“Bitcoin is an international asset—it's not based on any one currency—so it can represent an asset that people can play as an alternative.” - Larry Fink, CEO of Blackrock.
In 14 years, bitcoin has gone from an unpriced ledger system to an “international asset” worth billions of dollars and worthy of an ETF from the world’s largest money manager. Over a decade of mind-blowing dollar-price surges and temporary “crashes,” confusing investors and creating believers all along the way. With each adoption wave, it gathers more capital and attention.
Yet, when it comes to financial advisors, there is mostly apathy, avoidance, or ignorance. Why? Because incentives drive outcomes. Here we’ll explore the primary reasons financial advisors might hesitate to embrace bitcoin as part of their client’s investment portfolios.
Fees: They don’t get paid
Most financial advisors are more than content with the fees they earn from recommending traditional assets.
Most financial advisors typically charge a percentage of assets under management (AUM) as their fee. If your account is $1,000,000 and they charge 1%, they make $10,000. If your portfolio goes up, their revenue goes up. It’s a win-win.
But as you can imagine, these AUM-fee advisors gravitate toward incorporating only those financial assets they can easily stick in that account—so they can charge a fee. Stocks, bonds, and mutual funds are in. Real estate, commodities, and privately held businesses are out. The incentives drive the outcomes.
But what about bitcoin? AUM fees become challenging since bitcoin is decentralized and can be held and managed by individuals directly. Bitcoin users don’t necessarily need custodians or intermediaries. As a result, there is no easy way to debit those AUM-based fees that put food on the advisor’s table. Most advisors are financially disincentivized to understand, recommend, or include bitcoin in a client’s portfolio. So, they just don’t. The incentives drive the outcomes.
Keys: Who holds my client’s assets?
Figuring out private key ownership can be treacherous, with many possible paths to follow.
Another reason financial advisors might shy away from bitcoin is the custody issue.
With traditional assets, a multitrillion-dollar custody business, and thousands of government regulations exist to help clients safeguard their investments. FDIC insurance, SIPC insurance, SEC oversight, FINRA, etc. Advisors can open a client brokerage account at a major firm within minutes and have it filled with stocks, bonds, and mutual funds - all safely stored, accounted for, and insured. If something were to go wrong (a theft, a glitch, a mistake), there’s always a phone number to call or an authority to appeal to.
Bitcoin custody works differently. There is no number to call if something goes wrong. Nobody can unwind the blockchain. It’s immutable.
Two of bitcoin’s most important unbreakable rules are: 1) Only 21 million bitcoin can exist and 2) Whoever controls the private keys controls the bitcoin. The code is the law, and the private keys control the cheese.
Here are the possible ways bitcoin owners can secure their private keys, each with its own considerations.
- They trust someone else to hold keys (a friend, custodian, exchange, GBTC, etc.). Custodians and exchanges are the most common bitcoin on-ramps, but they are fraught with peril; billions have been lost numerous times. Leaving bitcoin on an exchange is not advised if you can manage it.
- They do it themselves (through a hardware or software wallet). They trade “counterparty risk” for a “single-point-of-failure risk.” Clients who hold their own keys are vulnerable to transaction mistakes, theft, natural disasters, memory loss, death, and the like - a list that is all too real and good advisors know well.
- They are holding keys in partnership with others (whether privately or professionally). The partner must be trustworthy with private and sensitive information, knowledgeable about the technical aspects of the bitcoin network and private key management, and easily accessible and responsive to the client when needed.
It’s not easy for an advisor to know which is best. They question themselves:
“Exchanges like FTX have blown up and hurt many investors… how can I be sure that won’t happen to my clients? Should I recommend my client hold their own keys? Are they capable of doing that? Am I capable enough to advise them? What if the client makes a mistake and loses everything? Am I to blame? What if I hold keys for my client? Is that even legal? Even if it were, do I want that responsibility?”
Very quickly, this becomes a cumbersome and risky endeavor.
For many financial advisors, navigating these “complexities of custody” might be outside their comfort zone, leading them to avoid bitcoin and private keys altogether.
Ease: Understanding and explaining to clients is difficult
Bitcoin is complex, and financial advisors have to do a lot of work to get their heads around it
"If [Charlie Munger of Berkshire Hathaway] were a business leader in South America or Africa or Asia and he spent 100 hours studying the problem, he would be more bullish on bitcoin than I am." - Michael Saylor
Some of the best investors and advisors worldwide do not yet understand bitcoin. The learning curve is steep, and the rabbit hole is deep. Even seasoned bitcoiners continue to learn new things after thousands of hours of exposure. No wonder it confuses advisors and, subsequently, their clients.
Advising clients on proper bitcoin strategies and ownership structures requires nuance.
To serve a client competently, an advisor should be able to understand and communicate:
- how bitcoin works technically and economically
- how to store private keys (see above)
- an appropriate allocation for investment portfolios
- how its dollar price volatility is managed
- proper ownership structures and registrations
- how it is taxed according to its vehicle and jurisdiction
- how it is inherited, both lawfully and technically
- what risks exist, and how might they be mitigated
- how to incorporate all of the above into a financial plan
Explaining these intricacies to clients and ensuring they comprehend the risks and rewards takes time and effort. Many advisors decide it isn’t worth it.
Freeze: Growing institutional support clashes with regulation
Financial advisors have no reason not to sit around waiting for regulatory clarity
The freeze is upon us. The most prominent players in their respective spaces (Blackrock, the SEC, and Coinbase) are currently hashing out their turf regarding bitcoin. BlackRock has filed for a bitcoin ETF with the SEC. BlackRock has named Coinbase as its surveillance-sharing partner in that filing. The SEC has charged Coinbase for operating as an unregulated securities exchange. It’s a tricky triangle coming to a crux, and how things will play out is not obvious.
Will an ETF be approved? What government bodies will attempt to regulate what additional parts of the industry? How will it be taxed? Which jurisdictions will be favorable?
An advisor freezes. They sit and wait, not to be caught offside or embarrassed. Caution prevails when it comes to adopting new and unproven assets. Some brokerage firms in the U.S. prevent their financial advisors from recommending stocks “related to bitcoin,” like Microstrategy, GBTC, and mining companies. Sticking your neck out there for an asset with a minimal regulatory track record is too risky.
So, advisors can stand on the sidelines and wait for the dust to settle before having a bitcoin opinion. The risk isn’t worth the reward to them, and we’re stuck with a first-mover problem.
Well… BlackRock is moving now.
And when the king of the hill makes a move, you’d better take note.
The king of money managers (by assets managed, at least) wants a bitcoin ETF, and you can bet they’ll have their influence on the process. Blackrock is chipping away at a bitcoin path, meeting with regulators, and providing career-risk-cover-fire for other companies to do the same. There is implicit acceptance now - even though legal and regulatory clarity will take time to develop. It’s coming, but it’s not here yet.
Some of the largest institutions in the world are starting to take bitcoin seriously, so maybe it’s not so foolish for advisors to give it a second look.
While bitcoin has demonstrated remarkable growth and captured many’s attention, financial advisors, as a whole, have been slow to embrace it. The reluctance to recommend bitcoin may be attributed to various factors, including the challenges related to fees, self-custody, educational hurdles, and regulatory uncertainty. As the landscape evolves, financial advisors may reevaluate their stance on bitcoin and explore ways to incorporate it into their client recommendations.
Until then, investors who choose to take bitcoin seriously should consider conducting their research and seeking guidance from specialized advisors familiar with its unique intricacies. As always, Sound Advisory is happy to meet with you and answer any questions you may have.