The hot topic of the century

Cryptocurrency is a subject that attracts disdain, intrigue and hysteria. It is the fastest growing asset class in the world, and the most disruptive technology that the world has ever seen.

It is invisible, unregulated and volatile.

The word cryptocurrency is misleading because while some of the many thousands of available investments look and feel like a currency (such as Bitcoin) there are others that are a platform that support the development of digital applications (such as Ethereum). Collectively the Australian Taxation Office has decided that cryptocurrency is not a currency. It is an asset.

Many early investors have made a fortune investing in cryptocurrency opportunities, and this in turn has attracted a growing number of people who base their decisions on fear or greed.

On the 7th of September Bitcoin became recognised as legal tender in El Salvador, and the total market capitalisation of the cryptocurrency markets exceeded 2.5 trillion US dollars. New developments emerge every day, and more and more people are keen to gain a basic understanding of the opportunities and the risks.

Why do superannuation industry participants need to understand cryptocurrency?

Fund members, and in particular younger members, are likely to start asking questions about this form of investment. To answer those questions, it pays to be forewarned. Readers should attempt to get a working knowledge of the underlying technology, the taxation implications and the estate planning issues that arise when the investment is a digital asset and not tangible.

Trustees of superannuation funds face some special challenges that relate to whether this form of investment is an allowable investment having regard to the investment policy statements of the funds. There are also ESG related issues that need careful consideration. Recent history shows that fund managers are starting to take an interest in cryptocurrency investments, and some US banks are making it easier for customers to invest in cryptocurrency.

Under the provisions of the Superannuation Industry (Supervision) Act 1993, superannuation funds need to comply with the ‘sole purpose test’ that stipulates that investments must be made in the best interests of members and should focus on the provision of an income in retirement. Debate still rages as to whether a cryptocurrency investment meets the provision of the sole purpose test.

Issues for individual investors

Many individual cryptocurrency investors are not sophisticated and may not have access to coherent advice. Financial planners are reluctant to provide advice because their approved product lists do not include cryptocurrency investments and, more importantly, their Professional Indemnity insurance arrangements do not cover this form of investment.

There are a number of estate planning issues that do not get adequately discussed in the context of cryptocurrency investments. Investors have the option of storing their investments with a digital exchange (akin to a stock-brokers portfolio service) or they can take the bold step of using a digital wallet. A digital wallet looks like a USB stick and users are, in effect, adopting a policy of self-custody. These investors are at risk of locking themselves out of their wallet because they may forget the passwords, or having their wallet stolen or lost. They may also be subject to a phishing attack or they may inadvertently share information with a hacker.

Cryptocurrency investments are invisible and there is no central register of investors, no central bank and no-one keeps a public register of who owns what. In this context it is impossible to trace an individual’s investments unless someone is told about what the investments are, and how to access them. This leads to the subject of granting someone a Financial Power of Attorney.

A Power of Attorney is a legal document that speaks while the investor is alive. Typically, a Power of Attorney is used when a person becomes incapacitated due to illness or accident. They may also be used when the investor is overseas and cannot be contacted. A well-drawn Power of Attorney should provide instructions on where to locate the investments (digital exchange or digital wallet) and specific details on how to access the investments.

Similar issues arise when a person dies. A cryptocurrency investor’s Will should also provide the executor(s) with details of where to find the investments and how to access the investments. There are a couple of other issues that come up when drawing up a Will. Cryptocurrency investments cannot be transferred in-specie to a beneficiary because there is no central register of investments. Investors should also understand that cryptocurrency investments cannot be insured. Almost every other form of ‘tangible’ investment can be insured.

In summary, there are a lot of ways of losing your money unless it is done correctly.

Alternative way of gaining exposure to cryptocurrency

There are a number of well-known companies that are listed on stock exchanges around the world that provide an indirect exposure to cryptocurrency investing. Some of the better known companies include International Business Machines (IBM), Visa and Oracle Corporation. There are several Exchange Traded Funds (ETFs) that provide exposure indirectly to cryptocurrency.

Readers who have started to think about this form of audacious investment, need to do a lot of research before putting a toe in the water.