Making crypto less cryptic

Author: Richard Webb, Policy advisor - Financial planning and superannuation, CPA Australia

When a top performing KiwiSaver fund was reported earlier this year to have allocated as much as five per cent of its assets to cryptocurrency, the investment world took notice. Cryptocurrency is one of the newest asset classes around. Like it or loathe it, the reality is it’s here to stay for the foreseeable future. The good news is that increased attention has attracted additional scrutiny, and this may deliver greater transparency and efficiency.

A small number of Australian SMSF trustees have already taken notice of these assets and waded into the market with some interest. And, despite its considerable volatility, some of the early investors of cryptocurrency have been rewarded with substantial returns. Of course, others have been badly burned, swearing never to touch this asset class again.

This stark polarity of opinions should not come as a surprise. Unlike assets such as shares, property or interest-bearing investments, cryptocurrencies don’t necessarily produce traditional income flows from the assets themselves. Even though cryptocurrency was developed as an alternative to cash, some cryptocurrencies’ slow transaction processing throughput and high-power consumption makes them unlikely to be useful for transaction purposes.

Thanks to public comments from notable enthusiasts such as Elon Musk, there are now more financial journalists writing about cryptocurrency. As a result of this media attention, we know more about the pitfalls and traps for investors looking to add this asset class to their portfolios. This is good for SMSF trustees, who haven’t benefited from the same level of transparency about cryptocurrencies which other asset classes provide.

However, trustees may still encounter problems in accessing information about these investments. Anecdotally, we know that auditors sometimes struggle when looking for a paper trail confirming when a cryptocurrency position was entered into or exited out of. The ability for investors to transact in and out of different cryptocurrencies at exchanges no doubt adds to this difficulty.

Stablecoins are often used at exchanges in preference to cash, to ensure speed and certainty in relation to transactions. Stablecoins and exchanges are not necessarily subject to the same level of transparency and regulation which accompanies cash or more traditional exchanges.

The level of price discovery between the same assets traded on different exchanges is still a long way off what might be regarded as efficient. Traditional exchanges have well understood processes for settlements and liquidity. Cryptocurrency exchanges often make it easier to swap cryptocurrencies, rather than cashing out, which may present liquidity risks.

Additionally, traditional fund administrators and their custodians don’t all have the systems in place to look after what is still a niche asset class. This means that trustees may find transacting through their administrators slower and more complicated than for other assets.

The transaction fees for cryptocurrency trades can be quite high, with charges of up to US$30 per transaction not unheard of, yet this can also vary with volume. While this may be a ceiling price, for members of SMSFs in the accumulation phase, who may have small amounts trickling into their funds, it’s sure to leave a sour taste. They’re likely to find this cost of entering the market unfavourable compared to other assets such as brokerage or buy/sell spreads.

The Australian Securities and Investments Commission has been consulting on providing access to this asset class in a more traditional way. Products being consulted on include exchange traded funds, managed funds and structured products. These products would be able to provide exposure to asset classes in a way that would allow investors to benefit from the economies of scale provided by pooling.

Active and passive products may allow trustees to better match their investment strategy with the assets themselves. Funds which hold assets long term could also benefit by providing fund managers and their beneficiaries with regular income from “staking”, which is a way of earning a percentage-rate reward for holding certain cryptocurrencies for longer terms. Increased scale could benefit funds by removing congestion from transaction processing and taking advantage of pricing inefficiencies in a cost-effective way.

Finally, the ability to enter and exit managed products on a traditional exchange could provide high levels of liquidity for cryptocurrency investors.

Leaving aside the ever-present investment risk of the underlying assets, features of managed products could present SMSF trustees with options which have until now been denied to cryptocurrency investors. And that’s always welcome.