to scandal. But financial history is rife with frauds involving seemingly innocuous investments, such as the original Ponzi scheme, where Charles Ponzi exaggerated the returns of buying international postal coupons for a profit.
Mutual funds benefit from multiple layers of protections for investors. Each fund is a separate legal entity, distinct from the fund companies that run them. Each mutual fund custodies its assets with an outside custodian bank (a feat currently impossible to do with bitcoin and a U.S. bank). The assets belong to the fund itself and the custodian guards the assets for the benefit of the fund. Add to these requirements for board of directors, annual audited statements and holding a fidelity bond to cover fraud or embezzlement by a fund employee and a relatively sound framework exists.
While I have plenty of doubts on the investment merits of bitcoin, I think investors first need to realize that without a proper, regulated investment vehicle for a bitcoin transaction, it is a moot point to discuss.
Thankfully, regulators are investigating how to treat bitcoin, but it may be years before sound protections for bitcoin owners are in place. While bitcoin naysayers may lose out on some sizable returns, the potential to lose all your money merely because you are holding an unregulated asset is reason enough to look elsewhere.
This recent episode with bitcoin is a fitting reminder that it is worthwhile to understand the underlying structure and terms of your investments well before you commit your hard-earned capital.
Jonathan Bernstein is a senior research analyst with Hefren-Tillotson, a Pittsburgh-based wealth management firm.