The dramatic rise in value (and then fall) of bitcoin and other cryptocurrencies has sparked interest among SMSF trustees on its potential as an investment, particularly in a marketplace of low-interest rates, erratic sharemarkets and an easing in property.
But its relatively short history makes it hard to predict, and there is uncertainty what (if any) future regulation will be placed on it. There are also uncertainties on how to manage cryptocurrencies within the tightly regulated SMSF space.
The ATO has made it clear that, at the moment, it cannot stop an SMSF investing in a cryptocurrency like bitcoin. There is no specific prohibition in the relevant legislation, and it is permissible as long as it meets the other rules for investment. But this does not mean there are no pitfalls for SMSF trustees.
The first thing a trustee or administrator must do is to check the trust deed. As it is a relatively new investment vehicle few, if any, trust deeds will deal with it directly, and may need amending.
It will also be necessary to review the investment strategy. Bitcoin is volatile, and in its short history there have been many booms and just as many busts. Therefore bitcoin only suits those investment strategies that are prepared to take risks. As it pays no income and is subject to wide variation, it is also unlikely to be suitable for fund members in or near retirement phase.
Another thing to realise with cryptocurrencies is that they have no physical assets backing them up — if they fail, you lose everything. They are only as valuable as someone is willing to pay for them, which also makes them particularly hard to value.
Given the electronic nature of cryptocurrencies, there is a need to ensure that there is a clear separation between the fund's assets and those of trustees. Thus, if you have both personal and SMSF investments in bitcoin, they need to be clearly separated. The ATO has highlighted this as an issue of concern, and something they will look out for when reviewing SMSFs with cryptocurrency investments.
One advantage though of cryptocurrencies is that all transactions are recorded. Therefore they can be checked by auditors (and regulators), however it is advisable to also keep a written note of all transactions including buying and selling prices and dates.
A new issue of concern for SMSFs that invest in bitcoin is that given the wide fluctuations in value, a fund may unwittingly breach the transfer balance cap of $1.6 million and have to wear the headaches and restrictions that breaching the cap brings, in particular if other contributions have been made to the fund.
Both the ATO and ASIC have issued a warning to SMSFs investing in cryptocurrencies. They are a highly speculative investment and not recommended for those who are not willing to make riskier investments. There is little long-term history of their performance, so it is difficult to understand how they will perform over time.
Having said that, there is nothing currently preventing an SMSF from investing in cryptocurrencies like bitcoin. Just make sure you do your homework and are prepared for the risk they present. Also, be aware that while at the moment they are lightly regulated (if at all) this is unlikely to be the case long term.