Cryptocurrency Investments within SMSFs: Opportunities and Risks
Cryptocurrencies have sparked global attention over the past few years, transforming from a niche interest into a serious contender in the world of investment. For trustees and members of Self-Managed Super Funds (SMSFs), the potential for high returns offered by digital currencies like Bitcoin, Ethereum, and many others has attracted a lot of interest from SMSF investors in the last seven years. However, these investments also bring a unique set of challenges and risks. We will delve into the opportunities and potential pitfalls of cryptocurrency investments within an SMSF.
Cryptocurrencies are digital or virtual currencies that use cryptography for security. They operate independently of a central bank and are typically based on blockchain technology—a distributed ledger enforced by a network of computers, or “nodes.” Bitcoin, the first and most well-known cryptocurrency, has seen significant price volatility, leading to substantial gains (and losses) for investors.
Cryptocurrency Opportunities within an SMSF
One of the major attractions of cryptocurrencies is the potential for significant returns. The price of Bitcoin, for instance, has seen substantial growth since its inception, despite periods of high volatility.
Moreover, cryptocurrencies offer diversification benefits. They have low correlation with traditional asset classes, such as stocks and bonds, which means they can offer portfolio diversification.
Further, the blockchain technology that underpins cryptocurrencies also offers transparency and security benefits. Every transaction is recorded in a public ledger, providing accountability.
Risks of Cryptocurrency Investments
Despite the potential rewards, cryptocurrencies carry considerable risks. The most obvious of these is their volatility. Cryptocurrencies can experience sharp price fluctuations within short periods, which could lead to substantial losses.
Another concern is the regulatory environment. As a relatively new and evolving space, cryptocurrencies are subject to changing regulations. For SMSFs, it is crucial to ensure that any investments in cryptocurrency comply with superannuation laws. For instance, all investments must align with the fund’s investment strategy and meet the sole purpose test – providing retirement benefits to members.
Further, cryptocurrency failures of stablecoins and staking and lending applications providers, demonstrates the unknown risks and hazards of crypto investment which are not suitable for all super funds or indeed all of its members, with respect to individual risk tolerances. An important distinction needs to be made between Decentralised crypto coins and centralised coins. The latter is principally responsible for much of the market mayhem we witnessed in 2022. Centralised crypto coins like Terra Luna and a variety of other coins that are operated with a highly commercial intent by corporate providers, who operate a centralised ledger, unlike Bitcoin which is fully decentralised and not exposed to hacking or counterparty risks . While blockchain technology provides security, low costs and speedy transfer that are not subject to legacy payment gateways, it is not entirely immune from hacks which were perpetrated against centralised coins in 2022. Also, if access details (private keys) are lost, it could lead to permanent loss of the cryptocurrency assets.
Considerations for SMSF Trustees
If you’re considering adding cryptocurrencies to your SMSF portfolio, it’s essential to conduct thorough due diligence. Consider the following points:
Understand the Investment: Make sure you fully understand the coins you intend on investing in. At My SMSF, most of our clients are IT and financial professionals who are very versed with crypto investing and the risks and return characteristics of these investments. With over seven years of experience in the crypto SMSF space, we have noticed that over seventy percent of our clients only invest in the top three crypto coins.
Update the Investment Strategy and Deed: The fund’s investment strategy should detail the approach to cryptocurrency investments and how they fit within the overall investment strategy and risk profile of the fund. Check that your super fund deed allows investment in crypto assets, as many deeds still do not.Annual Reporting: if you hold crypto assets in an self managed super fund ( SMSF) you will need to provide your accountant or provider with the following documents:
- Transaction report – for all trades in the financial year
- Buy/Sell/Swap/Shape – receipts or contract notes
- Value your Crypto Assets – you can do this by getting the values of coins from any online reporting service like www.coinmarketcap.com and obtain the value of the coin/s on the 30th of June of each year.
Security Measures: Have robust security measures in place to protect the fund’s assets. This includes secure storage of cryptocurrency in cold wallets and separate private key management strategies or failing this, using a reputable, well established local coin exchanges exchange wallet which makes reporting and management easier.
Valuation Concerns: The volatile nature of cryptocurrencies means their value can change quickly and dramatically.
Cryptocurrencies present a fascinating opportunity for SMSFs, offering potential for high returns and portfolio diversification and potentially tax free capital gains in the pension phase for many Australians. However, they also come with significant risks such as volatility and provider risks that most Australians might not be aware of. Super fund members, must carefully consider these risks, ensure regulatory compliance, and appropriately manage and monitor the fund’s cryptocurrency investments. As always, it is wise to seek professional tax, crypto and legal advice when embarking on crypto investing in an SMSF.