Many governments, economists, regulators, and financial experts globally are skeptical about cryptocurrencies as an asset class, some even labelling it as a “Ponzi scheme” because of its perception as being an imprudent investment. Although a crash in the value of major cryptocurrencies in June 2022 rattled the world, some industry experts feel that the market shakeout was necessary to remove “bad actors” from the industry. Some even called the event “healthy,” as they felt the market had become irrational and a correction was required. With institutional money flowing into cryptos, the market witnessed a steeper drop for risk assets, such as stocks, which affected digital coins more than it has in the past.
Cryptocurrencies have seen massive adoption and have become one of the hottest investment products for investors and asset managers alike. This increased uptake has been driven by its growth potential that it has demonstrated over the years, as seen in the following:
- The total market cap of cryptocurrency reached USD3 trillion in 2021. This increase was despite countries like China making all transactions of cryptocurrencies illegal and India’s crackdown on private cryptocurrencies.
- In 2021, 72% of institutional asset managers mentioned that they planned to develop solutions for asset tokenization.
- By October 2021, global assets under management (AUM) of digital asset investment products or crypto funds had reached an all-time high of USD74.7 billion.
Why is demand for cryptocurrency picking up in the retirement market?
The growing overall interest in cryptocurrency has stoked the desire of retirement plan participants and individual retirement account (IRA) owners to invest their tax-deferred retirement plan assets in cryptocurrencies and other digital assets. Younger cohorts, specifically, feel the need for more choices for diversification and consider these assets as desirable investment options. While the retirement market has high barriers for most innovative products, its investments make it a key target for asset management (AM) firms. The set-it-and-forget-it approach that many investors have for their retirement plan contributions provides a consistent source of demand for AMs providing plan line-ups. Also, going forward, since AM firms will be able to depend less on growth in assets derived from market appreciation, finding different avenues of revenue stream becomes imperative.
Lately, there have been some interesting developments in this space, such as the following:
- In May 2022, Fidelity made history by becoming the first firm to give an option to retirement plan participants to invest in Bitcoin within their employer-sponsored 401(k) plans. Fidelity is the largest retirement plan provider in the US, and about 23,000 companies use Fidelity to administer their retirement plans, with more than USD11 trillion in assets under administration (AUA).
- o As per the announcement, Fidelity will allow retirement investors to allocate up to 20% of their nest eggs to Bitcoin.
- However, individual fiduciaries can establish their own employee contribution limits and allocation maximums.
- In June 2022, retirement rob-advisory firm ForUsAll announced that it was pushing ahead with its plan to add cryptocurrencies to its 401(k) platform. Earlier (in 2021), it had also announced a partnership with Coinbase that would allow employees to put as much as 5% of their accounts into cryptocurrencies via a so-called brokerage window.
- Crypto.com hired LeBron James as the face of its advertising efforts, which will cost the firm more than USD1 billion
Following in Fidelity’s footsteps, more such financial institutions are aiming to get crypto added into employer-sponsored 401(k) plans where workers set aside pre-tax earnings for retirement.
However, are they a viable option for investors with limited resources, lesser risk appetite, or those who are nearing retirement? The answer is probably a No and the fear is real!
Some experts feel that adding cryptocurrencies and digital assets to a retirement portfolio diversifies it and allows the individual to enjoy Bitcoin’s inflation-hedging properties (a “digital gold” of sorts). As long as you keep it well-balanced with other assets, the yield can be desirable.
However, most people already have a hard time navigating the respective retirement savings system and are merely saving enough for old age. Therefore, adding an option that even professional investors struggle with, has a high chance of being counterproductive.
Even the younger generations, such as Millennials, may be interested but may be unfamiliar with more fundamental, but critical, strategies to build and protect their wealth in case of extreme price movements.
Apart from volatility and unpredictability, there are other challenges that act as barriers for retirement expansion. They include a limited historical track record, technical difficulties such as obtaining reliable pricing, limited practical use beyond speculation and crime, ensuring safe custody in a largely unregulated scenario, and finally a lack of real-world cash flows.
Total digital assets under management (AUM) plunged drastically since November 2021, because of a massive drop in prices of Bitcoin and Ethereum.
