The Bitcoin revolution and SMSF’s

How do I buy Bitcoin?

Can I buy Bitcoin using my Self Managed Superannuation Fund?

This seems to be two common questions asked by clients to the advisers at Wealth Plus on nearly a daily basis. Firstly, we would like to outline we don’t provide personal advice in relation to acquiring Bitcoin or in fact any cryptocurrency as it is not a regulated financial product. However given the hype of cryptocurrency plus the importance of ensuring compliance with superannuation law we thought it essential to provide an overview of this near cult-like global phenomenon.

Bitcoin was the first cryptocurrency created in 2009 as an electronic payment system not controlled by any government. Its underlying technology is called blockchain. It is independent of any central authority and no single institution or country controls the Bitcoin network.

As the name suggests, every transaction that has ever involved a Bitcoin can be publicly seen on the underlying blockchain ledger. It’s called a blockchain because transactions are processed in “blocks” which are “chained” together one after another to create a complete and unbroken transaction history.

People have made … and lost fortunes investing in cryptocurrency.

If you spent US$100 on Bitcoin on the pt Jan 2011 you would have received 333.33 bitcoins. Today the price stands at approximately US$11,000 making your investment worth just under US$3,700,000.

But the ride has not been all smooth sailing. Bitcoin is massively volatile.

In 2013, the online exchange Mt Gox briefly halted deposits: Bitcoin prices fell more than 20%. In 2014 the FBI raided a dark web marketplace called Silk Road – it allowed users to buy drugs and other illegal items with Bitcoins. After the raid, Bitcoin’s price collapsed.

Despite the risks, Bitcoin and other cryptocurrencies continue to grow and it appears it is here to stay but no one can predict its future price.

Currencies are only as good as the places that accept them . If stores all of a sudden decide that they don’t want to accept Bitcoin, then the value will fall. What is of interest is the plans to increase the number of ATMs that accept Bitcoins in Australia.

Bottom line: don’t put money into Bitcoin or any cryptocurrency that you aren’t prepared to lose.

Warren Buffett arguably the most successful investor in the world told CNBC: “I can say almost with certainty that cryptocurrencies will come to a bad end.” His long-term business partner Charlie Munger famously described the soaring values ofthe currencies as “total insanity”.

Giselle Roux, Chief Investment Officer of Escala Partners called Bitcoin mania: “Just a joke, it’s silly,” she said. “It’s symptomatic that there’s a bit of fear of missing out – money running around – and it’s not particularly well-informed money.”

How do I get Bitcoin?

 There are three ways to get Bitcoin – by mining them, providing goods and services to earn them through payment or by buying them.

Mining refers to the process by which bitcoins are created – miners use special software and high powered computers to solve complex mathematical problems and in return they are awarded a certain number of bitcoins.

The second way is possible because Bitcoin is becoming an increasingly accepted virtual currency used by businesses and individuals around the world, including in Australia.

The third way that is by far the most popular, is to set up a wallet and open an account via a Bitcoin exchange that puts sellers in touch with buyers.

A wallet stores and manages your “public key” and “private key”. The public key is for receiving money and the private key for  spending money. It’s crucial that the private keys remains confidential. Anyone having access to a private key has complete control over the stored bitcoin. Anyone having access to a wallet also has access to all the private keys in it. Establishing a wallet in Australia is like opening a bank account and users are subject to conventional banking requirements to verify identity and the source of funds.

Wallets

There are basically 5 types of crypto wallets.

This could be an online wallet (either part of an exchange platform, or via an independent  provider), a desktop wallet, a mobile wallet or an offline one (such as a hardware device or a paper wallet).

Online- Online wallets (most often owned by exchanges but sometimes owned by third-party organisations) run on the cloud and are the easiest to set up and use. Some only require an email address and a password, although the more secure ones, require other verification like scans of your passport or ID.

The biggest advantages to online wallets are that they cannot be lost and that they’re accessible from any computer with an internet connection. Businesses keeping online wallets for users also often have servers that are far more secure than the average user’s computer.

However, being online is unfortunately also their biggest disadvantage. Because some businesses maintain the wallets of thousands of users, they are the biggest targets for hackers. After all, why would a hacker attack your wallet when it can attack thousands at once?

Additionally, some online wallets will take a percentage (or flat) fee for every transaction you carry out, which could quickly eat into your balance unless you’re careful.

