Thursday, June 21, 2018

Should plan sponsors consider Bitcoin 

for retirement plans?

Bitcoin is a digital currency and worldwide payment system. It is the first decentralized digital currency, as the system works independently of a central bank or single administrator. Encryption techniques are used to regulate the generation of units of the currency and verify the transfer of funds.

By Charles Hodge, Guest Columnist

One of the requirements of retirement plan fiduciaries is to remain diligent, looking for ways to earn a return and protect capital in a prudent manner. Pension plans are looking for ways to add return while controlling risk, frequently through asset classes that offer diversification and attractive risk-adjusted returns. When plan sponsors look to commit capital to an asset class, they demand accurate information, transparency, and trust. No matter how attractive the historical return, plan sponsors and trustees must behave as prudent fiduciaries.

Bitcoin, as a cryptocurrency, is not backed by any government, commercial institution, or measurable asset or commodity. It is a digital promise backed by encryption and passwords. How does bitcoin fit in with the goals of plan sponsors?

Let’s examine a few issues:

·    Capital preservation: Fiduciaries need to know the expected upside of their investments and the risk of capital loss. Because cryptocurrency cannot be held and only exists as lines of computer code, the chance of it vanishing completely would be a concern to a plan sponsor who must have assets held independently in the custody of a trust company. Their value is based on limited supply and demand-driven price. One or two sizable thefts or the failure of a key bitcoin broker and demand could plummet, significantly diminishing the value of the plan sponsor’s holdings.

·    Expected return: Investors buy assets to generate returns, with dividends and interest or an increase in price. Frequently they will examine historical returns and risk premia. Return-since-inception for bitcoin is certainly attractive. It’s currently unclear how bitcoin’s future return would be modeled. Bitcoin doesn’t pay interest (though some cryptocurrencies do pay implied dividends), so the only source of earnings is a price increase. The expectation would have to be for increasing demand for a stable supply, a broader adoption as a medium of exchange. With new cryptocurrencies coming online, it’s hard to know how to measure this future supply/demand equilibrium and how that would affect price.

·    Asset classes: While bitcoin’s long-term returns look attractive, it also would seem to provide diversification. Plan sponsors are usually looking for asset classes that help their risk-adjusted returns: a higher Sharpe Ratio. Cryptocurrency cannot be held in custody like gold and it does not have any other use (industrial, jewelry, etc.). Gold, while not as portable as bitcoins, has a worldwide market. And while cryptocurrencies can be bought and sold quickly, converting them to other asset-classes is not as easy as many other plan sponsor holdings. In times of global distress or market corrections, it will likely be even more difficult.

·    Valuation: Owners of assets want to know what their holdings are worth. It’s unclear what the “value” of a bitcoin is because it’s not anchored to a purpose like dollars, euros, platinum, silver, etc. Former Federal Reserve Chair Janet Yellen called the cryptocurrency a “highly speculative asset,” saying it is not a stable source of value.

·    Intrinsic value: One of the biggest challenges of bitcoin is its intangible nature. How does an investor compare the value of bitcoin against monero, Zcash, Ripple, or other digital currencies when there are no earnings, assets, or other typical valuation metrics?

·    Custody: Many asset classes, including stocks and bonds, could be subject to theft or fraud so the role of the custodian is important to establish ownership. How do you establish custody for an asset that is only digital code and a password? Because the trades are anonymous and untraceable, how secure is a simple password? With a “hard wallet” and a couple of keystrokes, an untraceable trade could wipe out a plan’s account with no way to track down the offender.

·    Security: Plan sponsors remain concerned about security and access. Identity theft is on the rise, with hackers attacking 401(k) plan balances and pension benefit payments. Cryptocurrencies remain a significant target for hackers and thieves.

·    Governance: Because bitcoin exists outside the oversight of banks and regulators, it’s hard to know how disagreements can be resolved. As an owner of a cryptocurrency, do you have trust in the governance of the rules of ownership and trading?

At this time, bitcoin and other cryptocurrencies are not appropriate for retirement plan sponsors. Broader institutional market adoption such as futures, shorting, and opportunities to arbitrage might bring pricing efficiency and predictability that could make it an attractive asset class, but these market forces are in the early stages of development.  

To note, cryptocurrencies such as bitcoin rely on blockchain technology; these are distinct concepts and should be viewed separately when considering retirement investment opportunities. Institutional investors will likely own businesses that take advantage of blockchain technology, but it’s this author’s opinion that bitcoin isn’t ready for plan sponsor prime time. To read the full article, go to

The views expressed do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Milliman or TEXPERS.

Charles Hodge
About the Author
Charles Hodge is an investment services consultant in the Dallas office of Milliman. He has worked with investments for more than 20 years and has been an institutional investment consultant since 1991. Charles joined Milliman in 2000.

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