The continued decline in the market value of bitcoin has momentarily taken the wind out of the sails of crypto-mania. Any 401(k) plan fiduciary previously contemplating investing in or enabling plan investments in cryptocurrencies should use this opportunity to hit the pause button.
Fiduciary committees need to take a deep dive into the mechanics of cryptocurrency investments before they reach a prudence determination. Cryptocurrency is a virtual Rubik's Cube of financial complexity. Buyers beware.
Cryptocurrencies are a non-centralized digital means of exchange that rely upon blockchain technology — digital money. The market value of most cryptocurrencies fluctuates daily, and the volatility in market price can be substantial.
Not So Stable
In order to mitigate the challenges related to daily market volatility, and to facilitate efficient trading of a cryptocurrency, developers created a subcategory of cryptocurrency referred to as stablecoins. This form of cryptocurrency has its value pegged to another asset (dollars, gold, and sometimes other cryptocurrencies).
Often, an investment in a cryptocurrency first involves the purchase of a stablecoin, and then the onward purchase of the underlying cryptocurrency. For example, investments in bitcoin are often facilitated by the purchases of tether — a stablecoin. Therefore, plan fiduciaries must understand the risks associated and the relationship between these two related but distinctly different investments.
Setting aside the price volatility attributable to the surge in popularity of cryptocurrencies, the claim that a stablecoin such as tether is pegged to the dollar requires focused attention. In fact, notwithstanding the dollar peg, in the past few months the value of tether dropped below $1 to 95 cents before rebounding to $1. Terra, another stablecoin, imploded below 30 cents. In other words, investors who were expecting to receive $1 per coin received only 95 cents per coin, or worse, 30 cents.
Another Dollar-Pegged Investment
Pegging the value of an asset to the dollar is not a new concept. For decades, investors have transacted in money market funds at dollars per share. Unlike stablecoins, however, the dollar peg of money market funds does not rest simply upon the claim of a fund sponsor but is supported by a robust regulatory system.
At the heart of the investment/risk challenge for a dollar-pegged investment lies the discrepancy between the book value of the shares in the fund ($1 per share) and the fair market value of the underlying assets. Among the technocrats, this disparity in value is referred to as the deviation — i.e. the deviation between book and market value.
Detailed rules have been adopted related to the duration, credit quality and liquidity of money market funds so that the deviation remains in a manageable range, enabling investors to rely upon the book value of $1 per share.