  •  Desktop - The most common types of wallet out there, desktop wallets, are downloaded and installed on your computer.Desktop wallets provide a very high level of security since they’re accessible only from the machine on which they’re installed. The biggest disadvantage is that they also rely on you to keep your computer secure and free of malware. So antivirus and ant i-malware software, a strong firewall and a common sense approach to security are required to keep your coins safe and sound. A back up is always highly recommended in case your computer dies.
  • Smartphone - The same as above, but it’s an app for your phone instead.Smartphone wallets are often simpler and easier to use compared to their desktop counterparts, and include the ability to scan other wallet addresses for faster transactions .You will need to be extra careful about losing your smartphone, because anyone who has access to your device might also have access to your funds.
  • Paper - Paper wallets take the concept of entirely offline keys used for hardware wallets to the next logical step: simply print out your public and private keys and use that printout as your wallet .
  • Hardware (cold storage) - An option for holding your currency securely offline in a more physical form. Given they keeps the private keys away from your computer and off the Internet they offer superior security than storage on a computer that can be easily hacked and affected by a virus.  Hardware wallets promise enhanced security against software wallets in the case of theft or scams. Moreover, your coins are safe even if your computer is hacked or someone stole your hardware wallet. If you lose your hardware wallet, you can always restore all your coins on a new wallet.Without knowing your secret pin code, no one can transfer Bitcoins or other coins from your hardware wallet. Your keys are stored in an offline environment on the hardware device.Two popular Bitcoin hardware wallets in Australia are Ledger Nano Sand Trezor. For a long term investor such as a SMSF and if you are serious about safety and convenient storage, getting a hardware wallet is the smart choice.
Buying Bitcoin 
Cryptocurrency exchanges will buy and sell bitcoin on your behalf. There are hundreds currently operating, with varying degrees of liquidity and security. As with wallets, it is advisable to do your own research before you open an account as the costs can vary considerably. One such Australian based company is Independent Reserve and they have an offering especially catered for SMSF ‘ s.It is critical that if you are investing through your SMSF then you need to sign up with your SMSF company details and using your SMSF bank account not personal details.

 

Can an SMSF invest in Bitcoin?

 The quick answer is “YES, assuming it is appropriate to the members” an SMSF can invest in Bitcoins but with some if, buts and is it worth the risk?The issue here is the risky nature of bitcoins as an investment. Investing in Bitcoins, may not be a prudent SMSF investment, especially for those approaching retirement age, where stable income­ generating assets and minimal risk of significant capital loss are important.But there may be a role for Bitcoin as part of an otherwise appropriate st rat egy. For example the trustee may be able to argue that having 2% of the total fund’ s assets invested in Bitcoin does not constitute a material risk for the fund and yet adds the potential to increase the fund’s overall investment performance.Whatever the decision, Bitcoins as an investment must be approved in the SMSF’s investment strategy.

 

The investment strategy

 A SMSF investment strategy must consider the following:

  • Risk and return: the risks involved in, and likely return from the SMSF’s investments, having regard to its objectives and expected cash flow requirements;
  • Diversity: the composition ofthe SMSF’s investments as a whole, including the extent to which they are diverse or expose the SMSF to risks from inadequate diversification;
  • Liquidity: the liquidity of the SMSF’s investments, having regard to its expected cash flow requirements;
  • Liabilities: the ability of the SMSF to discharge its existing and prospective liabilities;
  • Insurance: whether to hold insurance cover for each member of your SMSF.

Before investing in Bitcoin using a SMSF, you need to make certain this is allowed by the governing rules of the SMSF. The investment strategy of the SMSF then must permit the investment. Bitcoin is not cash, it doesn’t have a physical form, therefore is not classified as a collectable, an d·it is technically a right. If the SMSF is to invest in cryptocurrency then it would be a separate asset class.

The trust deed

 The fund’s trust deed would also have to allow cryptocurrency. This asset class tends to form only a small part of most fund’s asset allocation and its likely prudent investors would only have a very small exposure to digital currencies.It may be necessary to amend the SMSF’s trust deed in order to allow an investment in Bitcoin.

The “Sole Purpose Test”? 