- As of June 23, 2022, global crypto asset managers collectively had about USD21.6 billion of AUM, which is about 75% lower than approximately USD87 billion held in November 2021.
- Cryptocurrency market cap crashed below USD1 trillion (i.e., to USD983.72 billion as on June 13, 2022, an 11.23% decrease y-o-y) for the first time since January 2021, amid extreme market conditions. It recovered to USD1,084.78 on July 21, 2022.
- The dominance of Bitcoin diminished as its value declined by almost 72% in this seven-month period (November 2021 to June 2022), touching a low of USD17,601.
- Ether dropped to USD880, its lowest value since January 2021, losing about 80% of its value from its record high in November 2021.
- The crash of Luna and TerraUSD sent shockwaves in the sector and set off panic amongst holders.
A recovery sometime in the second half of 2022 is being considered inevitable and unquestionable, given the returning positive sentiments and offshore premiums as investors are enthusiastic to long the market and invest for the future. However, this crash has led to higher levels of fear amongst market participants.
What are the regulators saying and why is there grave concern?
When Fidelity announced its big move, it immediately received a backlash from various regulatory and governing bodies in the US, which issued concerning statements and warnings. The Department of Labor’s (DOL) Employee Benefits Security Administration (EBSA), for instance, offered more explicit warnings related to crypto in retirement plans. The EBSA said that these are speculative and volatile investments that pose custodial, recordkeeping, and valuation concerns and create challenges for plan participants in making informed decisions. Compliance Assistance Release No. 2022-01 cautions 401(k) plan fiduciaries to “exercise extreme care” before investing plan assets in cryptocurrencies.
The backlash comes from the fact that the regulators have lesser clarity on the matter but must deal with it considering its potential to transform the traditional financial system, and its impact on financial stability and investor vulnerability. Policymakers are concerned about the risks posed by a sector where most activities are unregulated or lightly regulated. The fundamental challenge is that an internationally coherent policy approach is the need of the hour, which includes clarity on definitions, jurisdictional perimeters, curbs on market manipulation, and systemic risks in exchanges. Other risks that need to be mitigated include lending and payment risks; banking, payments, and anti-money laundering (AML) risks; tax policy and tax evasion risks; securities fraud and scam risks; and cybersecurity, hacking, and privacy risks. Clearly, as public awareness, acceptance, and adoption of cryptos grows, so does the need for regulatory regimes and controls.
So, what could be the future of cryptos in the retirement space?
Considering the very nature of this investment, its unproven track record, its extreme price movements, and other risks and regulatory uncertainty, people should be extremely cautious before including cryptocurrency investments in their retirement strategy.
And the risk is not just for plan participants, but also for plan sponsors. As per major legal firms in the US, plan sponsors that are planning to allow cryptos in their retirement plans could be exposing themselves to “a very serious risk of a fiduciary breach.” Such accounts are expected to have a much higher fee of up to 90 basis points, and undisclosed commission fees that could be 20 times as much as a simple index fund. Further, to accommodate such a volatile investment option, plan sponsors would have to offer an almost unlimited universe of investments.
Because of these factors and the recent crash, mass adoption amongst plan participants and plan sponsors is highly unlikely in the foreseeable future – it might not be a trend that, is here to stay. But, even after considering the risk, if participants are willing to allocate retirement funds toward cryptos, they should develop at least a basic understanding of the asset class, if not becoming pros on the esoteric investment. They must educate themselves on aspects like risks, ways to buy crypto for retirement accounts (tax-free, self-directed IRAs, solo 401(k) plans, etc.), how much to allocate, and which coins to choose.
How can Evalueserve help?
Evalueserve works closely with financial services companies that offer retirement services, including retirement plan advisors, recordkeepers, and third-party administrators. We offer market and competitive intelligence solutions to support our clients’ diverse strategic initiatives.
We provide Market Intelligence and Competitor Intelligence support to asset managers keen to invest in this asset class. We also provide this support to wealth managers providing retirement services and seeking information on aspects such as the evolution of crypto in the retirement/institutional space, the latest developments in crypto offerings by competitors, government and regulatory news, recent regulatory updates/changes, investor perspective, and the flow of funds into crypto options.
Proactively delivering differentiated insights in a timely manner for more informed and accurate decision making.