The sole purpose test ensures that an SMSF is maintained for the sole purpose of providing retirement benefits to members, or to their dependants if a member dies before retirement.This means that the SMSF cannot directly or indirectly provide financial assistance or benefits to its members prior to their retirement, including use of or access to the assets of the SMSF.An SMSF may be able to satisfy this requirement, if it could be shown that the SMSF’s Bitcoins are held securely in a public IP address, and that the trustee of the SMSF, and not the members are controlling any movement of the Bitcoins held in the public IP address.Any movement or transfers between the SMSF’s public IP addresses and a member’s public IP addresses, even temporarily, could cause significant issues under the sole purpose test.Care would need to be taken to ensure that the trustee of the SMSF, rather than the individual member, is in control of the SMSF’s Bitcoins at any given time.Under no circumstances should it be purchased in the name of an individual SMSF member. It is a legal requirement for the trustees of self-managed super funds to separate the fund’s assets from its individual members’ personal assets. This will ensure that the Bitcoin investment satisfies the sole purpose test of SMSFs (i.e. to provide for their members’ retirement needs). Failure to  satisfy this sole purpose test can lead to severe penalties, including fines and the loss of your self-managed super fund’s tax concessions.As you would use a single separate bank account for cash transactions, a single digital wallet make cryptocurrency transactions easier and more transparent. The proceeds of the sale of any Bitcoins should be transferred to your self-managed super fund’s bank account and that you declare any profit or loss you have made as part of your fund’s annual reporting.

Separation of assets

Following on from the sole purpose test is the requirement that SMSF trustees have always been required to keep money and other assets of the fund separate from any money or assets which are held by the trustee personally.The ATO’s view is that assets should be recorded in a way that distinguishes them from a trustee’s personal or business assets, and clearly shows legal ownership by the fund. To show clear ownership by the fund, the ATO considers that fund assets should be held in the name of the trustee(s), noting its capacity, and gives the following example:

  • in the case of a corporate trustee, ‘ABC Pty Ltd as trustee for the ABC Super Fund’

It is critical that an individual’s wallet is separate from a wallet dedicated to the SMSF. Otherwise it is an immediate breach of the separation of assets.If you sell the bitcoins owned by your SMSF all funds must go back into your SMSF’s bank account. Just like all superannuation investments you cannot spend your SMSF owned cryptocurrencies for any personal use until you satisfy a condition of release.

Summary

With the ASX recently announcing the adoption of a blockchain or distributed ledger technology to replace CHESS, it’s safe to say that decentralised applications are here to stay.

Bitcoin however is a completely different sto ry. Is it simply a 21st century version of gold, only without the storage issues? Or is it just a short-lived popular fad that may soon evolve into something quite different? Only time will tell. The only certainty is that its price will continue to be extremely volatile.

Remember your superannuation is your retirement savings that you have worked years to build so ensure you make smart, informed decisions and seek the right advice. If you are investing in cryptocurrency because you want to jump on the bandwagon, your friends have made a killing or trying to make quick money then you are investing for all the wrong reasons.

As the greatest investor of all time, Warren Buffet stated, “Risk comes from not knowing what you’re doing” so if you don’t really understand what you investing in – don’t do it!

Seeking the right advice empowers you to define goals, map out a plan to achieve them plus provide comfort and peace of mind. The true value of advice goes beyond financial gains but encompasses improved physical health, freedom to pursue your dreams, personal happiness and security.

FAQ.

Can my SMSF purchase Bitcoin from myself

  •  NO. Bitcoin cannot be used as an in specie contribution and the SMSF can’t purchase bitcoin from its members as it is neither a listed security nor a commercial property. It must be purchased with cash in the fund from an unrelated party.

What are the tax consequences of buying Bitcoin through my SMSF

  •  The ATO has confirmed that Bitcoin is a “CGT asset” thus if the  SMSF sells bitcoin, then you may be subject to Capital gains tax. The likely  tax outcome  is that this is taxable  as a capital gain (or loss). Bitcoin held for more than 12 months by the SMSF should qualify for the CGT discount, which is 33½% for a SMSF. The ordinary concessional tax rate for a SMSF is 15%, which means the ordinary capital gain concessional tax rate (ignoring  capital  losses)  is 10% (e.g. a capital gain of $50,000 results in $5,000 tax payable). However, if a capital gain on the disposal of bitcoin is made whilst  the  SMSF is in  retirement  phase, then the tax rate could  be as low as 0%.

Knowledge is power so please do not hesitate to call one of the experienced advisers at Wealth Plus Solutions for any further information